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Why there’s still plenty of energy in income trusts

This U.S. advisory keeps four Canadian income trusts on its Master List of Stocks — and it has some fateful words on liquidity and loans.

Despite Mr. Flaherty’s infamous tax, income trusts still have plenty of fans on both sides of the border.

We see in the most recent issue of Superstock Investor that the newest position on Mr. Jeff Manera’s Master List of Recommended Stocks is a Canadian income trust. That makes four Canadian trusts among the 20 equities on the advisory’s Master List of Recommended Stocks. All four are in the energy field.

Properties with potential to produce

The latest addition is Enerplus Resources (TSX-ERF.UN; NYSE-ERF), which recently announced its deal to acquire 90 per cent of Kirby Oil Sands. “Enerplus already had a great portfolio of property with the potential to produce strong revenues and this just adds to the company’s value.”

We note with interest that a leading Canadian authority on the subject, the Income Trust Guide published by the Money Reporter, named Enerplus one of its three Best Buys for the month of May.

Interestingly, the Income Trust Guide did so in spite of rather tepid first-quarter results that serve to explain a modest 2.3 per cent gain in price. “But we think it’s more appropriate to assess Enerplus Resources over the long term, and rate it as a solid buy-and-hold for that long term.”

Enerplus has certainly been around for the long term, having been founded in 1986 and grown into a $6 billion enterprise. Its property portfolio is evenly balanced between resource plays such as shallow gas, oil sands and coal bed methane on the one hand and conventional oil and gas assets on the other.

But let’s return to Florida, where Mr. Manera’s advisory is published, and examine the rest of the income trusts on his Master List.

Before the boom

They are PenGrowth Energy Trust (TSX-PGF.UN; NYSE-PGH), Penn West Energy Trust (TSX-PWT.UN) and Primewest Energy Trust (TSX-PWI.UN; NYSE-PWI).

Aside from all starting with the letter ‘P’ they have several other things in common. All have been around for more than a decade (although Penn West only converted from an exploration firm to a trust in 2005) and all trade on the New York Stock Exchange rather than the more esoteric Over the Counter Board that hosts so many Canadian trusts in the U.S.

That is, they were all in business well before the income trust boom took hold and they have been attracting American investment dollars for some time.

Now that we have established Mr. Manera’s appreciation of energy trusts, it’s worth taking a look at his rather interesting take on the markets in general. He focuses on one key aspect of market activity — liquidity.

The slippery free ride

“The primary fuel keeping a floor under the financial markets remains the tremendous sea of global liquidity splashing around out there. Nobody can define exactly where the liquidity is coming from or what will shut the spigot off.”

One source is the currently much-discussed “Yen carry trade” (i.e., exchanging borrowed Japanese yen against a currency bearing higher interest).

Then there is the great wealth possessed by private equity and hedge funds, plus the “strong balance sheets of corporations bent on buying back their own shares (these widespread buybacks also remove inventory from the equity markets and artificially advance corporate earnings since there’s fewer shares to spread the earnings over).”

Not least, there are the ever-changing strategies of the oil producing and exporting countries: OPEC. The members of this organization “know their slippery free ride will be over some day (now that we know we’re ‘addicted to oil’ and supposedly going to do something about it) — and they’ve been taking their vast oil $billions and diversifying into just about anything except oil and energy.”

But liquidity can’t cure everything, according to Mr. Manera. “At some point liquidity will moderate and fundamentals will again start to matter.’

Dumb decisions

That will leave us with “some very real threats to the markets and the U.S. economy,” says Mr. Manera. Leading the way is the housing crisis. The subprime lending disaster (the unravelling of housing loans to those with poor credit ratings) will likely invade the supposedly solid territory of prime lending as well.

“What is it with big financial players?” he asks. “Why every decade or so is there some huge disaster brought on by really dumb decisions by the banks, savings and loans or large financial institutions?” He answers his own question. “One reason: it’s a lightly regulated industry in which players willing to manipulate the system can abuse it to reap huge rewards. The industry needs more regulation and oversight!”

Admittedly, it’s a tad unusual to find the editor of a market letter calling for more, not less, regulation, but Mr. Manera makes a forceful argument for sounder credit and less “lax underwriting.” He’s also certain that in the wake of this credit crunch, consumer spending (70 per cent of America’s GDP) must slow down.

“Couple that with the clear trends of a slowing economy and slowing corporate profits and we have something that needs a watchful eye and an intelligent, diversified and hedged portfolio with built in ‘disaster insurance.’”

That would be the advisory’s Master List. According to which, buying into a handful of Canadian energy trusts is the very opposite of a dumb decision.