Advantage Energy Income Fund (AAV) – Part 2 – Business Issues

Early December 2007, Advantage announced a dividend cut of 20%. This cut was expected, as the Canadian dollar gaining strength along with depressed natural gas prices does not work in favor for the company. The size of the dividend cut was the sticker shock and the price per share slipped more than 10% following the announcement from an already depressed $10.25 per share. Even after the dividend cut, the yield was still pretty high at 14% and with the price dipping another 15%, the yield is attractive at 16%. Below is a look at natural gas prices over the years and the correlation to Advantage’s distribution and payout ratio:

Year	Natural Gas Average Pricing	Distribution	Payout Ratio
2007*	7.30	1.35	~85%
2006	6.86	2.66	101%
2005	7.98	3.12	84%
2004	6.08	2.82	93%
2003	6.07	2.71	88%
2002	3.71	1.73	89%

• 2007 information above is for the first 9 months.

Advantage’s dependency on natural gas prices is mitigated by the following factors:

• Hedging – the company has an active hedging program that aims to hedge roughly 50% of production. For the fourth quarter of 2007, approximately 42% of the net natural gas production is hedged at an average floor price of $8.09/mcf and an average ceiling of $9.42/mcf. For the first quarter of 2008, it has hedged 22% of the net natural gas production at a floor price of $8.85/mcf and a ceiling of $10.19/mcf.
• Asset Diversification – Over the years, Advantage has steadily managed to increase its oil reserves as a percentage of total reserves.
• Waning Competition from the majors - Drilling and production in Canada are down as majors are not channeling revenue into gas drilling and that will have an impact going forward.

Advantage along with other Canadian royalty trusts is negatively affected by a Canadian tax law change that comes into effect in the 2011 timeframe for existing trusts. At that point, the tax-exempt status on distributions expires and the trusts will pay taxes as regular corporations. Advantage is well positioned to minimize the effect of these taxes for an extended period of time because of the existence of $2B in tax pools in its books. This is a very good hidden asset that should allow it to escape the negative impact of the tax law change for the foreseeable future after the 2011 timeframe.

Provincial royalties is another area that has a potential impact on Advantage. Specifically, Alberta recently unveiled plans for increased royalties in the 2010 timeframe. The risk is fairly contained at the moment as royalties are tied to the rate per well – Advantage has a huge amount of lower rate wells and so the impact is little.

Related Articles:

1. Advantage Energy Income Fund (AAV) Analysis - Part 1 - Introduction.
2. Advantage Energy Income Fund (AAV) Analysis - Part 2- Business Issues.
3. Advantage Energy Income Fund (AAV) Analysis - Part 3 - Outlook.