“We do not expect to adjust our monthly cash distributions as a result of a conversion to a corporation.” Those are the words of Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF) CEO Gordon Kerr, spoken during the company’s fourth-quarter conference call. He also noted that Enerplus will convert to a corporation “around” Jan. 1, 2011.

Enerplus is Canada’s oldest income trust, and management fought as hard as anyone to keep the sector’s favorable tax laws in place. The affirmation of its dividend in the face of new taxes is further proof that, although the laws have changed, Enerplus’ pro-investor policies will endure. Equally important, its dividend is backed by an extremely solid underlying business that’s likely to grow cash flows substantially in coming years.

Like all oil and gas producer trusts, Enerplus’ income stream depends on three things: how much it produces, what it costs to get it out of the ground, and what price it fetches on the market. For much of the past couple years, at least two of these factors were working in concert against the company. Now the whole trio is lined up squarely in its favor.

Enerplus’ biggest acquisition of the past few years was of the former Focus Energy Trust in early 2008, a major producer of low-cost natural gas. That paid off in substantially increased production and cash flows, despite the fuel’s extreme up and down pricing moves. Management’s most recent major actions, however, have been to develop its existing properties in prolific areas such as the Bakken trend and in the oil sands, and to target acquisitions on new finds, such as the Marcellus Shale.

In 2009 the company acquired some 226,000 acres of land in three key areas: The Marcellus Shale gas trend, 78 net sections of Bakken/tight oil prospective land in Saskatchewan and North Dakota, and undeveloped land in the Deep Basin tight gas area of Alberta and British Columbia.

It also increased its best estimate of contingent resources associated with its Kirby oil sands project by 20 percent to 497 million barrels, bringing total gains to 100 percent since acquiring the lease in 2007.

The company ramped up capital spending markedly in the fourth quarter of 2009 and expects that trend to continue into 2010.

That will be partly funded by operating cash flow, which covered both 2009 distributions and capital spending by a comfortable margin, with an 87 percent “combined” payout ratio. The company also has an unused bank credit facility of CAD1.4 billion, and debt is just 0.6 times annualized cash flow, one of the lowest ratios of any energy company.

Overall daily production averaged 91,569 barrels of oil equivalent per day (boe/d) in 2009, beating full-year guidance of 91,000 boe/d, as the company added 11,500 boe/d of new output. This performance, however, masked major shifts in the company’s reserves and production inventory. For example, Enerplus sold approximately CAD100 million of assets in late 2009 and plans additional divestitures equal to 16 percent of current output. Those funds will also be available for redeployment in more promising core areas.

The company expects to spend 35 percent more on development in 2010 than 2009, spurred mainly by the improvement in crude oil prices. The lion’s share (CAD260 million) will be spent in Canada, with the other CAD165 million in the US. Approximately 55 percent will be spent on oil and 45 percent on gas. Coupled with divestitures, that adds up to roughly 86,000 boe/d for all of 2010, with an “exit rate” of 88,000 boe/d and more rapid growth thereafter, which would be further augmented by any further acquisitions.

As for reserves, the company suffered some devaluation, entirely due to the sharp drop in natural gas prices in 2009. Nonetheless, conservatively calculated net asset value comes up with a value of CAD31.84 per share, or nearly 50 percent above the trust’s current market price. Meanwhile, work at the company’s Marcellus properties has added more than 2.1 trillion cubic feet equivalent resources, providing the opportunity to more than triple Enerplus’ current proved plus probable (60 percent chance of development or better) reserves.

The shift will aid new production for Enerplus going forward. More important in the near term is the reduction in costs. Operating costs for the fourth quarter fell to just CAD9.27 per barrel of oil equivalent, and full-year costs averaged 4 percent below guidance of CAD10.20 per barrel.

Although the company’s efforts to develop shale gas and oil sands entail new development risks outside its traditional mature reserve base, it continues to manage costs effectively while maximizing prospective output.

The third factor–energy prices–was the culprit behind the trust’s shaving of its distribution from a mid-2008 high of CAD0.47 per month to the current rate of CAD0.18.

The company was able to generate CAD155.8 million in cash gains from hedging in 2009. Nonetheless, realized selling prices for natural gas were barely CAD4 in the fourth quarter, while for oil they were less than USD70.

The silver lining is that those are relatively easy numbers to improve on. Hedging is carried out on the forward curve for pricing, i.e. selling prices some months in the future. As a result, there’s no one-for-one correlation between trust cash flows and spot prices for oil and gas. Nonetheless, the direction in both the spot market and forward curve has been favorable in recent months for Enerplus.

Oil, for example, averaged somewhere between USD75 and USD80 in the first two months of the year, while gas has actually been over USD5 for most of that period. This suggests somewhat higher realized selling prices for Enerplus and other trusts in the first quarter, which should spur cash flows and a lower payout ratio, which is already moderate at just 51 percent based on fourth-quarter results.

One question I’ve received from many readers in recent months is why Enerplus units never seem to move past the low 20s. That may be starting to change now that the trust has set its post-conversion dividend policy in such a favorable way. But in any case, Enerplus units are a stark value, trading at a third less than conservative valuations for the trust’s assets in the ground. And it will continue to pay investors a more than 9 percent yield–leveraged to oil and gas prices and in inflation-hedged Canadian dollars–while we wait for the shares to rally.

Enerplus Resources Fund is still a super buy up to USD25 for income now and what should ultimately be explosive growth.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF) is virtually a Canadian Edge Portfolio charter member as Mutual Fund Alternative. As long-time readers well know by now, I almost always prefer buying individual trusts to “baskets,” be they exchange-traded funds (ETF) loaded up with the good, bad and ugly, or even well-managed closed-end funds. The six pack listed in How They Rate, however, are exceptions to the rule, particularly the two in the Portfolio: Blue Ribbon Income Fund (TSX: RBN-U, OTC: BLUBF) and EnerVest Diversified.

EnerVest Diversified has been through a couple of metamorphoses since we first added it to the Portfolio, having been bought by Avenir Diversified Income Trust (TSX: AVF-UN, OTC: AVNDF) and then sold a couple years later. In retrospect, the Avenir era was no disaster for the closed-end fund’s shareholders, but neither was it a particularly shining moment for pro-shareholder governance. Incentivized by Avenir to pump up the fund’s assets, EnerVest routinely engaged in dilutive moves, such as swapping its shares at a discount for those of other trusts. The result was a fund that generally produced decent returns but never lived up to its full potential.

That’s no longer the case after a series of moves by management over the past year and half. The fund still trades at a sizeable discount to net asset value of 14.67 percent, based on recent valuations. That’s a clear vestige from the days when management extracted larger fees and compensated by employing leverage. Today, however, it’s a far better indication of value than prospective risk.

For one thing, the expense ratio is now just 1.33 percent, far less than the vast majority of both closed- and Canadian open-end funds, which are not open to US investors.

The fund does employ leverage but is restricted from borrowing amounts greater than 20 percent of portfolio value and has a credit agreement with a limit three times its current debt employed.

As for EnerVest’s portfolio, it’s a fine collection of high-yielding fare, with top 10 holdings (Feb. 28, 2010) ranging from No. 1 Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF) at 3.7 percent of holdings to No. 10 Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) at 2.5 percent.

Eight of the 10 are buy-rated in How They Rate, and half are CE Conservative Holdings. Breaking it down by sector, oil and gas production comes in at 21.9 percent, energy infrastructure 12.7 percent, financials 11.1 percent, power 4.6 percent, real estate investment trusts 14.4 percent and bonds 12.2 percent.

The fund’s current distribution of CAD0.10 per month (paid approximately the 15th) looks very sustainable. It’s even roughly 2011-proof, as the bulk of holdings have either announced post-conversion dividend policies or won’t need to convert.

And there’s room for growth as well, with the current rate slightly less than half the CAD0.21 equivalent it once paid, accounting for a 1-for-3 reverse share split last April.

Investors are rightly slow to forgive an underperformer, and admittedly over the past five years there have been better investments. There have been a lot worse as well, however. And looking ahead, EnerVest Diversified looks on target to keep beating the broad Canadian market–whose prospects are better than average–as it has since new ownership implemented its changes. EnerVest Diversified Income Trust remains a buy up to USD13 for those seeking a fund of all things Canada.

Note that US investors are not permitted to exercise the warrants trading under the symbol “EIT.WT” on the Toronto Stock Exchange. These should instead be sold for cash.

For more information on Enerplus Resources Fund and EnerVest Diversified Income Trust, visit How They Rate. Click on the TSX symbol to go to the website of our Canadian partner MPL Communications for press releases, charts and other data. These are substantial companies, so any broker should be able to buy them. Enerplus is listed on the New York Stock Exchange. Meanwhile, EnerVest Diversified has a market capitalization of over USD1 billion and should be easily purchasable either on the TSX or the US over-the-counter (OTC) market. Ask your broker which way is cheapest.

Click on the trusts’ names to go directly to their websites. Enerplus is listed under Oil and Gas, while EnerVest Diversified is under Trust Mutual Funds. Click on their US symbols to see all previous writeups in Canadian Edge and its weekly companion Maple Leaf Memo.

Enerplus’ distributions are considered 100 percent qualified for US tax purposes, and they will be after the company converts to a corporation, slated for late 2010. EnerVest Diversified is a mutual fund; dividend taxability depends on the nature of the holdings. No conversion is required, other than what its holdings do. Tax information to use as backup for US filing–whether or not there are errors on your 1099–is available in the Income Trust Tax Guide.

As is customary for virtually all foreign-based companies, the host government–in this case Canada–withholds 15 percent of distributions paid to US investors at the border. If you hold these trusts outside an IRA, the tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can be carried forward to future years. Form 1116 recovery will also be possible after these trusts convert to corporations.

Distributions from both Enerplus and EnerVest Diversified should be exempt from 15 percent withholding, if they’re held in an IRA or other tax-deferred retirement account. That will also be true when they convert to corporations. For more information on IRAs and withholding, see Canadian Currents.