CanRoys (ENT, AAV, BTE, HTE, PVX, PGH, ERF, PWE) – A Comparative Analysis

Canadian income trusts span a vast selection of commodity and real estate based industries and parallel US based income trusts such as Master Limited Partnerships (MLP) and Real Estate Investment Trusts (REIT). A sub-category of these trusts focused on the oil and gas properties is called Canadian Royalty Trusts or CanRoys in short. The common thread is the trust structure, which allows for channeling income from the trust to the unit holders without being taxed at the business level. This favorable tax treatment mandates the Trusts to pay out most of their earnings as distributions to unit holders, resulting in relatively large dividend yields.

The business plan of most CanRoys can be summarized as acquiring mature upstream (production of crude oil and natural gas) oil and gas properties (usually from oil majors who have neglected investing on these less profitable properties) and then eking out additional value by using production enhancement and optimization efforts. Few of the CanRoys have also invested in midstream (storing, transportation, and marketing of crude oil and natural gas) and downstream (refining crude oil, distribution of products derived from crude oil, and distribution of natural gas) assets.

We started investing in CanRoys in early 2005, the main draw then was the substantial dividend yields along with energy exposure. Over the years, we realized a good return in yield along with modest capital appreciation. This year, our longer-term holdings in both Advantage Energy Fund (AAV) and Harvest Trust Energy (HTE) have halved though these trusts still provide sizable monthly distributions. Our conclusion from the analysis we had done earlier on these trusts (AAV – Stock Analysis and HTE – Stock Analysis)– was that high-energy prices were a requirement for these trusts to stay profitable and for growth.

CanRoys have a monthly dividend policy and for US investors, these distributions are:
  • Qualified Dividend Income, and
  • Subject to a non-resident withholding tax of 15%.
One exception is that in some cases, the trust classifies the distributions as return of capital.

The list of CanRoys listed as American Depository Receipts (ADRs) sorted by market capitalization with a brief description of each follow:
  1. Enterra Energy Trust (ENT) – It is the smallest and riskiest of the CanRoy ADRs with just under 27mmboe P&P reserves with 40:60 oil:gas split.
  2. Advantage Energy Income Fund (AAV) – A small-cap trust with P&P reserves over 150 mmboe with 40:60 oil:gas split.
  3. Baytex Energy Trust (BTE) – A mid-cap trust with low debt, P&P reserves over 150 mmboe with 76:24 oil:gas split and 5B barrels of Original Oil In Place (OIP).
  4. Harvest Trust Energy (HTE) – A mid-cap trust with substantial debt, P&P reserves of well over 200 mmboe with a 70:30 oil:gas split, 3B barrels of Original Oil In Place (OIP), and a large bet on an older refinery in the form of the acquisition of North Atlantic Refinery in October 2006.
  5. Provident Energy Trust (PVX) – A mid-cap trust with P&P reserves of over 100 mmboe with a 50:50 oil:gas split and a sizable midstream business.
  6. Pengrowth Energy Trust (PGH) – A mid-cap trust with P&P reserves of over 300 mmboe with a 50:50 oil:gas split.
  7. Enerplus Resources Fund (ERF) – A mid-cap trust with almost 450 mmboe in P&P reserves with a 40:60 oil:gas split.
  8. Penn West Energy Trust (PWE) – A mid-cap trust with 750 mmboe in P&P reserves with a 60:40 oil:gas split and 4.5M net undeveloped acres .
We have traded PWE and PGH previously and have long positions on AAV and HTE currently.

Below is a detailed look at different metrics of these CanRoys:

Financials:



CompanyENTAAVBTEHTEPVXPGHERFPWE
Market Capitalization$66.48M$805.16M$1.49B$1.51B$1.56B$2.63B$4.05B$6.48B
Enterprise Value$267.80M$1.46B$1.80B$3.29B$2.32B$3.78B$4.89B$9.84B
Shares Outstanding61.55M140.6M94.94M152.73M255.53M254.94M164.81M381.87M
Revenue$128.44M$480.91M$617.28$4.13B$2.71B$1.30B$1.38B$2.76B
Diluted EPS(1.38)(0.32)1.41(1.50)(0.39)0.832.510.06
Book Value2.967.5837.0912.364.768.7320.1716.60


Baytex Energy Trust (BTE) and Enerplus Resources Fund (ERF) look especially strong by these measures, given the relatively low debt. That is proving very valuable in this tight-credit environment.

Operations (Projected):



Company*ENTAAVBTETHEPVXPGHERFPWE
Cash Flow From Operations$48.13M$272.9M$333.28M$520.04M$484.35M$803.19M$891.19M$1.40B
Levered Cash Flow$23.75M$162.58M$368.34M$740.45M($830.26M)$404.32M$320.36M$541.95M
Dividend PayoutNIL – suspended as of 9/2007.$161M$232.6M$461.24M$309.19M$560.87M$632.87M$1.27B
Payout RatioNA59%70%89%64%70%71%91%
Dividend YieldNIL19.8015.6030.5019.8021.3015.6019.60
Capex $40M$250M$180M$240M$233M$387M$580M$900M
Production10,000 boe/day34,000 boe/day39,500 boe/day56,820 boe/day28,000 boe/day82,000 boe/day98,000 boe/day195,000 boe/day
Operating Netback per boeC$33.59NANAC$32.78NAC$43.11NANA
Oil/Gas Split37:6337:6376:2471:2949:5150:5039:6157:43


Pengrowth Energy Trust (PGH) shines here with a good dividend yield and payout ratio and sizable balanced production.

Reserves:


CompanyENTAAVBTEHTEPVXPGHERFPWE
P&P Reserves26.9 mmboe152.2 mmboe168 mmboe221 mmboe101 mmboe320 mmboe440 mmboe750 mmboe
Oil and NGLs10.9 mmboe61.1 mmboe143.27 mmboe154.7 mmboe50 mmboe160 mmboeNA427.5M
Natural Gas16 mmboe91.1 mmboe24.73 mmboe66.3 mmboe51 mmboe160 mmboeNA322.5M
Oil/Gas Split40:6040:6085:1570:3050:5050:50



57:43
Reserve Life Index (RLI)7 years.12.1 years.12.3 years.10 years9.7 years10.4 years12.4 years 10.3
Others255,513 acres undeveloped land5 years of RLI is conventional.5B barrels Original Oil In Place (OOIP).550,000 net acres undeveloped. 4B barrels Original Oil In Place (OOIP)Sizeable mid-stream business.Sizeable Enhanced Oil Recovery (EOR) options.None.4.5M net undeveloped acres.


Enerplus Resources Fund (ERF) shines here with an outstanding reserve life index (RLI) of 12.4 years and sizable reserves.

Hedging:


CompanyENTAAVBTEHTEPVXPGHERFPWE
Natural GasNone2009 – 37% at C$8.38NoneNA20%2009 - Approximately 62,782 mmbtu per day hedged at Cdn $7.99 per mmbtuNA2009 – 19%. Collars: $11.27 and $7.88
Oil2009 - 1000 bbls economically hedged2009 – 7% at C$94.322009 – 25% majority at WTI * 0.67NA – 75% hedged in 2007.20%2009 - Approximately 10,000 bbls per day hedged at Cdn $84.62 per bblNA2009 – 30%. Collars: $110.21 and $85


Many of these companies do not publish detailed hedging figures making it difficult to gauge how these firms fare by this measure. In general, using collars to cover both upside and downside seems a good strategy and Penn West Energy Trust (PWE) is doing the right things in this regard. The challenge for these firms is to establish hedging in a cost-efficient manner.

Valuation:


CompanyENTAAVBTEHTEPVXPGHERFPWE
As a multiple of P&P reserves9.9610.4210.717.65*8.12**11.8111.1113.12
Relative to current yieldNA4.626.413.285.054.456.415.10
As a multiple of levered cash flow11.288.654.894.44NA9.3615.2818.16
As a multiple of Book Value (BV) based on 10% calculation0.360.762.220.801.281.191.210.96
As a multiple of per flowing barrel oil equivalent26780429414557029750*29285**460974989850462

  • *Assumes HTE downstream asset valuation to be $1.6B, the purchase price at the time of the acquisition.
  • **Assumes a PVX midstream asset valuation at one-times revenue.
  • Stock Prices taken as of 11/07/2008

Harvest Trust Energy (HTE) and Provident Energy Trust (PVX) seem especially attractive by these measures. These firms however are more difficult to value as they have sizable other businesses – The North Atlantic refinery in the case of HTE and midstream business in the case of PVX.

Summary:

There are several risk factors worth understanding before investing in these companies:
  1. Energy Prices: The firms specialize on mature upstream assets rendering those programs capital intensive and are profitable only when energy prices are high. In a worldwide slowdown, energy prices go down and these companies quickly become unprofitable as we are seeing now - The sum of the Finding, Development, and Acquisition Costs (FD&A) and the operating costs BOE varies between $35 (PGH) and $50 (ERF) for these companies is telling in this regard.
  2. Currency Risks: CanRoys sell their product in the world market in US dollars but their costs are in Canadian dollars. Consequently CanRoys commands a premium when US dollar is stronger than the Canadian dollar. The risk can be contained easily at a cost using currency hedging.
  3. Tax Law Changes: These trusts are negatively affected by a Canadian tax law change that comes into effect in the 2011 timeframe for existing trusts. When the tax-exempt status on distributions expires, the trusts will pay taxes like other regular corporations. The probable scenario is for the trusts to then act like regular corporations where the lion share of its cash flow for capital expenditures will be used to fund future growth in place of distributions. The shareholder base will also undergo a similar shift from income-oriented investors to growth-oriented investors before that timeframe. However, many of these CanRoys have significant tax pools that will help them delay the effects of tax law changes for an extended period of time. A related uncertainty is whether these companies will qualify for the proposed Canadian Corporate Tax Reduction Act. For US investors, another risk factor is possible tax increases with respect to foreign tax credits and/or dividends.
  4. Provincial Royalties: Alberta recently unveiled plans for increased royalties in the 2010 timeframe and this will directly affect profitability for many of these firms that have sizable operations in that area. A saving grace for these companies is that royalties are tied to the rate per well and many of the wells are lower rate and so the impact is contained.
There are sizable risks and the corporate structure will change dramatically for these companies as they move to be entities with low dividends. The trusts are valued low based on a number of valuation metrics. As such, investment in these companies is a good bet for long-term oil and gas demand and higher energy prices. It is a good fit in portfolios that need low-cap energy exposure for diversification purposes.

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