Some Income Trusts Are Better Buys

05/15/2007 12:00 am EST

Focus:

Roger Conrad

Founder and Chief Editor, Capitalist Times

Roger Conrad, editor of Canadian Edge and associate editor of Personal Finance, says certain Canadian energy trusts can be good investments, but investors must still choose carefully.

Canadian income trusts have endured more than their share of turmoil during the six months since Canada's minority ruling Conservatives announced a scheme to tax them as corporations beginning in 2011.

Oil and gas producers have been hit doubly hard as a year of falling energy prices finally caught up to cash flows, triggering some two dozen dividend cuts and dragging even the strongest down in sympathy.

Trusts with vibrant cash-generating businesses, however, have attracted a whole new group of buyers-private capital. Since Halloween, we've already seen 20 takeovers of trusts by a wide range of private buyers. Several have been the result of bidding wars that have pushed prices for targets as well as sector rivals well past pre-Halloween levels. Most buyouts thus far have involved relatively small trusts.

For individual investors, trusts' primary appeal has always been high, sustainable, and growing distributions. Private capital is similarly interested in businesses that generate the high, sustainable and growing cash flow needed to pay those distributions. But unlike you, they can minimize any prospective taxes with a variety of means, including loading trusts with debt.

The fact that they're buying trusts across the board in record volume is rock-solid confirmation that the best of these are not only solid cash generators but that they're dirt cheap as well. No one should count on a private capital buyout as an exit strategy.

That's why the only viable strategy for investing in trusts is to buy and hold only those that can produce superior returns on their own, without any help from forces beyond their (and our) control.

Operating a business that generates robust, sustainable cash flow is the starting point for buying and holding a trust. That's the only way dividends will be paid over time, no matter how they're taxed. During the past few months, we've narrowed our focus further. We're concentrating on those trusts that are preparing their businesses to pay us big distributions well beyond 2011 anyway, working on the assumption that they'll ultimately be taxed as corporations.

Provident Energy Trust (NYSE: PVX ) [gets] about a third of cash flow coming from oil and gas properties in the US. These assets, however, should gain importance over time as the trust grows them through its BreitBurnpartnership. As a publicly listed US partnership traded on the NASDAQ market, BreitBurn is able to flow through cash to its parent-Provident-without paying US taxes.

The trust also controls the second largest natural gas liquids midstream operation in Canada, providing relatively stable, fee-based income. Provident Energy is a buy up to 13. (It closed Monday at $11.67-Editor.)

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