Petrofund: A Trustworthy Trust

09/02/2005 12:00 am EST


Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

"We’ve been playing the energy sector through the Canadian energy trusts," says fixed-income expert Richard Lehman. Here, he explains the market for oil and gas trusts and offers his top income-generating, north of the border pick in the sector.

"Since the middle of last year, we’ve been recommending these oil and gas trusts for income-oriented investors. Due to the change in the tax law in the US, these trusts were eligible for 15% tax treatment. Now can you find me another investment that pays 12% where the dividend is taxed at 15%? They have appreciated substantially over the last year and a half, and yields have dropped to about 9%. But we continue to recommend them, as these companies have set their dividend policies based on $25 per barrel oil policy. So now they have plenty of room to increase dividends.

"It is also important to understand that unlike US oil and gas trusts, these Canadian trusts are not depleting assets. A US trust is formed and is then not allowed to buy additional properties to replace the reserves that they have used. Therefore, you get a depletion allowance but you are buying into a wasting asset. Canadian trusts, on the other hand, are allowed to continually replenish their reserves. Thus, the money they distribute to shareholders is above the money that they need internally to replenish their reserves. Therefore, you would expect that they would be able to maintain their dividend policies going forward.

"Another aspect that needs to be factored in is that the Canadian law relative to liability of you as a shareholder has changed. Prior to this year, there was unlimited liability if you were a shareholder. It never actually happened that a trust went bust and creditors went after shareholders. But this risk was on the books as an unlimited liability. That has now changed and the Canadian government has removed that requirement. As a result, institutional buying of these trusts has begun.

"Also, because of that change, S&P has included the Canadian oil trusts in their Toronto exchange index. Being part of an index automatically puts you into a buying mode with various institutions, which tend the hold the members of a market index. This has created additional buying. So we have seen price increases in these trusts that are driven by more than just the price of oil.

"Back at the World Money Show in February, I was asked for my top pick and I selected Petrofund (PTF ASE). At the time it was a $13 stock and it was yielding 11%. In fixed income, that kind of yield is phenomenal. And the opportunity for capital gains these days in fixed income are rare. Since then, Petrofund rose to above $18 and the yield dropped to about 9%. But I’m sticking with this as my top pick.

"First, it is still a very good yield. The price of oil is obviously a big factor. But the kicker is that this company is really driven by the dividend rate. And the rate for Petrofund, as with most Canadian oil trusts, were set a year or more ago when the price of oil was $35. So you can image that at $60-$65 oil, these trusts have plenty of room to increase dividend rates. So even though the stock has done phenomenally well this year, I am sticking with it because of the potential for dividend increases next year. I think there is still a lot more upside left."

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