pengrowth

We’ve mostly avoided resource income trusts, due to their generally low investment quality. But we made an exception for Pengrowth (Toronto symbol PGF.UN), which is the sole oil & gas trust we recommend in The Successful Investor. We made a second exception for Pengrowth by recommending it on two of our Portfolios: our Aggressive Growth Portfolio and our Portfolio for Income-seeking Investors. The trust’s high-quality oil and gas properties make it a reasonably safe investment, compared to our other Aggressive Portfolio recommendations. We think it stands to prosper if oil settles into a long-term $40 U.S. to $80 U.S. trading range as we expect....

Ottawa’s plan to tax trust distributions in 2011 led to big drops for most income trusts. But high-quality trusts like Pengrowth and Fording have rebounded nicely. We feel they will continue to pay aboveaverage yields, even after 2011. PENGROWTH ENERGY TRUST $20 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 247.0 million; Market cap: $4.9 billion; SI Rating: Average) produces oil and natural gas from properties in Alberta and British Columbia. Oil accounts for 55% of its production, while gas supplies 45%. Pengrowth recently merged with Esprit Energy Trust in an all-stock transaction. It also acquired several properties in Western Canada from U.S.- based ConocoPhillips for $1.04 billion. Together, these purchases increased Pengrowth’s reserves by 60%, and its production by 70%....

NOVELIS INC. $34 (Toronto symbol NVL; Conservative Growth Portfolio, Manufacturing & Industry sector; SI Rating: Average) is making progress phasing out price caps, which prevent it from passing along rising aluminum costs to its customers. But this will take several more years. The company feels it will be unable to pass along $230 million to $255 million in extra costs in 2007, and a total of $380 million to $430 million after 2007 (all amounts except share price in U.S. dollars). Novelis lost $1.38 a share (total $102 million) in the third quarter of 2006. Novelis has fixed its accounting errors, and the stock has moved up lately. It’s also doing a good job paying down debt....

Starting in 2011, Ottawa will impose a tax on income trust distributions that will put the income trusts on an equal tax footing with conventional taxable corporations. Trusts will pay a 31.5% tax on distributions to unit holders, so your cash flow from those trusts will fall by the same amount. However, if you hold trusts outside of registered plans such as RRSPs and RRIFs, you will not see a large change in your after-tax position — even though the distributions you receive will likely drop by 31.5%. That’s because the distributions will now be taxed as dividends and Canadians will benefit from the lower tax rates provided by the combination of the dividend tax credit and the dividend gross-up (foreigners don’t quality for the favourable dividend treatment). For example, in Ontario, investors in the top tax bracket now end up with about $536 after tax on each $1,000 of trust income. Under the new tax proposals, investors holding trusts outside of RRSPs will end up with about $532 after tax. The difference is roughly similar for the other provinces....

PENGROWTH ENERGY TRUST $19.42 (Toronto symbol PGF.B; SI Rating: Average) produces oil and gas in western Canada, as well as offshore Nova Scotia. In the three months ended September 30, 2006, Pengrowth’s revenue fell 5.5%, to $287.8 million from $304.5 million. However, cash flow per unit rose 8%, to $1.08 from $1.00. Pengrowth’s average daily production of 58,344 barrels of oil equivalent is weighted 44% toward oil and liquids, and 56% to natural gas. In the latest quarter, the company’s average realized price for oil was $72.61 U.S. and $6.29 U.S. for natural gas....

PENGROWTH ENERGY TRUST $26 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; SI Rating: Average) produces oil and natural gas, mainly from mature properties in Western Canada. It also owns 8.4% of a pipeline that transports gas from offshore platforms near Sable Island to Nova Scotia. Pengrowth prefers to replenish its reserves with acquisitions instead of exploration, which adds to its risk. But Pengrowth’s focus on high quality properties offsets this risk. In fact, Pengrowth’s current reserves should last at least 50 years. Thanks to an aggressive acquisition policy and rising energy prices, revenue jumped from $406.4 million in 2001 to $955.3 million in 2005. Earnings fell from $1.24 a unit (total $88.2 million) in 2001 to $0.63 unit ($57.0 million) in 2002, but rose to $2.08 a unit ($326.3 million) in 2005. Cash flow per share fell from $2.93 in 2001 to $2.54 in 2002, but grew to $3.87 in 2005....

PENGROWTH ENERGY TRUST $25.23 (Toronto symbol PGF.UN; SI Rating: Average) has merged its class ‘A’ and ‘B’ units into a single class of units. The new units trade under the symbols ‘PGF.UN’in Toronto, and ‘PGH’in New York. Changes to Canadian regulations made a second class of units unnecessary, and having a single class of units has advantages. In particular, it makes Pengrowth more liquid, so it’s easier for the trust to pay for acquisitions with units. For instance, the trust has just agreed to buy Esprit Energy Trust for roughly $1.1 billion in new units. Pengrowth unitholders will own 82% of the combined trust, while Esprit unitholders will own the remaining 18%. Natural gas accounts for 75% of Esprit’s daily production; the merger will increase Pengrowth’s natural gas weighting from 45% to 52%. Although gas prices have come down in recent months, prices will probably move up over the next several years....

PENGROWTH ENERGY TRUST (Toronto symbols PGF.A $27 and PGF.B $26; Aggressive Growth Portfolio, Resources sector; SI Rating: Average) is getting rid of its dual-class system of “A” and “B” units. It put the two classes in place to comply with Canada’s foreign-ownership requirements and maintain its tax treatment as a Canadian mutual fund trust. However, new rules let Pengrowth keep its Canadian trust status, regardless of its foreign ownership. Effective July 27, 2006, Pengrowth will convert the “A” and “B” units into a single class on a 1-for-1 basis. Prices of the “A” and “B” units have been converging as that date nears, as we predicted. Pengrowth is a buy....

PENGROWTH ENERGY TRUST $24.80 (Toronto symbol PGF.B; SI Rating: Average) produces oil and gas in western Canada. The company was one of the first Canadian royalty trusts, starting up in 1988. It’s now one of the largest energy trusts in North America. Pengrowth also holds an 8.4% interest in the Sable Offshore Energy Project. This project consists of six gas fields located near Sable Island, east of Halifax, Nova Scotia. In the three months ended March 31, 2006, Pengrowth’s revenue rose 21.7%, to $291.9 million from $239.9 million. Cash flow per unit rose 7.3%, to $0.88 from $0.82. Pengrowth’s average daily production of 58,825 barrels of oil per day equivalent is weighted 55% toward oil and liquids and 45% natural gas. In the latest quarter, the company’s average realized price for oil was $63.31 U.S. and $8.76 U.S. for gas....

Oil is currently trading at around $71 U.S. a barrel, not far from the record high of $75.35 it reached in April this year. Despite high inventory levels in the U.S., the world’s largest oil consumer, oil prices remain high. That’s largely due to fears of supply disruptions centered around Iran’s nuclear ambitions, violence in Nigeria, and political pressure on foreign companies in Venezuela. Natural gas prices, on the other hand, are now at around $6 U.S. per thousand cubic feet. That’s well down from the record high of $15.71 U.S. reached in December, 2005 in the wake of hurricane Katrina. An unusually mild winter led to lower withdrawals of gas from storage, leaving very high levels of inventory at the end of the heating season. It’s the highest level of inventories in the spring in Canada and the U.S. since 2003. High production levels brought on by continued record drilling activity have also pushed prices down. A number of natural gas weighted trusts have cut distributions — including Shiningbank Energy Income Fund. Royalty trusts weighted toward oil have kept their distributions high....