Royalty Trusts Still Powering Through

07/19/2011 1:30 pm EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

New tax rules stopped these Canadian income investments for a while, but they came back in a big way in the past couple of years, says Roger Conrad of Canadian Edge in this exclusive interview with MoneyShow.com. Conrad also shares one of these trusts he recommends taking a look at now.

Roger, you did a piece recently about these old royalty trusts, which back in 2006 had a big upset because of the changing tax regulations. You actually tracked their performance since then, and you found that they have dramatically outperformed the S&P by really substantial amounts.

Well, it’s one of those things where perception is often very different from reality. Of course the royalty trust took a big hit after the tax was announced.

They took an even bigger hit in 2008, of course, when the market came down—us investors were hurt by the Canadian dollar coming down—but since that time we’ve had a tremendous rally in these companies. Partly because, as we went along, as we got closer to 2011 when the actual taxes kicked in, people began to realize that dividends were going to remain much more solid than they thought.

Many companies did not cut dividends. In fact more than a third of the trusts that converted did not cut their dividends, and earnings continued to get better, the economy got better, the Canadian dollar got better, and as a result we would up with two extremely bullish years in 2009 and 2010.

Again, it's another story, another lesson that often when the expectations for a group get so low, that’s when you’re going to get your biggest returns by buying them.

Interesting. Now, a lot of these trusts have now converted into regular corporations, but paying very high yields, right?

Right, and it’s interesting that they have been able to find ways to avoid paying the full tax rate. There are a number of incentives that Canada’s energy industry does have to invest money and also to pay dividends as well.

Most of the companies decided that hey, we’re not a super oil, we’re not a huge company like Suncor (SU). We’re small companies, so how we’re going to be able to raise capital is by offering a dividend, and thereby being able to make acquisitions when we need to, do the drilling where we need to do it.

As a result, they’ve stuck with this model, and they continue to be very successful in generating returns.

Well if they’ve done so well, is it too late to buy them?

Well I think, again, anytime you buy anything relating to energy,, you want to be very mindful of where the price of oil is. In particular, watch the hype factor regarding the price of oil and gas.

Now gas is obviously very weak, but oil has been somewhat hyped up, particularly in the wake of the Middle East crisis, so you know we will get opportunities I think to buy these things. I think there are plenty of companies, though, that are already in a pretty decent buying range, and again, natural-gas producers are even cheaper.

Can you name one or two of them that you like in particular?

Well, I like a company called Peyto Exploration (Toronto: PEY, OTC: PEYUF). This is a company that’s very heavy in natural gas.

It also has an extremely low cost, they’ve been very, very exceptionally successful at generating wealth at the drill bit, meaning doing drilling to find more reserves to increase production, extending their reserve life, gaining scale, and driving down costs. This is how they’ve been able to make a rising stream of earnings, quarter after quarter, even with natural gas prices very weak.

If gas prices get strong again, this company is going to do much, much better, but even here we are with the situation of low gas prices, they're able to do quite well. The real big kicker is that it trades at about 60 cents on the dollar per reserves. In other words, for every dollar of reserves, the market value of that company is about 60% of that. Very nice kind of bargain situation.

So do you own it personally or professionally?

I don’t own this one, but we do recommend it in the letters.

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