Sep 10, 2009

The High Yield Royalty Trust

During the past five years, Canadian legislation has been pretty rough on companies that have decided to convert to income trusts. In the past, this had been a very advantageous situation for them, since distributions were not taxes by any government, whether it would be federal or provincial.

Royaly trusts tend to work a lot like income trusts, except that they must operate in the oil and gas business. Their most appealing similarity is that almost all of the income generated by their assets is distributed, on a monthly or quarterly basis and at a very advantageous 10% tax rate, to unitholders, thus generating a very interesting form of income.

As it happened for income trust, legislation has been passed by the conservative government to fully tax realty trusts starting in 2011. Depending of the result of the next federal elections, investors still have about a year to still take advantage of the their incomes from realty trusts.

The one that has charmed to me the most is Provident Energy Trust, which is, according to their financial statements, an open-end investment trust created to hold, directly and indirectly, all types of petroleum and natural gas and energy related assets, including without limitation facilities of any kind, oil sands interests, electricity or power generating assets and pipeline, gathering, processing and transportation assets. The Trust’s business activities are conducted through two business segments: Canadian oil and natural gas production (Provident Upstream) and Provident Midstream. Provident Upstream includes exploitation, development and production of crude oil and natural gas reserves. Provident Midstream includes processing, extraction, transportation, loading and storage of natural gas liquids, and marketing of natural gas liquids. The Trust’s oil and gas production business segment operates in Canada, and Midstream business operates in Canada and the United States.

With a 0.06$ monthly distribution and a unit price of hovering around 6$, this gives this trust a yield a little bit over 12%, which is a very reasonable rate of return in the current economic conditions. In the past, the unit price change has matched the changes in the distribution amount, always keeping the distribution yield between 10% and 13%. As the economy recovers and energy consumption increases, I expect to see the distribution amount raise back to historical levels, consequently making the yield even more interesting.

10-year target selling price: 13$

Disclosure: The author is long PVE.UN

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