Yield-seeking investors might want to consider a new breed of cross-border energy trusts, but should look beyond their hefty payouts.
While Ottawa killed a previous generation of income trusts in 2006 with new tax legislation, the current wave of trusts takes advantage of a loophole that exempts Canadian companies that own assets in the United States. Four trusts that have gone public since late 2010 now have robust yields ranging from 10 to 15 per cent.
Only Argent Energy Trust, an oil producer which listed last August, still trades above its initial public offering price (IPO) of $10 a unit. Other entries include the oil producer Eagle Energy Trust, as well as Parallel Energy Trust, which focuses on natural gas and liquids production, and Crius Energy Trust, which distributes energy to homes and small businesses.
The allure of the new trusts stems from the fact “the yields are higher, for the most part, than what you would find in Canada” from comparable dividend-paying energy companies, said Les Stelmach, a portfolio manager with Calgary-based Bissett Investment Management.
In addition, trusts with oil assets in the southern United States can benefit from higher commodity prices because they are closer to the refineries than firms operating in Canada. “You don’t have the same worries that you do in Canada about pipeline capacity,” Mr. Stelmach noted. “It’s the same for natural gas … which gets a higher price [south of the border] than in Alberta.”
But Eagle and Parallel have seen their units take a hit because of “growing pains,” said Mr. Stelmach, who holds stakes in those trusts, as well as in Argent, through his Bissett Canadian High Dividend Fund. He bought Eagle and Argent units during their IPOs, and snapped up more Eagle and Parallel units as their prices have pulled back.
Eagle, which drills for oil in Texas, has missed production guidance in its prospectus, while its payout ratio has grown higher than expected. But it appears to be turning the corner, said Mr. Stelmach, who bought more Eagle units after they tumbled below $7.
His bullish view on Argent and Eagle is based on his belief that oil prices will remain above $90 (U.S.) per barrel.
Mr. Stelmach did not buy units of gas-focused Parallel at the time of its IPO because he thought the units were too expensive. But he has been a buyer since the unit price tumbled to around $4. “They just have to prove some better operational consistency, and I think they should do reasonably well,” he said.
Parallel, which went public in 2011, missed initial production targets, and has been hurt by weaker prices for certain natural gas liquids. But the trust has purchased the 41 per cent of the West Panhandle Field in Texas that it did not own so it is now more in control of its own destiny, Mr. Stelmach said.
Argent Energy, which is drilling for oil in Texas and Oklahoma, has more potential upside than its peers because it has been growing organically, and has made “pretty good acquisitions,” he said. “It is the easiest one to own.”
Trusts with assets in the southern United States benefit from lower costs because they have access to wells nearly year-round, and don’t need to winterize equipment as energy firms in Canada do, Canaccord Genuity analyst Benny Wong noted in a recent report.
“We have the brightest outlook for Argent amongst the cross-border energy trusts at this time,” said Mr. Wong, whose target is $13 a unit. The trust is “poised to deliver on its targeted 5-to-10 per cent per annum growth,” along with an approximate 10 per cent yield, Mr. Wong added.
He also has a “buy” recommendation on Eagle with a target of $8.50 a unit. “We believe Eagle is in the process of turning things around,” he said. “The units currently pay a 14-per-cent yield, although we believe there will be compression as the trust continues to demonstrate the sustainability of its operations.”
His “hold” rating on Parallel Energy and target of $4 a unit stems from its history of guidance misses and operational hiccups. It is also the most “financially leveraged in our yield-paying energy and production universe,” he added.