Maple Leaf Memo
Editor’s Note: Welcome to Maple Leaf Memo. This is a free e-zine we’ve developed to keep you posted on the current market happenings and update you on CE-recommended trusts between issues of CE. As a CE sub, you’ll receive Maple Leaf Memo every week (excluding CE issue weeks). You can also access it from the CE Web page.
You’d have to be a firm believer that a boom is coming to stick around for a while in Fort McMurray, Alberta, high up in the wilderness of northern Canada. On bad days, you’ll wait 45 minutes for your coffee at Starbucks, and foul-smelling smog clouds begin darkening the sky every afternoon, long before sunset.
On the better days, you can at least find a place to sleep. But if you want to live here, it’s a different story: A couch in the basement will set you back about CD500 a month.
Fort McMurray is hailing itself as the new Klondike, the capital of the late-19th century gold rush. The city’s inhabitants proudly proclaim themselves to be solving the world’s energy problems. And despite the inhospitable living conditions in the northern part of the province in winter, statistics show that the city’s population–currently at 61,000–rises by 100 newcomers every week. Many of the soldiers of fortune who arrive here are attracted by high wages, but it’s mainly oil workers who are drawn to Fort McMurray.
The draw? The lands surrounding this former Hudson Bay Co trading post contain oil–and lots of it.
It may not be the cheap, easily extracted stuff found in Saudi Arabia, but geologists claim that Alberta could well match the Middle Eastern oil exporter as far as quantity is concerned. Experts believe the accessible oil reserves here could total as much as a whopping 174.5 billion barrels–a volume greater than supplies in Iran and Libya combined. If the calculation is accurate, then Canada is No. 2 in the global ranking for oil reserves.
The dreams currently associated with Fort McMurray were triggered by massive oil sands–a thick, sticky mass that looks like waste oil dumped in a sand pit. During the brief Canadian summer, the oil has the consistency of syrup. In the winter, it’s hard as concrete.
Fields The Size Of Greece
The oil sands fields are the size of Greece. The plan to use this sediment to prolong the age of petroleum by several decades isn’t new. Companies have been struggling to extract petroleum from the oil sands for 40 years.
The undertaking hasn’t been particularly profitable for these oil pioneers; the production costs for a barrel of oil are higher in Alberta than anywhere else in the world. It costs about USD30 to transform the bitumen into usable energy.
But that hasn’t stopped almost every major oil corporation from
announcing its entry into the oil sands business. With the barrel price
at more than USD71, investing in Fort McMurray has become a worthwhile
endeavor. ExxonMobil, Shell, Chevron and Total
have arrived here, and two of the largest Chinese oil corporations have
also entered the business. Small-scale local businesses that secured
the extraction rights for themselves early on are being flooded with
takeover and merger offers.
The oil giants want to invest USD70 billion in these oil fields during
the next 10 years. Interest in nonconventional reserves has risen
dramatically. “A lot of people are realizing how important these
reserves are,” said oil expert Daniel Yergin, the founder of Cambridge Energy Research Associates.
And there are political reasons for the run on the oil sands, too. The Canadian government is fond of reminding people that this oil is located on the territory of one of the most stable democracies in the world and isn’t in the hands of Tehran, Iran, Caracas, Venezuela, or Moscow.
The greasy mix from Fort McMurray will “change the geopolitical situation,” the Ministry of Finance in Ottawa proclaimed proudly. The US–the world’s main consumer of petroleum–is, of course, also fascinated by the idea of having a friendly oil provider right next door.
The Sights, The Sounds, The Smells…Of Money
The US Senate has already sent a group of delegates to the area where the oil sands are located, and then-US Treasury Secretary John Snow also stopped by. The plan is for the oil sands to make up a fourth of North America’s petroleum production by 2015. “We will depend on our friends for energy security, not necessarily dictators and sheiks and rats from around the world,” cheered Montana Gov. Brian Schweitzer following a recent visit to Fort McMurray.
If there’s still any need to prove the hypothesis that the era of
easily extracted oil is nearing its end, then that evidence can be
found in Fort McMurray. Huge excavators with a capacity of 100 tons
scrape the tar sediment from the ground and deposit it onto giant
trucks. When they rumble off to one of the processing facilities, the
trucks weigh as much as a jumbo jet.
There the oil sands are heated with hot water and natron brine until
foamy bitumen forms on their surface and can be removed. The amount of
chemicals required is so massive that Fort McMurray is often plagued by
the biting stench of cat’s urine. The oil companies dismiss the
inevitable complaints by pointing out that “that’s what money smells
like.”
The bitumen content of the black earth can be as high as 18 percent. On average, 2 tons of sand yield one barrel of oil. The processing rate has now been raised to the point where a million barrels are produced every day, with plans to triple this output during the next 10 years.
But the largest reserves lie deep underground. They can’t be accessed using straightforward, open-pit techniques. To extract the deep reserves, hot steam is forced into the strata of oil sands. This liquefies the bitumen to the point where it can be suctioned off. Companies are developing technologies that would enable them to lower huge radiators into the ground in order to heat up the bitumen and make it easier to extract.
But even the present ecological side effects of this latter-day alchemy are controversial. For every barrel of oil produced, up to five barrels of water are consumed. The toxic broth swashes about in giant lakes. Cannons constantly fire into the sky to scare migratory birds away from the poisonous mix.
Environmental Impact
What’s worrisome is that the Canadian government is no longer able to meet the targets for emissions reductions it set when it signed the Kyoto Protocol. Experts have calculated that emissions in areas with oil sands will continue to rise.
By 2015, the area around Fort McMurray is expected to produce as much carbon dioxide as all of Denmark. But Charles Ruigrok–the head of Syncrude, one of the oil sands industry veterans–shrugs off the problem: “I believe technology will fix it.”
Even if that prediction doesn’t come true, Canada is unlikely to curb petroleum extraction for ecological reasons. The economic boom in the north has spread to the entire Alberta province. The province that used to be Canada’s problem child is now experiencing a change in fortunes. Alberta is debt-free and doesn’t even impose sales tax on its residents.
Just to make sure the new wealth doesn’t go unnoticed, Alberta Premier Ralph Klein has opened up the public treasury to the province’s citizens. In January, residents received “rebate” checks for CD400 that people here have endearingly dubbed “Ralph Bucks.”
The Round-UpEarnings are now in for Canadian Edge Portfolio trusts. By and large, the news was very good and has been reflected in the recent rise in share prices for our recommendations.
What we’re most looking for in trusts’ earnings reports isn’t any specific number or whether it made guidance or Bay Street estimates. Rather, it’s whether or not the trust in question is becoming a more valuable business and is worth holding for a rising stream of dividends.
The good news: Even the weaker trusts in the Portfolio mix measured up in the second quarter. That’s good news; it means we can continue to hold each of the shares below with confidence.
Note some are safer than others, while some have greater growth potential. Make sure you’re holding the trusts that are right for you, and be sure to maintain a diversified portfolio. That way, your overall portfolio will avoid taking a major hit if there’s a problem in a particular sector.
As has been the case for some time, the sector most at risk to a violent reaction at any time remains oil and gas producers. This is still the sector that attracts most US investor dollars, and it remains the sector most prone to panic selling, particularly trusts that trade on the New York Stack Exchange (NYSE).
The best way to protect yourself and get the benefit of owning high-yielding Canadian trusts is to diversify outside the oil and gas sector into some of the buy-rated trusts below. I’ll have more on each of these in the upcoming September issue of Canadian Edge.
Note payout ratios and growth in outstanding share numbers are presented in the How They Rate table on the Canadian Edge Web site. We’re in the process of updating the numbers for other trusts.
Algonquin Power (TSX: APF.UN, OTC: AGQNF) increased
its power output by 4.7 percent in the second quarter, largely the
result of better water flows to its hydroelectric plants. Funds from
operations (FFO) were off slightly, pushing the second quarter payout
ratio to 100 percent of distributable cash flow. The power plant fleet
and wastewater businesses, however, remain exceptionally healthy. That
should safeguard the dividend. Algonquin power is a buy up to USD9.
Altagas Income Fund (TSX: ALA.UN, OTC: ATGUF) announced a 3 percent boost in its dividend, along with a solid 14.3 percent jump in FFO per share over year-earlier levels. Strength at the trust’s power, resource extraction and transmission operations offset weakness at the gathering operations due to a now-resolved issue and seasonal weakness. The pattern at the trust has been weak second quarter earnings followed by explosive results later in the year. That’s what I expect to see this time, as the trust expands its business and holds its margins. Buy Altagas up to USD26.
ARC Energy (TSX: AET.UN, OTC: AETUF) saw its cash flows rise 50 percent as higher oil prices and a 12.6 percent increase in output offset lower natural gas prices. Not even mighty ARC is immune from the cost pressures now gripping the oil and gas production sector. But while slightly higher, the trust’s operating costs were well under control, particularly versus those of its chief rivals. All in all, it was another solid quarter for the strongest of all producer trusts. ARC Energy is a buy on any dip to USD24 or lower.
Avenir Diversified Income Fund (TSX: AVF.UN, OTC: AVNDF) nearly tripled second quarter sales from year-earlier levels, though FFO were flat versus the prior year due to a 67 percent increase in outstanding shares and the trust’s adjustment following the spinoff of its oil service operations this summer. Avenir’s income mix is now 40 percent oil and gas production–which boosted its output by 5 percent–with the rest being financial services and real estate. The latter are exceptionally steady, which offset flatter production results from the seasonally weak second quarter. Overall, the dividend was well covered, which should continue to be the case. Buy Avenir up to USD8 or lower.
Boralex Power (TSX: BPT.UN, OTC: BLXJF) enjoyed a 12 percent boost in its hydroelectric output. That offset maintenance costs at a thermal plant and kept the payout ratio in the low 80s, despite a large increase in shares to finance growth. The work on the thermal plant should be a major plus in subsequent quarters, as it boosted capacity by 11 percent. Boralex is a buy up to USD9.
Calpine Power Income Fund (TSX: CF.UN, OTC: CLWIF) continues to bear the burden of the bankruptcy of its parent Calpine Corp. The trust was forced to dip into its cash reserve in the second quarter to maintain its second quarter distribution, largely because of maintenance costs at its Calgary Energy Center. The plant is now back up and running, and its output is being contracted on a short-term basis, as management attempts to find a long-term buyer. Until there’s a long-term deal in place and the remaining bankruptcy issues are resolved, the trust’s dividend should be considered at least somewhat at risk. But the trust is also rapidly coming out of the woods. As a result, Calpine Power Income Fund is still a buy for aggressive investors up to USD9.
Canetic Energy (TSX: CNE.UN, NYSE: CNE) increased its revenue 92 percent over 2005 levels, largely the result of a spate of acquisitions. FFO per unit slid 2 percent, as a 131 percent increase in outstanding shares combined with the seasonally weak second quarter and a 23 percent drop in realized natural gas prices. Production was also slightly less than anticipated, despite being 75 percent higher than year-ago levels. Overall, the trust’s results should be viewed positively, though we want to see a few additional quarters to assess the success of the Acclaim/Starpoint merger, as well as other acquisitions. Canetic is a buy up to USD22.
Essential Energy Services Trust (TSX: ESN.UN, OTC: EEYUF) enjoyed a 183 percent jump in its second quarter earnings and boosted its cash flow margin from 25.4 to 25.6 percent of revenue. The oil services trust also lifted its earnings margin from 6.2 to 8.8 percent, a clear sign that rapid growth is flowing to the bottom line. The trust is enjoying growth at its full range of services, which are less cyclical than those of other trusts since they’re tied to existing–rather than new–wells. Management is keeping the payout ratio conservative. But Essential Energy Services is a solid buy for more aggressive investors up to USD9.
Fording Canadian Coal (TSX: FDG.UN, NYSE: FDG) has been all over the map since we originally added it to the Portfolio. Maintaining the current quarterly distribution of CD1 a share depends heavily on what happens to the price of metallurgical coal in coming months, a factor that’s beyond the trust’s control. But with production up from first quarter levels and the trust’s operational problems apparently largely resolved, that’s a speculation worth taking, at least for those who can handle the risk. Fording remains my highest-risk Super Yielding Portfolio pick up to USD35.
Harvest Energy Trust (TSX: HTE.UN, NYSE: HTE) has recently purchased both reserves (at a relatively high price) and a refinery with related assets (at an apparently low price). The jury will be out on the success of both deals until we see a few quarters of earnings out. But the trust did post strong second quarter earnings on a comeback in heavy oil prices. The payout ratio is now down to a more manageable 79 percent, and management anticipates that the refinery purchase will bring it down to the 50 to 60 percent range. Production of oil and gas together rose 75 percent over year-earlier levels, largely on the strength of the merger with Viking Energy. But the trust appears to be on the right track. Hold Harvest.
Keyera Facilities Income Fund (TSX: KEY.UN, OTC: KEYUF) was hurt by a 31 percent drop in contribution from its gathering and processing operations, which were hurt by extensive turnarounds at two facilities. Overall income, however, was solid thanks to very strong results and natural gas liquids infrastructure operations. That’s a testament to Keyera’s solid overall asset mix and a good reason to buy it on any dip to USD18 or lower.
Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) posted a 39.5 percent increase in second quarter cash available for distribution, as its oilfield services and industrial services segments showed strong growth. Both divisions also scored increases in profit margins, indicating that growth is flowing to the bottom line at this emerging environmental services giant. The trust’s results are particularly impressive in light of the 138 percent jump in maintenance capital expenditures over the year-ago period. Buy Newalta on any dip to USD28 or lower.
Paramount Energy Trust’s (TSX: PMT.UN, OTC: PMGYF) second quarter earnings clearly demonstrated why it was forced to cut its distribution last month. The trust suffered a 24 percent drop in cash flow per share from 2005 levels, almost entirely due to the decline in natural gas prices over the past year. Encouragingly, the trust recorded a 9.7 percent increase in natural gas output and continued to add to its hedged positions. But with the payout ratio still at more than 88 percent, Paramount Energy is best held only by more aggressive investors.
Peak Energy Services (TSX: PES.UN, OTC: PKGFF) saw its revenue rise 46 percent on an 18.9 percent jump in rig days over the year-earlier period. Cash available for distribution was off sharply, and the trust’s payout ratio ballooned to 500 percent. The second quarter, however, is a seasonally weak one traditionally, and the trust enjoyed good full-year payout coverage. The results were a little off-putting, considering other trusts were able to hold down their payout ratios. We’re not ready to give up on Peak yet, and we’re willing to see how third quarter earnings play out, which is a more seasonally strong time. But until then, Peak rates a hold.
Pembina Pipeline (TSX: PIF.UN, OTC: PMBIF) increased its dividend for the second time this year in summer, as its second quarter sales rose 15.4 percent and cash flow surged 17.3 percent. Both the trust’s portfolio of conventional pipelines and its oil sands transport projects continue to thrive, and it’s also spending heavily on growth projects that will enhance future profit. The trust’s midstream assets recorded a 71 percent jump in revenue. Buy Pembina up to USD15.
Penn West Energy (TSX: PWT.UN, NYSE: PWE) had a slightly disappointing second quarter, as daily production of oil and gas fell 7 percent. The trust’s cash flow per share was marginally higher, as higher realized prices for its output outweighed the dip in production and increased costs. Needless to say, we expect more from this high-quality trust, and we should get it beginning with the third quarter. In the meantime, the market seems to have ignored the results, pushing up the shares. Buy Penn West Energy on any dip to USD40 or lower.
Precision Drilling (TSX: PD.UN, NYSE: PDS) saw its second quarter revenue surge 42.4 percent as it enjoyed higher capacity rates both for its rental and service rigs. That was despite the seasonal weakness faced by drillers due to weather in Canada’s second quarter “mud season.” The trust also continued its expansion into the US and paid off CD179 million in debt, which should enhance growth in future quarters. Management’s payout policy remains conservative, which is a good thing in the current environment. But there’s more room for increases when it loosens up. Buy Precision up to USD38.
RioCan REIT (TSX: REI.UN, OTC: RIOCF) boosted its property portfolio occupancy to an all-time high in the second quarter at 97.3 percent. Perhaps more impressive, “anchor” tenants–generally the most creditworthy renters in Canada–accounted for 83 percent of its total revenue. The trust’s rising cash flow stream continues to fund a growing pile of dividends. Buy RioCan, the strongest of Canadian real estate investment trusts, up to USD20.
Summit Properties (TSX: SMU.UN, OTC: SEIFF) continues to add to its profitable portfolio of light industrial properties in fast-growing Edmonton. The trust’s facilities in the province are now 98 percent occupied. Such solid results enabled management to cut debt back to 50 percent of capital once more and boosted same store sales by 9.1 percent in the quarter. Summit remains a buy up to USD22 for conservative investors who want a stake in Canadian real estate.
Timberwest Trust (TSX: TWF.UN, OTC: TWTUF) had another solid quarter, as ice and snow continued to shut in rivals’ output and forced a greater reliance on higher margin sales of Douglas Fir. Real estate profits also helped the trust, which enjoyed an overall 130 percent increase in distributable cash flow and pushed its payout ratio down to just 58.5 percent. Canada’s victory in the timber wars over the US is another plus for the trust, which had been victimized by steep protectionist tariffs on this side of the border. Buy Timberwest up to USD13.50. Note the trust’s quarterly dividend isn’t withheld at 15 percent by Canadian authorities.
TransForce Income Fund (TSX: TIF.UN, OTC: TIFUF) posted a 16.1 percent increase in revenue, not including the charge to automatically pass through rising fuel costs. The trust continued to expand its base of transportation assets, including a to-be-constructed hub facility in the Toronto area. The shares continue to languish under the mistaken impression that higher fuel costs are doing them in, but results say otherwise. Buy TransForce, which yields more than 9 percent, up to USD17.
Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) continues to post strong results, recording a 35.8 percent jump in FFO. Management, however, remains very stingy with its cash flow, holding the payout ratio down to just 42 percent based on second quarter distributable cash flow. Instead, the trust has pushed its available cash into acquisitions, which should lengthen the life of the trust, such as the recent purchase of oil reserves in France. This is a high-quality play, but the yield is too low to consider purchases. Barring a dip to the mid-USD20s or a boost in the payout, Vermilion is a hold.
Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) increased its distributable cash flow by 11.1 percent as it continued to grow advertising revenue at its core print directory operation and record explosive growth at its new Internet-based services. Earlier this month, two analysts released a report detailing the trust’s loss of advertising pages in recent quarters and postulated that it meant Yellow Pages’ revenue base is in decline. Nothing could be further from the truth, however; revenue and cash flow continue to surge, boosting the distribution. As a result, now is a great time to pick up Yellow Pages up to USD15.
David Dittman is associate editor of Canadian Edge. Roger Conrad is editor of Canadian Edge.