Penn West, Pengrowth, Enerplus: High Distribution Yields Arouse Interest

Buy-recommended Penn West Energy Trust (PWE) is our top choice among mid cap producers, distributing cash at the annual rate of about 10% or more, despite an adjustment in estimated net present value [NPV] to $36 a unit from $39 a unit.

The change reflects in part a shorter adjusted reserve life as a result of a decline in reserves before adjustment for acquisitions.

Estimated NPV of $36 includes about $7 a unit for the potential value in Peace River oil sands, Pembina CO2 enhanced recovery and drilling by others on Penn West lands. Reported on February 28, fourth quarter 2006 results of operations confirmed steady production volume that generated expected cash flow. Politically, the chance that Canada might not implement fully a punitive tax on existing oil and gas royalty trusts could be a positive surprise this year.

Meanwhile on January 16, we scaled back our suggested unlevered weighting to one and a half from double for the stock in our illustrative energy portfolio concentrated on real assets that promise a high return providing clean fuel for global growth.

High-Income Mid Cap Oil and Gas Producers
Penn West’s low McDep Ratio among multi-billion dollar market cap, high income peers supports our buy rating. Only in its second year as an income stock, Penn West is the largest conventional oil and gas producer among Canadian Income Trusts. Enerplus (ERF) and Pengrowth (PGH) are pioneers of the industry and among the next largest.

Along with our revision of NPV for Penn West, we also lower NPV for Pengrowth to $17 a unit from $20 a unit. Simultaneously reported on February 27, latest results for Pengrowth are included in our valuation comparisons. Enerplus has the longest reserve life, as we measure it by counting just proven developed reserves and half of proven undeveloped. While proven reserves understate likely future production, it is the most objective measure for comparing companies, imperfect though it may be.

The subjective adjustment we have made for Penn West compared to Enerplus contributes to a higher present value to cash flow multiple despite a lower reserve life. Each of the three trusts is financially active, making deals regularly that make it more difficult to measure operating trends consistently.

Indicated distribution yields at 10-15% a year are the highest of all the stocks in our coverage and are the main reason for investor interest in the three stocks. Distributing about two thirds of Ebitda, Penn West and Enerplus may have the best chances to maintain the current high level. Though Pengrowth pays the highest distribution yield at 15% a year, it also has less Ebitda, or cash flow, remaining for reinvestment to sustain the distribution.

Originally published on Feb. 28, 2007

PWE vs. ERF vs. PGH 6-mo chart