If I were a politician, I would change my last name to Honestman. Now there's a name you can trust!
Even though they are about to become rarer than an honest politician, I believe that investors can still find trustworthy names among the Canadian royalty trusts (or "Canroys") before new tax rules take effect in January 2011.
Penn West Energy (NYSE: PWE ) has formed the nucleus of this Fool's long-term energy exposure for several years running, and below I will attempt to share my rationale for holding onto my own investment through the looming conversion from a royalty trust to a traditional corporate structure.
As the largest of the energy Canroys, and the leading producer of light and medium oil in western Canada, Penn West Energy possesses a scale, a well-diversified asset base, and even a track record of impressive growth that I believe will serve the company well through the looming transition.
What a long, strange trip it's been
The Halloween massacre of 2006, a steep sell-off in all Canroy shares following Canada's announcement of an end to their tax-exempt joy ride, presented an opportunity for entry into the red-hot energy sector that this Fool simply could not ignore. For the next two years, I patted myself on the back while collecting gorgeous monthly dividend payments for double-digit annualized yields.
Of course, my premature celebration of a stock well chosen was destined to be challenged.
When the floor fell out from beneath the energy markets in September 2008, Penn West units went along for the free fall with a gruesome 75% collapse in per-unit price to an adjusted March 2009 low of $6.07. Suddenly, that Halloween massacre didn't look very spooky anymore!
Unable to stomach selling these high-quality units at such a loss -- particularly in the face of what then became an annualized dividend yield of 22% -- I held this position straight through the commodity collapse and to the present day. Sure, the dividend payments have been chopped down substantially from their glory days; but at a present annualized yield of 8.5%, the monthly payouts have continued to provide a strong incentive to stick around.
All the while, Penn West piled multiple landmarks of strategic growth atop those lofty cash dividends by completing five acquisitions in less than three years. It is precisely that proven ability to achieve significant growth despite a hefty cash flow drain from those dividends that I believe makes Penn West a name Fools can trust through the conversion. When the company sets the new dividend later this year, I expect a sensible balance between growth and income to prevail.
The moment of truth approaches
Penn West will execute its conversion to a corporate (non-trust) capital structure at the end of this year, and the fine print regarding what to expect will be issued during the fourth quarter. Already, however, we have enough information to paint (with broad strokes) a picture of the resulting corporation.
For starters, income investors will be pleased to note that Penn West will not go the way of recent convert Enterra Energy, which axed its dividend altogether while making the switch to a growth-focused corporation under a new name and ticker symbol: Equal Energy (NYSE: EQU ) . Advantage Oil & Gas (NYSE: AAV ) , which jumped in front of the deadline by converting to a growth company midway through 2009, has underperformed Penn West units since that time on a total-return basis.
Particularly given the role that income undoubtedly played in attracting existing investors, I believe that maintaining at least a modest income component will prove a common characteristic of the more successful converts through next year and beyond.
Precision Drilling (NYSE: PDS ) , another recent convert that discontinued its dividend when making the switch from Precision Drilling Trust, has cited company debt as the primary obstacle to reinstituting a payout. Precision -- a popular five-star pick among Fools (with nearly 1,700 votes of confidence in CAPS) -- offered no specific guidance regarding when investors might look forward to a touch of income to accompany the onshore gas contract driller's solid growth prospects.
By contrast, the new Penn West will pay a sensible dividend after calculating sufficient cash flow to provide for both sustaining capital and growth capital. An explicit promise to continue payouts after the conversion formed a key element of this Fool's selection of Enerplus Resources Fund (NYSE: ERF ) as a vehicle for royal returns in natural gas.
Income is a handsome incentive, to be sure, but I see plentiful reasons to retain my investment in Penn West through the looming conversion.
Three more reasons to stick with Penn West
- Penn West has effectively replaced recent production, maintaining a stable reserve life index above 11 years. The company appears well-positioned to continue that success through highly prospective exploration assets. Current reserves of 687 mmboe feature an oil-heavy mix (69% of reserves).
- Following a strategic joint venture with China Investment Corp. (CIC), Penn West's Peace River oil sands project has effectively been fast-tracked for large-scale development by a massive injection of foreign capital. CIC picked up a 45% stake in the project, a 5% stake in Penn West units, and a substantial obligation to fund capital expenditures at the project. Now that oil has broken above $80 per barrel once more, we may find key oil sands plays like Peace River and the Fort Hills joint venture between Suncor Energy (NYSE: SU ) , Teck Resources (NYSE: TCK ) , and Total come back into focus.
- Producing about 165 mboe per day, Penn West is already the largest of the energy trusts heading into this conversion event. Sitting upon a $2.25 billion bank facility, and cash flow from operations that topped $340 million in the first quarter, Penn West enjoys the necessary heft to continue its role as a major consolidator of Canadian energy assets.
Has the impending conversion to a non-trust corporate structure altered your opinion of Penn West as a long-term investment in the energy sector? More than 1,350 members of Motley Fool CAPS believe that Penn West Energy will outperform the S&P 500 going forward. Please join our vibrant community of investors if you have not already done so, and share your own valuable perspective on this and other quality stocks.