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OTTAWA (GlobeinvestorGOLD)—Got gas?
Investors looking to profit from high natural gas prices would do well to ask this question of royalty trusts. Most trusts in this sector have a mix of oil- and gas-producing properties, but some are more gassy than others.
Gordon Tait, an analyst with BMO Nesbitt Burns in Calgary, offers these examples of royalty trusts with a heavy emphasis on gas:
Mr. Tait divides this group into large- and smaller-cap entries, with PrimeWest and EnerPlus ranking in the former category. He says the benefit of a large-cap royalty trust is greater liquidity, or more competitive prices for buying and selling. Both PrimeWest and EnerPlus are listed on the New York Stock Exchange, which gives them wider exposure than their smaller-cap peers listed on the Toronto Stock Exchange.
In Mr. Tait's view, the main benefit of playing natural gas with royalty trusts is the monthly or quarterly distributions they pay. The amount of these payouts is tied in large part to prices for oil and gas.
"Distributions don't go up immediately in response to upticks in commodity prices," Mr. Tait said, "but when commodity prices are high you get paid pretty well."
Right now, commodity prices are high and investors are getting paid extremely well. At the beginning of June, Paramount and Shingingbank had yields in the 20-per-cent-plus range, while the remainder of the trusts mentioned above ranged between 13.6 per cent and 17.6 per cent. When you consider that a five-year guaranteed investment certificate now pays no more than 4.5 per cent and a 30-year Government of Canada bond yields about 5 per cent, you'll understand how impressive these royalty trusts yields are.
The question when you see double-digit trust yields is how sustainable they are. The higher the yield, the more skepticism there is that distributions can continue at current levels. If gas prices were to plummet, you can bet that gas-heavy royalty trusts would have to cut their distributions. Still, Mr. Tait says trust managers have been judicious in setting their current level of payouts.
"Trusts are reluctant to let cash distributions spike up because they know that spikes (in natural gas prices) don't last," Mr. Tait said. "You'll just have to bring distributions down and then everyone says, Oh, they're cutting distributions."
Trusts are primarily an income play, but royalty trusts in particular can also deliver impressive capital gains. With natural gas prices are buoyant as they have been, the unit price appreciation of the trusts mentioned above has for the most part ranged from impressive to astounding. Enerplus had a five-year cumulative gain of 46 per cent as of the beginning of June, Shiningbank was at 67 per cent and Advantage was at 480.7 per cent.
"Trading prices are at the high end of the valuation range based on our commodity price forecast," Mr. Tait said. "But I have to note that our commodity price forecast is under where commodity prices are now."
The message here for investors who are looking at royalty trusts as a way of capitalizing on high natural gas prices is that these trust already reflect the bullish state of this sector through both their unit prices and the level of their distributions. Is it too late to get in now? The answer depends on where you see natural gas prices going.
If prices were to decline sharply, royalty trusts would likely have to cut their distributions, which would in turn hurt their unit prices. But the status quo, or even a modest decline, might not hurt too badly at all.
"These are good commodity prices we're seeing today," Mr. Tait said. "Even if they fell a bit, royalty trusts would still make lots of money."
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.