Five Canadian Income Trusts for Value, Distributions

by: Kurt Wulff

Among five stocks in our Canadian Income Trust group, we rate Canadian Oil Sands Trust (OTCQX:COSWF) Contrarian Buy. “Contrarian” acknowledges that current stock price is in a downtrend defined by price below the 200-day average. “Buy” signifies the appeal in production of high quality synthetic crude oil, long life resources, lowest McDep Ratio of 0.67 and cash distributions currently at the rate of 7.6% a year. The remaining four stocks are also attractively priced at McDep Ratios of 0.73-0.87 and distribution yields of 9.2-11.0%. Believing that Canadian proven reserves can be conservative, we include reported probable reserves in our determination of adjusted reserve life used in estimating Net Present Value for those stocks. In addition, Penn West Energy Trust (PWE) justified our raising NPV to US$23 a unit from $19 as a result of the May 13th announcement that China Investment Corporation would invest C$817 million in a partnership to develop PWE’s Peace River oil sands resources. The good news may be helping PWE units to trace an uptrend with current price above the 200-day average. Natural gas producer Peyto Energy Trust (OTCPK:PEYUF) also trades in a unit price uptrend. Measured by futures prices for the next six years, natural gas may turn up before winter, but oil has turned down amid the week’s market turmoil.

Upsides in Resource Value
A longer life usually means a higher value. We see reserves to production ratios (Adjusted R/P) ranging from about 7 to 31 for the five trusts. At the same time, unlevered cash flow multiples (PV/Ebitda) range from 7 to 13. Natural gas multiples are higher than oil multiples because we expect future natural gas price to be higher relative to oil price than it is today. PV/Ebitda increases steadily with reserve life up to about 15. Present value increases further at a declining rate for reserve life beyond 15 as we can see for the long life natural gas reserves in Peyto and oil reserves in COSWF.
Value is created in longer life resources when there is a credible intention to develop those properties. COSWF’s resources will be developed by the Syncrude oil sands mine and upgrader that is already in place. PWE’s Peace River resource became more valuable in its stock when an investor committed the funds for development.

Volume Up for Long Life Trusts

Natural gas volume has turned up at Peyto. The trust is spending aggressively on horizontal multistage fracturing in Canada’s Deep Basin. Volume is also increasing at COSWF after reduction for maintenance operations in the first quarter 2010.

Gentle volume decline is normal for shorter life production. Yet Enerplus Resources (ERF), Pengrowth Energy Trust (PGH) and PWE are each pursuing a version of new technology to tap unconventional resources. Surprises are possible. Otherwise volume trends tend to moderate at higher commodity price and accelerate at lower commodity price.

Distributions Trending to Sustainable Level with Corporate Taxation

Strongly encouraged by the change in Canadian tax laws, each of the five trusts expects to convert to corporate form around year end. The main implication is that distribution capacity may be reduced by perhaps 10-20% for new taxes. The irony is that few corporations pay cash taxes. Each of the trusts is accumulating ‘tax pools” that allow deferral of cash taxes, sometimes indefinitely. Distributions have already been reduced toward a sustainable corporate level. None of the current payments exceeds our measure of Equity Ebitda except for Peyto. Peyto has the extra covered with hedges for now. PWE management may likely want to allocate more cash flow to drilling programs and may make lower distributions next year. In all cases, distributions depend on oil and gas price among other factors.

Originally published on May 21, 2010.