Zeroing in on energy trusts for sustainable income

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Investors in the trust sector are always worried their selections might crash and burn if companies unexpectedly slash their payouts.

To try to avoid those unpleasant surprises, Peters & Co. Ltd., the Calgary-based investment firm that specializes in the energy sector, has compiled a list of 13 trusts it believes are best positioned for "sustainable income," as the sector faces conversion into conventional corporation status at the beginning of next year.

In making its selections, issued in its latest Energy Update, the firm also weighed debt levels of the trusts and assessed the prospects for their operations.

The baker's dozen includes a variety of names from among oil and gas producers, oil field services companies, and those involved in energy infrastructure. Peters says its selections "provide the best opportunities for investors to gain income exposure."

"We're just looking for levels of sustainability from the distribution," says Peters analyst Jeff Martin, referring to the main reason for the selections.

The top picks among infrastructure plays were Inter Pipeline and Keyera, which have the best combination of sustainable distributions and the ability to generate free cash flow to support growth projects. Inter Pipeline gets the nod in part because it will be bringing on oil sands pipeline expansion projects over the next three years, while Keyera should benefit from strong margins in its midstream and marketing businesses.

Both companies have a forecast total payout ratio (a figure that includes dividends and capital expenditures) of less than 70 per cent of cash flow, according to Peters.

While their yields are lower than some competitors, the two trusts are the best positioned to maintain current distribution levels after becoming fully taxable entities, Peters said.

Among producers, the firm favours NAL Oil & Gas, Peyto Energy, Pengrowth Energy, Bonavista Energy, Crescent Point, Canadian Oil Sands and Baytex Energy.

Mr. Martin said these producers were selected based on having a good inventory of drilling prospects and a strong exploration and production focus.

If energy prices continue to rise, Mr. Martin said he expects companies will earmark the extra cash flow to finance growth rather than use the money to fund larger distributions.

The firm based its assumptions on oil prices averaging $83.98 per barrel and natural gas at $4.98 per million cubic feet, both figures in Canadian dollars, during 2011.

Rounding out the selections were four oil services sector entities: Black Diamond Group, a remote accommodation provider; Phoenix Technology, a horizontal and directional driller; Trinidad Drilling, a drilling equipment company; and Mullen Group, which besides having a large logistics and trucking division is a transportation provider in the oil and gas sector.

Among the trusts it follows, Peters ranked as "underperform" only one - oil and gas producer Penn West Energy.

Top Energy Trust Picks for Sustainable Income