Energy trusts that keep the cash flowing
Not sure which energy stocks will come back with the price of oil, asks this U.S. expert? Try those that never left, including a Canadian trust.
Watching the price of oil bob up and down can give you a headache.
You can aggravate that headache by trying to figure out which energy stocks are a good buy again after a long stint in the desert. It’s not as though they’re all soaring up the charts.
One answer: buy stocks that didn’t leave their investors high and dry when the price of oil dried up. Or more accurately, buy trusts, including one from Canada.
That’s the recommendation we get from a leading American analyst, Mr. Roger S. Conrad, writing in Personal Finance.
A week ago, we reported Mr. Conrad’s bullish views on the best Canadian income trusts (see Daily Buy-Sell Adviser, October 20).
His views on the subject are sure to catch our eye, since he has made a special study of Canadian investments for many years (he also publishes a newsletter called Canadian Edge).
It’s also a reasonable assumption that his recommendations to U.S. investors will work to the advantage of the Canadian shareholders.
This time, he’s less interested in the general state of trusts than in a couple of energy investments that have rewarded investors all along, irrespective of the price of oil.
One of them happens to be his favourite oil and gas royalty trust, Vermilion Energy Trust (TSX-VET.UN; OTC-VETMF). The other is a U.S. partnership known as Linn Energy (NASDQ-LINE).
Robust distributions
Mr. Conrad devotes more time to Vermilion than Linn Energy, which is just as well. Linn is a limited liability partnership (LLC), meaning it is not tax-friendly for Canadians. But, with its Calgary counterpart, it stands as a solid example of how to be friendly to your unitholders.
Headquartered in Houston, Linn has a portfolio of long-life oil and natural gas assets in Mid-Continent America (Texas, Oklahoma and Kansas) and California.
Like Vermilion, it is a “flow-through” investment, Mr. Conrad explains. “Distributions are paid from pre-tax cash flows and therefore greatly exceed ordinary dividends paid by corporations.”
For both Linn and Vermilion, adds the analyst, those cash flows depend on how well they manage their cost and production. But they also rely heavily on the prices received for oil output, which is still down 50 per cent from last year, and natural gas, which is down 75 per cent.
But here’s where these two firms separate themselves from others. “That Linn and Vermilion consistently boosted distributions when energy prices rose is no surprise,” says Mr. Conrad.
“More impressive: Almost uniquely in the trust/partnership producer universe, neither has trimmed its payout in the past year. In fact, distribution coverage and finances are robust, and prospects for boosting production are rich.”
Here’s why Vermilion’s prospects look so bright.
The latest coup
Vermilion’s latest good news, Mr. Conrad says, comes “ironically” from Libya. The sale of its 42 per cent stake in Verenex Energy (TSX-VNX; OTC-VRNXF) will net it some $120 million from Mr. Qadaffi’s government.
“The deal with a government entity is worth somewhat less than a scuttled one with a Chinese company,” he adds. “But it’s enough to retire more than half of Vermilion’s long-term debt.”
The cash will likely come in handy supporting Vermilion’s production strategy, the analyst says. This strategy has several components. One consists of valuable oil and gas wells in Australia — a big window on Asian markets. It also includes wells in Western Europe (in competition with Russia) and in North America.
“Management’s latest coup,” the analyst informs us, “was the summer purchase of an 18.5 per cent interest in a field 83 miles off the northwest coast of Ireland.” Operated by Royal Dutch Shell (NYSE-RDS.A), the Corrib field should pump up Vermilion’s cash flow by 30 per cent.
Mr. Conrad sums up with three big check marks in Vermilion’s favour.
A solid bet
“Being able to sell energy into different markets and minimizing debt has insulated Vermilion’s distribution and balance sheet from crashing energy prices over the past year.”
This also ensures that the government’s plan to tax royalty trusts in 2011 will have “no impact” on Vermilion’s dividends, the analyst insists. The annual distribution stands at $2.28.
Not least, there’s the upside that higher energy prices are likely to bring with the global economic recovery.
“All that makes Vermilion a solid enough bet on energy even for the most conservative investors,” Mr. Conrad concludes. “Buy Vermilion Energy Trust up to US$30 if you haven’t already.” The price today is $26.77 in New York, $29 in Toronto.
When it comes to shareholder value, it appears that cash flow is even thicker than oil.
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