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Steady production supports high payout

PENGROWTH ENERGY TRUST $11 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 291.3 million; Market cap: $3.2 billion; Price-to-sales ratio: 2.1; Dividend yield: 7.6%; SI Rating: Average) is one of North America’s largest energy royalty trusts. Its main properties are in Alberta, B.C. and Saskatchewan. The trust also holds interests in other energy projects, such as its 8.4% stake in the Sable Offshore Energy Project, which operates three offshore-drilling platforms south of Nova Scotia.

Roughly 60% of Pengrowth’s production is natural gas. The remaining 40% is oil. Investors see this a negative in light of today’s low gas prices. However, a colder-than-normal winter could cause gas prices to shoot up again. Pengrowth’s focus on proven properties with large reserves and predictable production rates also tempers its risk.

New properties spurred revenue jump

Pengrowth’s revenue rose 83.2%, from $955.3 million in 2005 to $1.8 billion in 2008. The jump was largely due to acquisitions, including the $1 billion of properties Pengrowth bought from U.S.-based oil company ConocoPhillips in January 2007. However, lower oil and gas prices caused the trust’s 2009 revenue to fall 44.2%, to $977.4 million.

Despite the higher revenue, earnings fell 28.4%, from $2.08 a unit (or $362.3 million) in 2005 to $1.49 a unit (or $262.3 million) in 2006. Thanks to the ConocoPhillips properties, earnings rose 50.9%, to $395.9 million in 2008. Pengrowth typically issues new units to pay for acquisitions. As a result of more outstanding units, its earnings per unit rose 6.0%, to $1.58 in 2008. In 2009, earnings fell 79.8% to $0.32 a unit (or $84.9 million).

Cash flow per unit fell from $3.93 in 2005 to $3.15 in 2006, but jumped to $3.65 in 2008. In 2009, cash flow fell 42.7%, to $2.09 a unit.

Gas field offers long-term potential

Pengrowth continues to expand through acquisitions. In September 2010, it bought the 82% of Monterey Exploration Ltd. that it did not already own for $366 million of units, which it issued to Monterey investors. Monterey produces oil and natural gas at properties in Alberta and B.C.

Pengrowth plans to spend $65 million to develop Monterey’s promising Groundbirch unconventional gas field in northeastern B.C. Unconventional fields cost more to develop than regular deposits, but can last decades longer. The trust will spend a total of $350 million on exploration in 2010.

Pengrowth’s units trade at a high 32.4 times its depressed 2010 earnings estimate of $0.34 a unit. However, they trade at a much more reasonable 5.1 times its forecast cash flow of $2.17 a unit.

Distribution safe for now

The trust will convert to a corporation before Ottawa starts taxing income trusts at the start of 2011. Pengrowth has $2.7 billion in tax pools it can use to offset the new taxes. As a result, it plans to maintain its current annual payout of $0.84 a unit, for a yield of 7.6%, for several years.

Pengrowth is a buy.