Three Petrol Picks That Pay

09/03/2008 12:00 am EST

Focus: GLOBAL

Neil George

Editor-in-Chief, Income Publication and Products, Agora Financial

Neil George, editor of Personal Finance, finds three energy trusts and partnerships that pay nice dividends.

We’re not about loading up on a few picks that seem to be working at the moment, nor do we want to shift in and out of investments every so often. What we can do is adjust to market developments. We’ve therefore sold many holdings and continue to recommend [stocks and bonds that] pay us well with steady, and in some cases rising, dividends. Those dividends might not overcome short-term sell offs, but they increase our patience while we wait for stock-price improvements.

We recommended a collection of petrol companies not as a one-way bet on the direction of crude and natural gas prices but because it’s composed of good businesses. The key, as it is for all of our portfolio holdings, is to evaluate companies and stocks based on revenues, profits, and financial stability.

We have two groups of petrol producers: US-based publicly traded partnerships (PTP), including Legacy Reserves LP (Nasdaq: LGCY), and Canada-based royalty trusts, including ARC Energy Trust (OTC: AETUF) and Vermilion Energy Trust (OTC: VETMF).

[Of late] Legacy has been up a scant 2%. But Legacy is paying nearly a 10% dividend. Revenues continue to climb, 87% for Legacy over the past year. More importantly, it is a heavy hedger, so petrol’s spike doesn’t make it a flash in the pan. In fact, its hedges have actually been a drag on quarterly nets, making it less exciting for traders but confirming that the management team is more focused on the long haul.

As a PTP, Legacy maximizes returns for investors by minimizing taxable distributions. As depreciation and other expenses ramp up, the net current income tax paid by investors on rising distributions is reduced or eliminated. Buy Legacy Reserves up to $25. (It closed above $19 Tuesday—Editor.)

[Meanwhile,] Canadian trusts have been on a market roller coaster because tax policy changes have brought in a host of sellers as well as speculators. But the trust tax laws are being phased in, and although not all will succeed between now and 2011, quality businesses will. This doesn’t mean distributions won’t be reduced in the years to come, but for the coming year at least, low-payout-ratio trusts will continue to provide for us.

We own two petrol-related trusts, ARC Energy, and Vermilion. ARC has climbed 35%, while Vermilion is down 1%. The respective distributions remain ample and solid: ARC is yielding 11.5%, Vermilion 6%. And both are increasing payouts—ARC by 40% this year, Vermilion by 16%.

The payout ratios for both are below many of their peers: ARC reported a rate of 53% in its second-quarter regulatory filing, and Vermilion reported 21%. Both are solid plays for the next year on Canadian and global petrol production. Buy ARC Energy Trust under $28 (it closed slightly above that Monday) and Vermilion Energy Trust under $44 (it closed above $40—Editor).

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