Numbers and News

Three more Canadian Edge holdings have come in with fourth quarter earnings: Northern Property REIT (TSX: NPR-U, OTC: NPRUF), Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) and Trinidad Energy Services Income Trust (TSX: TDG-U, OTC: TDGNF). Meanwhile, Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF) is the subject of some disturbing news.

Starting with Paramount, the bottom line is solid results for the fourth quarter and full-year 2007. Management also affirmed the current monthly distribution of 10 cents Canadian, equivalent to an annual rate of well more than 15 percent.

Paramount is foremost an aggressive bet on natural gas prices. All output is natural gas, and despite aggressive hedging, prices are critical for cash flow and, therefore, the distributions the trust can pay. That’s been bad news over the last two years, but times are changing.

Funds from operations (FFO) per unit dipped to 55 cents Canadian in the fourth quarter, from the prior year’s 69 cents Canadian. That figure reflected a lower realized price for natural gas but also a 28 percent increase in outstanding shares to cover the cost of last year’s massive purchase of reserves and producing properties from US utility Dominion Resources.

That deal has already increased Paramount’s output by 11 percent. But the biggest impact will be in coming quarters, as the trust boosted its proved reserves by 66 percent and nearly doubled its proved plus probable count. Land holdings were hiked 40 percent, with undeveloped land increasing 57 percent.

The trust should also get a lift in 2008 from the conservative stance it took in 2007 to shepherd cash flows for further capital spending, for which the opportunities on the new lands are substantial. Paramount’s fourth quarter payout ratio was low at 55 percent of distributable cash flow.

Ultimately, this one is about natural gas prices. And happily the outlook for these is the most bullish it’s been since the fuel’s slide began two years ago. That means higher cash flow in 2008. 

In fact, the trust has already locked in substantially higher prices for a portion of projected output. Given its development needs, I don’t view a distribution increase likely at this time. But improved prospects are certainly welcome news for Paramount’s battered share price. Paramount Energy Trust remains a great aggressive bet on gas up to USD10.

Note that the rest of the oil and gas trust universe is also benefiting from higher natural gas prices in 2008—which is the main reason we’ve seen solid gains in stronger trusts, such as ARC Energy Trust (AET.UN, AETUF). For information on these, see the March Canadian Edge.

As expected, Trinidad Energy Services reported strong results at its growing US operations, balanced by weaker results in Canada. Overall cash flow per unit for 2007 was flat with 2006 totals, though the payout ratio based on last year’s distribution crept up to 66 percent.

As noted in the March CE and prior flash alerts, that payout ratio is pretty much moot at this point because Trinidad has elected to convert to a corporation. That decision resulted in a halving of the distribution, with the objective of using the cash to expand more rapidly in the very depressed North American energy services industry.

The actual payout ratio based on projected 2008 cash flows is now less than 30 percent, making it very safe despite still-turbulent market conditions and the risk that a US slowdown will eventually hit energy prices. Encouraging, utilization rates at Trinidad’s US rigs were actually higher in 2007 than in 2006 at a robust 85 percent. That, plus a 71.9 percent boost in US rig operating days because of expansion, offset a huge drop in Canadian rig usage from 62 to 43 percent.

Higher natural gas prices will take longer to affect energy service trust cash flows than producers’ because boosting rig rates will require decisions by producers to spend more to increase output. It’s a good sign, however, for a trust that’s expanding rapidly and has solved its 2011 taxation risk problem. Trinidad Energy Services Income Trust remains a buy up to USD14.

Now for Arctic Glacier’s less-positive news: As I wrote in the March 10 Flash Alert, the trust’s very strong fourth quarter numbers were almost immediately overshadowed by the announcement of a US Dept of Justice (DoJ) investigation of its industry.

As reported then, Arctic didn’t appear to be a target of the probe, which involved a raid of the corporate offices of rival Reddy Ice (NYSE: FRZ). That still appears to be the case, and management maintains it’s cooperating with the investigation.

Unfortunately, the trust may now have a problem on the Canadian side of the border. The CEO of smaller rival Polar Ice—which settled a claim for $50,000 against Arctic for alleged predatory behavior in the Edmonton, Alberta, market—is trying to make waves again by getting involved in the US case.

As I wrote earlier this week, DoJ investigations are pretty much impossible to forecast unless you have inside knowledge or are somehow clairvoyant. That may be doubly true this year, as the department confronts the possibility of a Democratic White House in 2009 even as it takes heavy fire from congressional Democrats.

On the face of it, it’s very hard to argue there’s a monopoly on ice production because almost every refrigerator sold has that capacity. But on the other hand, Arctic is several times the size of its largest competitor in most markets, and an investigative victory—no matter how small—could be big for DoJ careers in a political year.

In any case, this ups the ante. An awful lot will have to happen to really hurt Arctic, given its strong business and good numbers. And the market is already pricing in a lot of bad things that are still unlikely. But the resulting uncertainty is enough reason to downgrade Arctic Glacier Income Fund to a hold, pending further developments.

It’s also worth pointing out that just because a trust’s price has come under pressure doesn’t necessarily mean there’s anything wrong with the business. That lesson was made clear again by the strong earnings reported by Northern Property REIT, which investors have for some reason seen fit to dump lately.

The REIT’s 2007 distributable cash flow (DCF) per unit surged a robust 10 percent, as commercial vacancies fell again to just 1.9 percent, not including properties under renovation. Fourth quarter DCF-per-unit growth actually accelerated 15 percent to 45 cents Canadian, pushing the payout ratio down to 80.2 percent including the 7 percent distribution hike in November.

Northern’s strength remains its successful strategy of building out into markets in Canada’s more remote regions and adding to its base of blue chip clients. It completed CAD189.7 million in purchases last year, all of which will add further to 2008 cash flows and distribution growth. That’s pretty compelling for a REIT yielding nearly 8 percent, which is treated like a qualified dividend for US investors.

And there’s no 2011 tax risk either. Take advantage of the mindless selling to lock up Northern Property REIT at USD25 or lower.

Note that the market action today has also turned positive for another scorned high-quality trust, Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF). The trust yields more than 9 percent and continues to grow DCF at a double-digit rate.

Take advantage of those who’ve lumped it in with battered US directory companies, with whom it has little in common. Buy Yellow Pages Income Fund.