Precision: High Yield "Edge"

04/21/2006 12:00 am EST

Focus:

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad , long an expert in the utility sector, has developed developed an industry-leading expertise in Canadian income trusts, and was the first advisor to introduce an newsletter devoted to this sector. Here’s a look at his latest featured buy in his Canadian Edge newsletter.

"Whether your time horizon is five years or five months, robust and reliable dividend growth is always more important than a big, fancy initial yield. For one thing, without growth there’s no assurance a trust will be able to keep paying its dividend. And nothing will gut your principal like a dividend cut.

"Growth is also your best and only protection against the ravages of inflation, which are always a threat to destroy principal. And eventually, a growing dividend always translates into a higher share price, even as your cash stream rises. The best thing about Canadian trusts is that you can have both robust growth and high income—that is, if you choose wisely and avoid the temptation of always chasing the highest yield numbers.

"Precision Drilling (PDS NYSE) is a new member to our ‘super yielding portfolio.’ Precision is Canada’s biggest oilfield services company, with about 30% of the country’s drilling rigs and a leading position in related services. The company reorganized as a trust in mid-2005, spinning off international rig contracting and industrial cleaning units. Management is now squarely refocused on the original core of Western Canada oilfield services.

"The trust’s operations are in two segments. Contract drilling services include land drilling services, camp and catering services, procurement and distribution of oilfield supplies and rig building and maintenance. The rig fleet is designed to penetrate all areas of the Western Canada Sedimentary Basin (WCSB), featuring a wide array of configurations and capabilities utilizing state of the art industry technology.

"The trust has a 40% market share in Canada for rigs with a depth capacity of at least 3,600 meters, a major plus with many customers continually going deeper to find new reserves. Its 56.2 percent rig utilization rate last year was the highest this decade, up substantially from 50.3 percent in 2004. Completion and production operations focus on well completion and makeover services, rentals and related services. Assets consist of 237 service rigs (24 percent of the industry), a wide range of equipment for rent and 30 percent of the live well service market.

"Precision has enjoyed a boom time in the past two years, as oil patch activity has heated up in Western Canada. Contract drilling service revenue surged 25.9% in 2005 from year-earlier levels, and completion/production services sales rose 18%. With drilling continuing to pick up—increasing demand for rigs and services, as well as rents—profits should keep rising at a robust clip for 2006 and beyond.

"Precision is cyclical. As long as the long-term energy bull market is intact, drilling activity will be robust and demand for their equipment and services will likely accelerate. That means strong growth in their already generous distributions. With Precision’s payout ratio, only 54.4% in the fourth quarter, and earnings more than tripling from 2004 levels (excluding one-time items), there’s plenty of room for it to grow in 2006.

"At some point, energy conservation will accelerate. Real alternative energies like nuclear power and coal-to-liquids will kick in, reducing demand for oil and natural gas. There will be a major new discovery of conventional reserves and possibly a demand-killing global recession. When that happens, just as in the mid-1980s, the energy bull market will come to an end. Drilling activity will go into a prolonged slump and cash flows will be crunched.

"Fortunately, we’re a long way from there. And as long as the energy bull market continues, oil service trusts like Precision and Peak will continue to surge. Because it trades on the New York exchange (as well as in Canada), it is more liquid than some some of its Canadian peers. Buy Precision up to 35 (based on its NYSE price). Note that the trust has issued an opinion written by their US council to the effect that their dividends should be considered qualified for US tax purposes."

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