Low payouts cut risk for these royalty trusts

Royalty trusts with natural gas exposure are mostly down lately, as higher North American production and lower oil prices have prompted natural gas prices to move down from their highs of $13.50 per million British thermal units in July, to $8.18 U.S. today.

These three royalty trusts are cheap in relation to cash flow, based on the latest quarter. If natural gas and oil prices remain low, it would lower cash flow among royalty trusts — but these royalty trusts still have good value, even at lower cash flow levels. Moreover, all three royalty trusts pay out a relatively small percentage of their cash flow to unitholders, so the risk of a distribution cut is low if oil and gas prices drop further.

ZARGON ENERGY TRUST $21.75 (Toronto symbol ZAR.UN; SI Rating: Speculative) (403-264- 9992; www.zargon.ca; Shares outstanding: 18.2 million; Market cap: $395.6 million) has oil and gas production assets in Alberta, Manitoba, Saskatchewan and North Dakota. Output is weighted 54% toward gas and 46% to oil.

In the three months ended June 30, 2008, Zargon’s production rose 9.1%, to 9,239 barrels of oil equivalent per day, from 8,465 barrels. However, cash flow per unit rose 47.6%, to $1.55 from $1.05 a year earlier on sharply higher oil and gas prices. Zargon’s monthly distribution of $0.18 gives the units a yield of 9.9%.

The trust flowed just 35% of its cash flow through to its unitholders in the latest quarter. The units now trade at around 3.5 times forecast cash flow based on the latest quarter. Debt of $85.4 million is equal to just under three quarters’ cash flow.

Zargon Energy is a buy.

TRILOGY ENERGY TRUST $10.75 (Toronto symbol TET.UN; SI Rating: Speculative) (403-290-2900; www.trilogyenergy.com; Shares outstanding: 95.4 million; Market cap: $1.0 billion) holds oil and gas properties in the Kaybob and Grand Prairie areas of central Alberta. Production is weighted 79% toward gas and 21% to oil.

In the three months ended June 30, 2008, Trilogy’s cash flow per unit rose 26.8%, to $0.71 from $0.56. Production rose 3.6%, to 21,195 barrels of oil equivalent per day, from 20,467 barrels.

Trilogy’s monthly distribution of $0.10 gives it a yield of 11.2%. It flows approximately 34% of its cash flow through to its unitholders. Debt is reasonable at $341.3 million, or 34% of market cap. Trilogy now trades at around 3.8 times its latest cash flow.

Trilogy is still a buy for aggressive investors.

TRUE ENERGY TRUST $3.87 (Toronto symbol TUI.UN; SI Rating: Speculative) (403-264-8875; www.tketrust.com; Units outstanding: 79.2 million; Market cap: $306.5 million) produces oil and gas mostly in Alberta and Saskatchewan. About 65% of its production is gas.

In the three months ended June 30, 2008, Trilogy’s production fell 30.4%, to 11,922 barrels of oil equivalent per day, from 17,122 barrels. The decline came as the company sold its oil and gas assets in Saskatchewan to focus its operations in Alberta. Cash flow per unit was $0.33, down 29.8% from $0.47. The shares now trade at 2.9 times cash flow.

True’s monthly distribution of $0.04 gives it a yield of 12.4%. It flows about 59% of cash flow through to its unitholders. The company used the proceeds of its asset sales to cut its debt to $205.7 million, or 67% of market cap, from 81% at the end of 2007.

True Energy is still a buy for aggressive investors.