Trust the Royalty Trusts

10/16/2007 12:00 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

Roger Conrad, editor of the Canadian Edge, says the best run Canadian royalty trusts could be targets for deep-pocket foreign investors.

Two wholly owned units of Abu Dhabi National Energy Co. [recently] offered approximately $26.75 per share for PrimeWest Energy Trust (NYSE: PWI). The offer was nearly 40% above PrimeWest’s pre-deal trading range, and it immediately triggered a sharp surge in stronger oil and gas trusts.

That cash-rich Arabs are looking for a place to put their money is nothing new. That they’d choose to buy a gas-reliant Canadian income trust—at a time when gas prices are slumping—is noteworthy, to say the least. These are well-run businesses loaded with valuable reserves, and this energy-savvy enterprise wants in while prices are low.

The huge premium paid for PrimeWest is the first indication we’ve seen of what prospective buyers are willing to pay for more solid fare. The price was still just 1.6x book value. But it’s far above what similar trusts are going for: Even Penn West—one of the biggest and strongest trusts—is going for 1.6x book.

Penn West Energy Trust (NYSE: PWE) has been aggressive on the acquisition front. The trust had no sooner wrapped up an offer for junior producer C1 Energy than it announced a takeover of battered Vault Energy at a price below book value.

The Vault deal will immediately boost Penn West’s cash flow, reserves and production per share when it’s completed later this year. A shareholder vote is expected in November. Meanwhile, cash costs are nil because the deal is entirely funded by new Penn West shares. That should help reduce the debt ratio of 1.5-to-1, as well as its payout ratio.

Penn West shares have been relatively weak in the past few months. The combination of this deal and the takeover of PrimeWest have turned that around for the moment. But the important thing is all fundamental measures of strength remain solid, from operating costs to reserve life. As long as that’s the case, it matters not what volatility hedge funds and traders cause in the near term. PWE is a solid buy all the way up to $38. (The shares closed below $32 Monday—Editor.)

Provident Energy’s (NYSE: PVX) substantial natural gas liquids (NGLs) operation provides a natural hedge to falling gas prices. That’s because gas is the primary input for NGLs, which sell at prices more akin to oil. Swelling NGL profit margins offset lower net from gas production.

Last month, management announced its most aggressive deal yet: the $1.45-billion purchase of energy reserves and midstream assets in four US states from Quicksilver Resources. The move triples Provident’s operations in this country and is expected to be immediately accretive to cash flow. That’s very good news for the 11%-plus distribution, up to 2011 and beyond. Buy Provident Energy Trust up to $14. (It closed below $13 Monday—Editor.)

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