RE: Capital gains in payoutEIT.UN is a substantial part of my portfolio, and represents my trust investment. Having said that, I posted this in $trsts this AM and believe it is worth reading. I am not changing my investment strategy because of it, but I am remaining warry.
Energy trust cuts reflect overvaluing
January 23, 2007
James Daw
MONEY TALK
Canadian investors — many of them retirees — have been hit hard by the plunge in value of energy income trusts.
The losses were due partly to the fall in the price of oil and natural gas that began in early August. Then Ottawa announced it will start taxing income trusts in 2011.
But independent consulting analyst Diane Urquhart thinks things became worse because of a fundamental problem with income trusts and how they were sold. That problem, she argues, “is baked in the cake right now,” and losses will continue to be greater for income trusts than for conventional energy corporations.
She has argued long and hard that the so-called income yield advertised by trusts and their stockbrokers does not adequately distinguish between a return on investors’ capital and the return, or refunding, of their own capital. Trusts were supporting their monthly or quarterly distributions of cash with loans, and with the sale of new units to a fresh crop of eager buyers. As long as energy prices were rising, everyone was laughing.
Now, having seen many income trusts cut distributions long before the companies have to pay taxes, retail investors are going to be more skeptical. Urquhart observes that Enterra Energy Trust has recently cut its distributions 50 per cent; Shiningbank Energy Trust, by 39 per cent; True Energy Trust, 83 per cent. Yesterday, BlackWatch Energy Services Trust and TerraVest Income Fund joined the parade.
Seeing such reductions, investors may be less inclined to pay a premium price for energy trust units. If so, the trusts will have trouble raising new capital from outsiders to replace dwindling resources.
Energy trusts may have to cut their distributions to stay in business, to retain cash to find new energy reserves as the old wells run dry.
An index that tracks the unit prices of the most valuable energy trusts fell by nearly 26 per cent between Aug. 1 and the close of trading this past Friday.
Cash distributions helped cushion investors from the full brunt of that loss, cutting the effective loss to 22.4 per cent, according to Bloomberg News.
Losses have been far less severe for an index of energy stocks dominated by conventional corporations such as EnCana Corp., Suncor Energy Inc., Canadian Natural Resources Ltd., Petro-Canada and Talisman Energy Inc.
Total return, including dividends, for this index was a negative 9.8 per cent between Aug. 1 and Jan. 19. Most of the difference from the 22.4 per cent loss for energy trusts is explained by the pending tax change, but not entirely, Urquhart estimates.
It’s her theory that we are witnessing the “wringing out of the large premium in energy income trust unit prices” because distributions that were excessive in the past are now being cut.
She calculates that billions of dollars of excess unit values remain to be wrung out, from both energy trusts and trusts that hold other types of business operations.
Urquhart argued in a note to journalists and politicians that “the energy income trusts received access to low-cost capital that had been artificially propped up by the inaccurate cash yields containing substantial return of capital that was in fact needed to finance reserve replacement.”
She readily admits she is not an energy analyst, and her estimate of the potential future losses is rather theoretical in nature. So, I will not repeat her figures here.
Urquhart maintains that seniors, and their advisers, were misled about the nature of cash distributions and the suitability of income trusts as investments for these clients.
Canadian securities administrators are now circulating a proposed set of guidelines aimed at improving the quality of disclosure income trusts make about their distributable cash.
The administrators, representing securities commissions across Canada, hope the guidelines will improve transparency “and allow investors to more easily compare distributable cash reconciliations among trusts.” Among the recommendations, which are open for public comment until March 6, the securities watchdogs want income trusts to discuss any difference between actual yield and what was communicated to investors through sales and marketing materials.
Sellers of income trusts would be in breach if they published figures for “distributable cash” without appropriate additional disclosure.
Urquhart regrets the proposed guidance will not include hard and fast rules on how to define the components of a trust’s so-called yield. She doubts the guidance will do much to inform the typical elderly investor.
Maybe a realization that such investors have lost billions of dollars already will awaken new crops of investors to the considerable risk.