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The safest income trust is an energy trust

It may seem surprising that anyone would recommend an energy trust nowadays, but this U.S. expert actually likes three energy investments.

If someone were to tell you with a straight face that the safest of all income trusts is an energy trust, you might respond with a smirk.

But someone is telling us that, and he’s America’s foremost expert on Canadian income trusts.

The expert is Mr. Roger Conrad, and the trust is Vermilion Energy Trust (TSX-VET.UN; OTC-YLWPF). He recommends it as a solid buy to the readers of Personal Finance.

It certainly will not hurt Canadian unitholders of the trust that a leading American advisory gives it an enthusiastic thumbs-up.

But let’s back up a moment. Why is anybody recommending energy investments of any kind these days?

Oil prices have fluctuated somewhat lately, but the fact remains that they are more than $100 down from the highs they reached last summer and show few signs of getting anywhere near that lofty level again.

And natural gas is about 70 per cent cheaper than it was. So it’s no surprise that the energy sector has been knocked for a loop, says Mr. Conrad. “What’s more surprising is how successfully many companies are dealing with the stresses.”

In fact, he has two other energy firms to recommend as well. But we’ll start with Vermilion.

The income trust challenge

Vermilion has operations at home in Canada and in France, the Netherlands and Australia. Right off the bat, these locations give the company a certainly “safe-country” stability that other firms lack.

But it also gives the company a finger in a nicely diverse number of pies around the globe, another advantage. Natural gas comes from Canada and the Netherlands, oil from France and Australia.

For his American readers, Mr. Conrad stacks Vermilion up against the challenges Canada’s income trusts are facing today.

“Canadian income trusts have been cutting distributions dramatically over the past few months,” he points out. “Sharply lower energy prices have cut into cash flow, leaving management with a menu of distasteful choices: borrowing, scaling back operations or cutting payouts.

“The latter has the least negative impact on trusts’ ability to recover when energy prices do, but they’re also the most painful for investors in the short term.”

Vermilion, he announces, passes the test on all three counts.

Little affected in 2011

“Happily for shareholders of Vermilion,” says Mr. Conrad, “the trust has thus far avoided all three steps. That’s thanks to an almost debt-free balance sheet, diversification in global markets and management’s strategy of keeping a rock-bottom payout ratio in the recent good times.”

That is, Vermilion played conservatively even when many others were lavishly distributing favours as if there were no tomorrow.

“Alone among major trusts, Vermilion has verified its 2009 cash flow will cover both its current distribution and planned capital spending at an average global price of $50 oil and $7 natural gas,” adds the analyst.

“Those are somewhat above current levels in North America, but certainly easily achievable. And only a steep plunge below those levels would seriously threaten Vermilion’s payout.”

But wait there’s more good news. “And Vermilion’s extensive overseas operations mean its distribution will be little affected by the 2011 tax on Canadian income trusts.”

So this American expert is perfectly confident recommending this Canadian income trust as the safest of them all.

A cut above

Safety is also the watchword with two other firms. These are both Super Oils, giant integrated companies with enormous resources behind them.

One is Eni (NYSE-E), the oil and natural gas multinational that is Italy’s largest industrial company. The other is the American giant Chevron (NYSE-CVX).

Both of these behemoths have the same advantages going for them, says Mr. Conrad. Their durability lies in their ability to make money on both the upstream end (production) and the downstream end (marketing, refining and distribution).

“Chevron and Eni are a cut above their peers by virtue of rising production profiles, which result from a bevy of prolific finds around the world,” explains this analyst.

“Earnings for both companies haven’t been immune from collapsing energy prices,” he admits. “Neither’s dividend or credit rating, however, is remotely in jeopardy, and both are in fact well positioned for potentially huge strategic moves as they prepare for the next upturn.”

That’s why they rest firmly in this advisory’s Income Portfolio along with Vermilion.

You’ll have noticed that the world hasn’t stopped using oil and gas. And it won’t in the foreseeable future. So if you’d like to tap into energy before prices rise again, pick a company that will pay you while you wait.