Add to Your Income

12/15/2006 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Although the proposed regulatory changes have created much uncertainty surrounding Canadian energy producer and service trusts, income and energy expert Roger Conrad still finds compelling reasons to add several trusts to his portfolio, including this one.

"I'm adding Peyto Energy (PEY.UN , PEYUF OTC) to the Aggressive Portfolio as a buy up to USD22. Peyto is heavily focused on natural gas, with 82% of its third quarter output coming from the fuel. Unlike most other gas-dependent trusts, however, it's had no problems covering distributions with cash flow. In fact, the trust actually increased its dividend by 17% during the last 12 months. And with the payout ratio at 61%, there's more to come.

"One of Peyto's secrets is a reserve base that's fundamentally stronger than those of most trusts. Reserve life based on proved reserves alone was 13.6 years at the end of the third quarter, twice that of the average trust. And throwing in probable reserves (with a 60% or better chance of development), that figure rises to 18.9 years. The trust operates more than 95% of its production and has the lowest operating costs in the sector, at just CD1.90 per BOE.

"Low costs and a huge reserve base have exempted Peyto from having to pay exorbitant development and acquisition costs to maintain output in recent years. That, in turn, has limited the amount of debt and shares it's had to issue. Net debt, for example, is currently just 1.5 times the cash flow generated in the third quarter alone. The growth in the number of outstanding shares, meanwhile, was just 6% during the past 12 months.

"With gas prices backing off sharply this year, Peyto has moved into a self-described "live within our means" mode. Third quarter production per share dipped 9% and funds from operations (FFO) slipped 12%, but that was positively stellar compared to other gas-focused trusts. And with realized sales prices for the fuel again rising, results should stabilize in coming quarters. The trust's marketing efforts have been extremely successful in moderating the impact of volatile energy prices on results.

"As for 2011 taxation issues, Peyto's return of capital portion was 25% in 2005. The trust, however, invests a higher percentage than most into developing and finding gas assets. Consequently, management has stated that it expects to offset a substantial portion of the prospective tax with Canadian Exploration and Development Expense. That hasn't kept its shares from losing ground during the past month. But it's another reason to take advantage of the current low price to pick up shares."

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