Canadian Oil Sands Trust: FCF Rockets Higher

Canadian Oil Sands Trust (COSWF) is one of my long-held and much-loved positions. Though its share price has suffered by the surprise move against the trust structure last year, and more recently by announced production outages and worries over a potential increase in royalty rates, I continue to find the shares attractive.

While in USD terms the Trust has done well enough year-to-date--up around 20%, including dividends--in Canadian dollars it's barely budged. With the salvo of negative news items being delivered over the past year (mostly by Canadian politicians), many foreign investors especially have been sellers of the Trust's units.There have been some much-publicized tirades against investing in the Canadian oil and gas sector because of the changing political atmosphere lately. But where have these investors gone?

On a relative basis, especially if you are concerned with owning long-life oil reserves, there's no real competition--something those who took their money back to the States might realize in a not-too-friendly fashion over the next couple of years.Although these macro trends have an importance in investing, as they have undoubtedly held down share prices throughout the sector, I believe undue attention has been placed on them. While nobody has been looking, the Trust's FCF numbers have exploded. Here are my per barrel estimates for the most recent quarter, which ought to prove reasonably accurate:

C$81.00 Revenue after currency, transportation and marketing costs

-24.00 Operating costs

-1.80 Non-operating costs

-3.20 Interest, admin, insurance and other costs

-13.00 Royalty costs

______

C$39.00 Funds from operations

-5.00 Cap ex costs

______

C$34.00 Free cash flow

Given the above FCF/barrel numbers, and 11.9 million barrels net to the Trust produced over the quarter, Q3 free cash flow ought to be somewhere around C$405 million. With 479 million shares outstanding, FCF, under the above assumptions, comes out to 85 cents per unit.Worth pointing out: the current dividend payout is 40 cents per unit--amounting to a 5% yield at today's prices--the debt level is below management's target already, and the Trust has guided towards a near-full payout of free cash flow (unless other opportunties arise that would better increase shareholder value).

While I don't expect management to double the dividend payout when they announce earnings, which would give the Trust a 10% dividend yield at today's prices, a hefty increase would be anything but surprising. Thus, although macro events have been on center-stage for some time already, I believe the spotlight is about to shine on the star that matters most to investors (or should): free cash flow.

Importantly, though the price of oil could drop handsomely and take the budding star down with it (for an act or two), the royalty report is hardly the deadly villain that everyone is making it out to be. Running the same numbers for Q3, but using a royalty figure of 30% instead of the current 25, FCF per unit would be roughly 77 cents. That's still enough to support a 9% dividend yield--which is a very hefty payout for a resource that lasts 50 plus years. (There's a good chance too that the Trust won't be subject to the recent, recommended increase in rates--as they have a contract with the Alberta government that doesn't expire until 2015.)

In a world where most of the world's major oil fields have peaked, and where the consumption of oil in those exporting countries and around the world is growing substantially, I think it's a very smart bet to own a free cash flow stream from long-life oil reserves. It may take another year, or even a few, before the market starts to price POE (Peak Oil Exports) into the oil sands plays, but at some point it most assuredly will. In the meantime, with Canadian Oil Sands Trust, unit-holders get paid for waiting (in ever-greater amounts).

Disclosure: Author has a long position in COS.UN