Royalty Trusts are Still Attractive
11/03/2006 12:00 am EST
Value-based investment pro Richard Band has a legion of subscribers who have successfully followed his advice for many years. Known for his thorough research and common-sense evaluations, his recommendations cover investments for building appreciation and income.
"Income investors are in a bit of a pickle. Utility stocks and real estate investment trusts (REITs), two staples of the income seeker's diet, have skyrocketed in recent years. Bond prices are off their highs, but still far above where they began the decade. All great news for folks who bought years ago-we love the capital gains! For new money, though, high prices spell trouble in the form of low yields.
"But, if you are really thirsty for income.royalty trusts give you a cut of the proceeds when oil and gas are pumped out of the ground. Because they pay no corporate income tax, royalty trusts can afford to pass along a larger chunk of their cash flow than giants like BP, ConocoPhillips, or Occidental Petroleum.
"Canadian royalty trusts offer an additional edge over their stateside counterparts. Under Canadian law, a trust is permitted to acquire new properties, whereas U.S. trusts are set up with essentially fixed portfolios. Result: Canadian royalty trusts can maintain (and even grow) their production over the long haul, instead of wasting away. Of the trusts with a dual listing on both the New York and Toronto stock exchanges, my hands down
favorite is Enerplus Resources Fund (ERF NYSE). ERF boasts a long-lived reserve base: Proved and probable reserves of oil and gas amount to 13.5 years of production at current rates.
"ERF also shoulders less debt than some other trusts do. Thanks to these two factors, Enerplus shareholders are less exposed to the risk of a distribution cut should oil and gas prices sink further. At today's commodity prices, I think ERF will be able to keep up the current monthly distribution, which works out to about U.S. $4.48 annually per share.
For tax purposes, the bulk of ERF's cash distributions qualify as dividends, eligible for the 15% maximum federal tax rate. However, the Canadian government also imposes a 15% withholding tax. You can obtain a credit against the withholding tax on your Form 1040, but only if you own ERF in a taxable account-not an IRA or other tax-sheltered
account. Buy ERF on a dip to $49.75 or less, where the yield hits 9%. (We're tracking Enerplus outside the model portfolio as a Niche Investment for income.)"