Limited Upside Makes PDS a Sell

I sold my shares in Precision Drilling (PDS) on Thursday, largely because of the changing dynamic for this company and its fellow income trusts following the Canadian government's decision to change the taxation status for trust distributions.

It wasn't long ago that I bought these shares -- a very poorly timed buy in mid-October, just a little while before the tax change was surprisingly announced -- and I hate to give up on the shares at this early stage.

But after spending some more time going over the company and my portfolio, and reconsidering how the tax changes would impact me in the future, my assessment has changed; PDS may well still be a profitable company, but the reduced dividend potential is enough to make me want to sell.

I counseled patience (at least for myself) after the tax change was announced, and I'm glad I didn't sell immediately -- the shares have recovered somewhat from their initial shellacking. But now that I've taken my time to look it over, it doesn't make sense to wait for the ax to fall in a few years. I'll take my 15% loss now and move on.

PDS came with a fair amount of risk -- it's primarily an oil and gas driller after all, so faces commodity price risks that are not dissimilar to those of my largest holding, SeaDrill (SDRLF.PK)(even though the two companies are very different). Additional risk came from their concentration in a particular geographic area (even though that area, Western Canada, is one of the prime hydrocarbon-producing regions in the world), and in their exposure to natural gas.

That risk was nicely accounted for by the fact that the company was quite cheap, and by the fact that their trust structure provided a very strong dividend to prop up the price during any shorter term business slowdown that might occur.

But now, with the potential for that dividend to shrink over the next four years by roughly 30%, with all else being equal we might expect the share price to eventually fall by a similar amount (trusts are income-oriented investments, and I'd expect them to trade more on their dividend than anything else).

So far it has fallen by about 15%. I don't know how long it will take the market to discount the remainder, or if it will happen at all -- it might be that the cheapness of the company is enough to keep folks holding on, believing that oil services revenues are likely to grow enough to make this a worthwhile hold. It is, after all, even cheaper now, and nothing has changed in their operations or outlook.

For me, though, this was an add-on to my core energy holdings, and the one that I am least operationally comfortable with. As long as I have solid well-managed exposure to natural gas through my holdings in Chesapeake (CHK) preferred shares, and heavy exposure to oil drilling in general through my investment in SeaDrill , which I think has a much higher return potential, my holdings in Precision Drilling became expendable as soon as the future dividend became questionable.

Full disclosure: My PDS shares were sold on Thursday at $24.97 (purchase price had been $28.90). I continue to hold shares in SeaDrill and Chesapeake Preferred (D series).

PDS 1-yr chart: