Two Energy Trusts That Still Look Good

03/31/2008 12:00 am EST


Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says two Canadian energy trusts will continue to pay high dividends for years even after the tax laws change.

Penn West Energy Trust (NYSE: PWE) and Harvest Energy Trust (NYSE: HTE) both reported profits for the full year down significantly from 2006. However, most of this was an illusion.

Because of a change in Canadian tax law, the companies took a charge for future taxes that they are not ever likely to pay. They have plenty of tax deductions that they can apply to those future liabilities, and they will accumulate more before the 2011 enactment of the laws.

The stocks also suffered last year because of increased royalty rates from Alberta, where the companies have a large portion of their operations. What the market didn’t realize is that both of these companies get most of their output from low-production wells that will see almost no royalty increase under the new rules. They are sheltered under the statutes, which seek to promote exploitation of underutilized resources.

The bottom line is the distributions on these units are likely to remain high for at least another four or five years, and probably longer. Penn West is currently yielding about 13%, and Harvest about 15%. Penn West has a payout ratio of only 71%. Its dividend is probably safe for at least the rest of the year, and far beyond that, in my opinion.

Harvest’s payout ratio is high, however, more than 90%. It will be less than that in coming quarters; nonetheless, the distribution could be cut by a few cents, but would still be very good. On the other hand, if oil prices stay above $90 per barrel, we could also see an increase.

Another thing: even after the new tax laws go into effect and the tax credits are all used, the distributions are estimated to decrease only about 24%. That would reduce the Penn West yield to 10%, assuming they don’t rise from here due to higher energy prices. The Harvest yield would be reduced to about 11.25%. Not too tough to take.

The one legitimate rap on these companies is that they don’t grow production very much, and sometimes they don’t replace 100% of their reserves in house; hence, they tend to make acquisitions frequently. But with energy prices very firm, the companies are getting capital cheaply, despite disruptions in the financial markets.

As long as they keep making returns above their cost of capital and production expenses, we can live with the acquisitions. With the distributions so high in these companies, you have to expect that they won’t replace reserves as fast as regular exploration & production companies, which invest a lot more of their earnings in exploration.

Penn West is a buy up to $33.50, and Harvest is a buy up to $29. (Penn West closed below $28 Friday, while Harvest closed above $22—Editor.)

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