This royalty trust’s payout should stay high

On January 1, 2011, Ottawa will impose a tax on distributions of income trusts and royalty trusts. (Royalty trusts are a form of income trust. They profit from royalties associated with the sale of oil, natural gas or minerals.) The new tax will put income and royalty trusts on an equal tax footing with regular corporations.

However, as we note in a just-published issue of The Successful Investor, one royalty trust has an enviable advantage when it comes to dealing with the new tax.

This royalty trust’s tax losses will help maintain its high yield through 2011 and beyond

Oil and natural-gas producer Pengrowth Energy Trust (symbol PGF.UN on Toronto) will convert to a corporation before Ottawa starts taxing income trusts at the start of 2011. However, the royalty trust has $2.7 billion of tax losses on its books. It can use these to offset the new tax for several years.

That, along with its steady production, should help Pengrowth maintain its current annual payout of $0.84 a unit, for a yield of 7.6%.


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2011 advantage only one of this royalty trust’s strengths

Pengrowth 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, including an 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. Pengrowth prefers to focus on proven properties with large reserves and predictable production rates. The trust has interests in six of western Canada’s top nine oil-producing areas. At current production rates, Pengrowth’s reserves should last 10.6 years.

New gas field boosts this royalty trust’s 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 likely 2010 earnings 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.

You can get our latest buy/sell/hold advice on Pengrowth and 14 other high-quality companies in the latest issue of The Successful Investor. Even better, if you act now, you can get this issue absolutely free. Click here to learn how.

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