Energy Pause Is No Problem for Canadian Trusts

There has been a lot of talk lately about oil's need to pull back. With global infrastructure one of the areas we advise on, it remains my sincere impression that despite the investment world's awareness of the China/emerging markets/raw materials story, most folks still don't quite grasp its sheer immensity and its ongoing implications for raw materials.

This backdrop that has caused me to say that energy, base metals and agriculture prices had little downside risk and that most commodities would outperform gold for awhile the last couple of times I was on CNBC (watch here: May 8, March 24).

Despite the recent strength in crude, let's entertain an oil price correction based on short-term technicals and even perhaps a nod to the revelation that Iran is storing 20 million barrels of oil in tankers offshore.

Let's say oil pulled back $10-15/barrel... it would indeed weigh on related stocks. Regardless, the group investors should come back around on is the energy trusts. As part of our ongoing work on a Canadian energy trust portfolio on which we advise, we speak with and visit these companies regularly. None will talk about their own future dividend policies, of course, but they can speculate on their peers and all say they're aware of a number of competitors who they believe are likely to hike distributions later this year.

Even should energy prices cool a bit, widespread distribution increases in this sector in '08 look increasingly likely. Despite the group's solid performance so far this year, I'm convinced investors are still behind the curve on this one and don't fully appreciate the powerful position the energy trusts are now in. That's the energy group I would look at first should the price of crude correct.

And, keep in mind: such a pullback is not a given, so start re-discovering these stocks now. You might determine a game of half now, half on any pull back might be the way to go.

Comments

[User 106026]

Doesn't really tell much, besides tout his own products/service. Don't really need such a generic column that basically says nothing.

[davboz]

Well then,...I will say something:
I have only owned a little HTE for 10 or 12 weeks and a bit of AAV for 3 or 4 weeks, but on these days of oil per/bl surging, the Can Trusts have kept even, while rising in contrast each day oil drops. All the while earning 14.38% and 11.49% div. yield.
Sure, it looks like its a ploy to pump up what he's sellin'.
And maybe I'm trying to pump what I already own, but that does seem to be the name of the game. Your job is to ferret out the B.S. from the straight talk.
A beginner like me can see that these are good plays in the kind of market we've been in. And maybe when the rest of the market starts to outperform them, maybe it'll be time to use some of those dollars elsewhere. Right now they serve one quite well when bubbles are frothy and extended, and choices are sketchy.
Beware of contempt prior to investigation!

[ErnieMontague]

Canroys are always risky, anyone who went through the halloween massacre knows that. I am still glad I have held my positions in PWE for years, and will hold HTE as well.

[Jack Yetiv]

I agree the article was superficial. If you want a detailed write-up, look at my article on PWE.

I recommended it about 10 days ago, when it was about $30. It closed today at $33.60. The details of why I recommended it are well-laid out in the article, but oil prices have continued to go up since. Although I am of the opinion that oil is more likely to go $15 down to $111 than it is to go up to $141, as the author notes (not too clearly), even if oil goes down all the way to $110, the earnings of the Canroys will go UP--a LOT.

Indeed, if oil averages $115 during this second quarter (and we are more than half-way through the second quarter and oil has probably averaged more than $115 already), and nat gas averages $10 (it has been over $10 most of this quarter), PWE's cash flow in this quarter will be about DOUBLE what it was in the second quarter of 2007. Yet the stock has barely moved in the past year.

Ergo, barring a crash of oil below $110 or nat gas below $9, I expect PWE will be $40 when PWE reports this quarter, and $50 well before the end of this year.

Add to that a 12% dividend, and you're looking at a return approaching, if not exceeding, 50% this year.

Jack

[mcaudit]

Agreed...what a waste of space!!!

Also, everyone should remember that the 'preferred' tax status of the Canadian Trusts will expire 31Dec10 when starting 01Jan11 they will be taxed as corporations are!
As that date approaches, do not be surprised to see the prices decline do to the obviously reduced future cash flows.
So then might be the time to buy the strong entities like Penn West and Baytex which will continue to produce strong results.

[ace41]

Strongly agree with Jack, COS and PWE have long been favorites of mine. Thank God I had plenty to offset some nasty REIT stuff I have had this past year. Recommend mcdep.com as an excellent way to stay in touch with these Canroys and some US oil/gas trusts.

[Jack Yetiv]

Mcaudit, SIFT tax doesn't come into effect until 2011. In addition, most of the Canroys have enough "tax pools" to protect themelves from that tax for several years.

In PWE's case, the SIFT tax is not expected to become a factor until 2014.

If a Canroy is doubling its income, I doubt a 10-15% tax (effective tax rate) will cause people to run for the exits.

Finally, the SIFT tax is already fully priced in. Unless a WORSE tax is implemented, I don't see any impact of the SIFT tax.

Jack

[mcaudit]

Jack

1. If you read again, I said 2011!

2. Corps in Canada have a large (+/-) 40% rate subject to reduction by the available tax pools.

3. I doubt every entity will have the depletion allowance reserves to carry on for a number of years.

4. Energy prices/costs and the markets will determine the pricings as the tax date approaches.
Time will tell
said the tax kicks in

[d_teller]

FYI - there are some CanRoys that will be unaffected by the nominal taxation change: ATPWF (Atlantic Power Income Fund Trust Units) is one example, because its income is almost entirely from U.S. operations...and the Harper tax plan is to tax income from Canadian operations. There are several others, in other industries ...burial services, medical clinics, food services ...with mostly income from U.S. operations.

Secondly, some will be converting to limited partnership- Publicly Traded Partnerships (PGH had applications in and approved as of Feb, 2008) These will be best held in taxable accounts -NOT in Tax-Sheltered accounts, because K-1 reports showing UBTI > $ 1000.00/per holder, may disqualify the tax shelter... and the returns of capital, depletion losses, and other benefits of PTP's are lost in a tax shelter, wherein all income and gains are eventually taxed at marginal rates.

The PTP format allows a certain amount of nominal dividends to be transformed into cap gains by lowering the basis (cost) of the security over time...an advantage after 2010, when "qualified" dividends may no longer be taxed at low rates.

[Whisper OnThe Wind]

I like HTE, PWE, and PGH, and I even have a bit of AAV, along with a few other oil/natural gas trusts. If I can take these dividends for the next couple years, and maybe longer if they do have the tax increase covered with the pools as they say they do, then why not just keep playing? After all, it's like finding pennies on the ground. It may not mean much to the people who don't see the worth, but for the rest of us, it's money in the bank.

[mcaudit]

Whisper:

I in fact have some dozen trusts; tax-sheltered....where else do you get such yields today.

You have the right attitude!

[bill d]

Was vaguely familir with canroys until I heard Cramer talking about them.
What I do now is sell naked puts in the current month on those I want to own anyway. If I don't get the stock put to me I get to keep the premium, otherwise I get the stock at a discount. I then also sell covered calls on them. PBT & PVX so far. Probably AAV will join my strategy as I like to keep the stock price low. My return/yield are doing very nicely and I don't see much risk. Staying pretty much to 20% of my investment capital at least so far.
Any advice ??

[Jack Yetiv]

Sounds like a fun approach, Bill D, but in a rising market for these stocks, I am afraid there's a decent risk of never having the stock put to you. Sure, you keep the premium (which on the Canroys is relatively small, I have found) but you may miss a big move up.

For example, when PWE was at $31, you might have sold a $30 put. But it will probably not be put to you because PWE is $33 and rising.

Jack

[paultaut]

About time! Respect for Oil companies. Where else in the world are you likely to find additional reserves in your own back yard...most of these trusts have huge unexplored acreage. Some of them have huge tax credits allowing their payouts for years after 2011. But regardless of how you want to hack it, if forced to, as oil companies they will be able to translate their current payouts into earnings and increased multiples.

[jjason]

I am long PWE and I agree with the author and Jack. PWE is returning a yield, at my cost, of 16%. I bought PWE just after the Canadian tax minister's announcement.

What could happen is a change in government in Canada whereby the taxation of income trusts is reversed to what it had been.

My downside to PWE was that the unit price would be at my cost till 2011. But PWE's management has the tax pools (so they say) and the increase in Canadian taxes will not effect PWE until 2014.

I would hope that the Canadian Finance Minister, Jim Flaherty, would change his mind and not tax Canadian Income Trusts. These trusts were one of the few investments that I have found that pay excellent dividends with a low to medium risk. However, do not take my word for it. Do your own research.

Long PWE

[bill d]

Thanks Jack - I see your point.
Friday both my covered PBT call and PVX put were exercised. So essentially I traded my PBT for PVX. Also had some May 15 MEA calls that I bought a week ago Friday for a quickie and naturally it stopped moving but I got out Friday losing only about $17. I do this once in a while and have been successful most of the time. I feel like an options day trader but it's fun and safer than mountain climbing or being shot at !!!

[dollarbear]

Nice job Hanlon! I noticed he has his own blog (hanlon's pub) on greenfaucet. He has been chiming in there a few times a day. He wrote an Ag pullback article a month or so that was very good also.

[misterchan]

Whisper - I agree with you, except that I don't especially like PGH. It seems to be stuck at 20, and makes very minimal moves. One that I would like very muck to add is BTE, which I think has not been mentioned yet. That one looks very appealing re its earnings, etc., but I haven't been able to catch it pulling back even a little bit to an interesting buying point. I'm still watching and have written some naked puts on it and also on PWE. Bill d - You are smart. When was it ever not profitable to NOT get put with a naked put? You end up with a profit. What I do is go out a few months, sometimes to the max, and write a put which defines the price I would like to pay for the stock. Especially PWE. I wrote some recently, before the big move, and got about 3.00 for them. Jack Yetiv sounds like he does not appreciate the opportunity in carefully monitored naked puts. I also write covered calls and on other stocks, naked calls. But the real gem is those dividends. Any of you who wrote disparagingly about CanRoys should take a second look and re-read all the positive comments above.