Oil Sands Cinderellas

08/03/2010 12:34 pm EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Two of Alberta’s best operators boast undervalued deposits and attractive cash flows, writes Roger Conrad in Canadian Edge.

Penn West Energy Trust (Toronto: PWT-U, NYSE: PWE) has inked a joint venture with giant sovereign wealth fund China Investment Corp (CIC) to deploy the latter’s capital to develop its oil sands properties. These are assets in the Peace River area [of Alberta], where Penn West is currently producing at [a] low rate, but which include 237,000 net acres of leases with potential for dramatic expansion.

Under the terms of the deal, Penn West retains 55% of the venture and will develop the asset with C$817 million of CIC’s money. CIC is also acquiring 5% of Penn West’s units for an additional C$435 million in proceeds to be similarly deployed. The result is a major opportunity for Penn West to boost its production from this valuable resource (something it has not counted on in growth projections) and with limited financial risk.

The biggest question mark about Penn West—which also draws about 60% of its current output from conventional light oil—is what dividend it will pay when it converts from trust to corporation, probably at the end of 2010. Management has [stated] that it wants to invest more cash in its portfolio of promising properties, which has implied at least some reduction in the current monthly payout of C$0.15 per share.

My expectation is that Penn West will reduce its payout to some degree. And when it does so, at least some investors are going to sell their shares, pushing down its share price.

Whether that happens or not, however, Penn West currently trades at only about 80 cents per dollar of proven reserves, as calculated at the beginning of the year.

In my view, the only possible explanation of that discount is uncertainty about its 2011 plans, which will disappear when management makes a statement one way or the other. In the meantime, Penn West Energy Trust is a solid value in the energy patch and a Buy up to US$22.

Canadian Oil Sands Trust (Toronto: COS-U, OTC: COSWF) is also likely to cut its distribution when it converts to a corporation in 2011. In fact, management has already telegraphed this move by lifting the quarterly payout to C$0.50 per unit in May for the purpose of maximizing tax pools for after the conversion.

That being said, however, this pure play on oil sands—virtually all income is from its royalty on its 37% stake in the Syncrude partnership—remains the best leveraged bet on oil sands with aggressive plans for production increases, the best possible operating management, and a very strong balance sheet. Cash flow after conversion will rise and fall with oil prices, meaning dividends and the share price will as well. But for those who can weather the ups and downs, Canadian Oil Sands Trust is a solid Buy below US$35.

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