Canadian Investment Trusts

Canadian Investment Trusts: Why Trust a Canadian?
by Craig Walters
The Rude Awakening
Wall Street, New York
Thursday, November 17, 2005

Craig Walters explains the benefits of putting money into a Canadian Investment Trust.

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Eric Fry, reporting far from Alberta, Canada...

Here at the Rude Awakening, we like energy stocks and we
like high-yielding stocks. So a high-yielding oil stock
always piques our interest. Petrofund Energy Trust is just
such a creature. It is a Canadian investment trust with a
lengthy history of paying high dividends and making astute
acquisitions, as our colleague Craig Walters explains
below.

Ironically, immediately after putting the finishing touches
on today's column, the news crossed the wires that
Petrofund had made another acquisition. The company agreed
to acquire all the outstanding shares of Kaiser Energy
Ltd., a private Canadian company for C$485 million. The
transaction is expected to close on December 15, 2005.

"With this acquisition," the company's press release
explains, "Petrofund is acquiring approximately 5,400 boe/d
[barrels of oil equivalent per day] of almost 100% natural
gas weighted conventional production...The assets also
include 55,000 net acres of highly prospective undeveloped
land on which Petrofund has already identified 166 (net)
low to medium risk development drilling opportunities."

"The gas weighting of these high-quality long life assets,"
beams Jeffrey E. Enrico, Petrofund's President and CEO,
"combined with the significant upside potential from
development drilling and coalbed methane development
opportunities make this an ideal acquisition for the
Trust."

Trading in the stock was halted after the close of
yesterday's trading, pending the announcement of the
acquisition. So it is possible that stock's price action
may be much more volatile than usual when it reopens for
trading this morning. To learn more about what makes
Petrofund tick, read on...

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WHY TRUST A CANADIAN?
By Craig Walters

The 12% Letter's portfolio is made up of twelve income-
generating stocks. Some of them are real estate investment
trusts (REITs), some are business development/registered
investment companies (BDC/RICs), and some are just ordinary
common stocks. There are two stocks in the portfolio that I
think are typically less understood than all of the rest.

One of them, Petrofund Energy Trust (AMEX: PTF), currently
yields about 10% annually, while the other, Pengrowth
Energy Trust (NYSE: PGH), yields 11%. They are both
classified as Canadian Oil Trusts, and have generated both
excitement and confusion by investors. This month, we will
examine Petrofund and this particular type of investment
vehicle.

The term 'trust' is a legal term that means to hold an
asset for the benefit of another individual or group. A
financial trust buys property to hold for another party,
giving them the benefits of ownership while the trust
management actually owns it. The avoidance of taxes is the
primary motivation behind setting up trusts, and Canada has
been a better environment for this type of investment,
than, say, the United States - hence the popularity of
investment trusts north of the border.

Current tax laws in Canada exempt Canadian investment
trusts from paying taxes on all profits that are
distributed to trust unitholders. The unitholders pay taxes
on what they receive, but this avoids double taxation -
paying taxes on dividends already taxed at the trust level
- and actually increases the amount of the distribution
that ends up in shareholders' hands.

Canadian Investment Trusts: Petrofund

That's the good news. But because of this tax-advantaged
structure, investment trusts pay out so much of their
earnings in dividends that they have very little cash left
to invest in their operations. So if they want to acquire
or explore for more oil and gas production, they have to
sell more units of their trust, or increase their debt
load. Naturally, some trusts raise new capital and invest
better than others. Petrofund is one of the best in the
business.

Headquartered in Calgary, Alberta, Petrofund buys and
manages oil- and gas-producing properties mostly in the
western part of Canada. The trust has been in existence for
about seventeen years. While that doesn't seem like a long
time, it makes it one of the oldest publicly-owned
investment trusts in Canada. It's also noteworthy for being
the first Canadian oil and gas trust to list on the
American Stock Exchange.

The management team of Petrofund has been together for
nearly a decade. Throughout that time, the team has
demonstrated a talent for prudent and disciplined
acquisition of oil and gas assets.

Obviously, acquisitions keep the cash flowing to
unitholders. However, trusts can't just buy assets
indiscriminately, as capital is scarce and a poor
performing group of wells is best left unpurchased.
Petrofund typically looks for: 1) areas with mature
production, operations and longevity; 2) the bulk of the
reserves classified as 'proved producing;' 3) modest
capital expenditure requirements; 4) consistent cash
generation; 5) low-risk development drilling; and 6) an
experienced, competent production team. All of these
criteria are consistent with smooth cash flow delivery to
shareholders.

This acquisition strategy has done two very important
things for unitholders of Petrofund:

1) It has grown proved and probable reserves
consistently.

2) Dividends have remained stable. Since January 2004,
Petrofund has paid out a consistent C$0.16 per unit
to shareholders each and every month, then boosted
the monthly payout to C$0.17 per unit in October of
this year. Today, that's a yield that almost reaches
double digits.

And given Petrofund's substantial earnings generation,
dividend coverage is not a problem. Looking at it from a
free cash flow perspective, the trust brought in cash flow
available before capital expenditures in 1Q05 of C$71.7
million. In turn, the trust paid to unitholders C$47.9
million in distributions, for a payout ratio of about 67%.

That is well within our comfort range. Petrofund has about
C$220 million in long-term debt, which works out to be a
debt-to-equity ratio of about 25%.

At the current price of $17.48, Petrofund is trading for
about 14 times this year's estimated earnings. [Editor's
note: Back in February, when Craig Walters first
recommended Petrofund to the readers of the 12% Letter, PTF
we selling for $14.69, which means that that stock has
produced a total return (dividends plus appreciation) of
almost 28% since his initial recommendation].

Canadian Investment Trusts: Why We Love Petrofund

The primary reason we love Petrofund is because it does -
very well - the things it needs to do in order to grow its
business and satisfy its shareholders. At the end of 1Q05,
it had a very busy drilling program with seventy-three
wells drilled. Seventy of those wells were working-interest
wells and three were farmout wells. All told, this totaled
fifty gas wells, twenty oil wells, one service well...and
two "dry holes."

Since two wells proved worthless, the overall success rate
was 97%. Such a high success rate has made the trust more
aggressive in its drilling efforts, and the drilling budget
for the year is being increased by one-third.

The acquisitions that the trust is making are having a
significant positive effect on cash flow. In fact, cash
increased nearly 50% compared to 1Q04.

With Petrofund, we are making more of a financial call on
these shares than an industry call. If you buy at current
levels, you may be risking a drop in share price, but
you'll still be entering at a good yield with a good chance
of that being maintained. Still, oil and gas commodity
prices are going to affect Petrofund's cash generation, as
will exchange rates, and its ability to add new reserves
and sell product. We expect commodity prices and currency
rates to be as choppy next year as they have been last
year, so there could be some volatility ahead.

Furthermore, as more oil and gas trusts come into
existence, the competition for quality acquisitions will
intensify. Since Petrofund won't be the only one that has
to keep growing its reserves, the price for new reserves
will likely rise, while the overall quality will likely
decrease. Even so, high energy prices will mean high cash-
flow generation for Petrofund.

Net-net, Petrofund is one of the premiere names in the
Canadian investment trust universe: solid assets; solid
management team; solid dividend-payment history.

That's why Petrofund is one Canadian we trust!

[Joel's Note: Be sure to have a look at another Canadian
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astute readers. This is not a stock or an option...this one
comes straight from the Canadian Constitution and it's
flown under the radar for some time now. Find out how to
start collecting your checks here:

A Canadian you can trust

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[Joel's Note: You may have heard some whispering around the
traps a little while ago regarding the storming of Capitol
Hill. The impenetrable fortress that is the mindset of
politicians is about to find itself under siege. The chosen
arsenal for the assault is 527 copies of Bill Bonner and
Addison Wiggin's new book, Empire of Debt: The Ride of an
Epic Financial Crisis. That's one copy for every Senator
and member of the House and a special edition for the fed
head and Dubya himself. Each copy is accompanied by a
letter of introduction; call it polite warfare in an age
lacking in etiquette but replete with questionable methods
of enemy engagement.

If your politicians decline the invitation to read the
whole book (wake-up calls are not always welcomed in even
the most vigilant of political circles), the letter from
Addison points out a few of the pressing issues at hand for
Mr. Bernanke and his cohorts:

1) Consumer Credit has skyrocketed from $672.2 billion
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2) Outstanding household debt has grown $2.7 trillion to
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3) Domestic business debt shot from 1.9 trillion to 5.2
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We'll be sending reminders to the aforementioned Capitol
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We know you'll enjoy this one! Email me your thoughts on it, or any of our daily essays here at: aussiejoel@the-rude-awakening.com

Cheers,

jOEL

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And the Markets...