Citigroup Expects Higher Debt To Weigh Down Harvest Energy

Citigroup Global Markets Inc. believes Harvest Energy Trust (HTE) could be in for a bumpy ride in the short term as management retrenches to work on long-term growth opportunities.

The global investment services firm lowered its 12-month target to C$25.50 from C$28 after Canada’s only oil and gas trust with large upstream and downstream operations chopped its distribution last week by 21%.

Harvest Energy reduced its annual per-unit pay-out to C$3.60 from C$4.56, due in part to low natural gas prices and to the tough slugging many trusts have faced in the wake of new tax rules set to take effect in 2012.

Citigroup said it believes Harvest Energy could generate lower-than-forecasted cash flows in coming months as it fights off declining oil and gas production in Western Canada, and due to volatile commodity prices and volatile refining margins at the company’s 115,000-barrels-a-day refinery in Come By Chance, Nfld., which Harvest bought in 2006 for $1.6-billion.

Citigroup also said Harvest’s higher-than-average debt could continue to weigh on financial performance. However, it applauds the company’s move to lower distributions and likely use that cash flow to invest in management’s strategy to make Harvest more sustainable in the long term.

“We recognize that in the long-term, enhancing the recovery of its conventional oil in place as well as proper management and strong refining margins could create value …,” Citigroup analyst Richard Roy wrote to clients Monday.

However, at this point, execution of the strategy is key. As such, over the next few quarters we will be closely observing the trust’s operational metrics in order to better estimate its future prospects.

Harvest is evaluating its stable of conventional oil and natural gas exploration opportunities and has identified more than 1,000 drilling locations in Western Canada, which represents four-to-five years worth of development work based on present-day capital expenditure levels.

Citigroup noted Harvest is also investing in ways to squeeze better margins from its refinery, and is evaluating projects to boost the refinery’s capacity.

Harvest Energy Trust units are down almost 14% this year and touched a 12-month low earlier Monday, amid a big drop in oil prices and as investors continue to digest last week’s distribution cut and disappointing upstream and downstream revenues in the third quarter.

HTE 1-yr chart: