A "Prime" Income Play

04/15/2005 12:00 am EST

Focus:

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

"I first began recommending Canadian oil and gas trusts last August, and these high yielding securities have been on a tear ever since," says Richard Lehmann. "But the fun is far from over." Here, the income expert adds a new trust to his buy list.

"Believe me when I tell you that it’s rare for income-oriented investors to find securities offering a double digit cash dividend rate of return without significant credit or interest rate exposure. Moreover, it is unheard of to obtain such a cash return taxed at only a 15% income tax rate. When you factor in a potential 20%+ price appreciation, well it just doesn’t get any better than this.

"Dividends at today’s rates will be subject to cuts if oil prices drop back to $35 or lower. However, given the long-term outlook for oil, any cuts are likely to be reversed over time. Also, with yields in the 10% to 12% area now, even a 50% cut in dividends would leave you with a very healthy rate of return for a 15% taxable security. I see few other fixed income alternatives today that offer such a winning profile over time.

"I am adding PrimeWest Energy Trust (PWI NYSE) to my recommended list of Canadian energy trusts. At a price of 24, this issue yields a 12.1% annual dividend, paid monthly. PWI recently increased its dividend payout by 9% and still is only distributing 76% of its free cash flow. The remainder goes to expansion of its reserves, which went up from 9.8 to 10.3 years. Hence, you are not buying into a depleting asset. Despite this, for 2004, 45% of the dividend is a non-taxable depletion allowance and the rest is only taxable at 15%. In other words, 45% of your dividend is a reduction in your cost basis and only taxed when you sell your shares.

"Meanwhile, you can take the full 15% Canadian withholding tax as a credit against your US tax. The after tax effect is that for every dollar of dividend, you keep 91 cents. Buy for medium to high risk taxable accounts with a view to a long term hold. Overall, this year may prove to be a watershed year for such trusts because of legal and structural changes. I also believe we will see further price appreciation this year due to an expansion of the institutional buyers for these trusts. And if I’m wrong, take your 12% totthe bank and have a 'good cry'. Buy at or below 26."

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