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Published: June 25,
2007
Advantage Energy Income Fund (NYSE: AAV, $13.94) is a Canadian royalty trust paying a monthly dividend of $0.15 per
share in Canadian dollars. That translates to around $0.14 per
share in U.S. dollars based on a Canadian to U.S.
exchange rate of 0.9414. The $0.14 monthly payment equates to
$1.68 per share annually, giving AAV a dividend yield of
12.5%.
Like other Canadian trusts, AAV shares were sideswiped by the
Canadian government's announcement on October 31st, 2006 that it
plans to tax income trust earnings at the corporate tax rate by
2011. The move would reduce the income available for
distribution to investors, making many trusts considerably less
attractive to income investors.
However, AAV shares suffered less than many other trusts and
have now returned to their pre-October 31st levels, partly
because the company is well positioned to handle the
government's proposed tax measures. That's because it has
accumulated enormous tax pools worth $1.2 billion. The firm can
use these pools of unrealized capital losses to reduce future
tax liabilities, allowing AAV to sustain its dividend payments
for the foreseeable future.
The company is also partly insulated from volatile commodity
prices. With the majority of production tilted toward natural
gas, earnings and dividends have been exposed to changing
natural gas prices. Last year, for example, the company cut its
dividend as gas prices weakened. However, in an effort to
provide shareholders with a stable dividend going forward, this
past April management locked in over half its production at
attractive prices through October 2007. It did so by purchasing
futures contracts on the New York Mercantile Exchange.
In the past five years, Advantage has quadrupled its daily
production base to about 30,000 barrels of oil equivalent
through a series of acquisitions. For the latest quarter,
production rose +64% and revenue gained +56%, despite weak
natural gas prices. The increases were largely due to a recent
merger with Ketch Resources Trust, another income trust with a
large inventory of undeveloped lands for future growth.
Although AAV is moving in the right direction, the company still
has some work to do on its bottom line. Despite increased
production revenue during the latest quarter, funds from
operations (a key industry measure) declined -25% to $0.59 per
share, mainly due to high operating costs. Management said it
expects costs to remain high through the balance of the year,
which could squeeze profit margins and pressure dividend
payouts.
However, a relatively low payout ratio of just 76% of cash flow
for the quarter bodes well for future payouts. As well, the
dividends qualify for the reduced dividend tax rate of 5% or
15%, depending on your income, so the stock can be held in a
taxable brokerage account.
Action To Take --->
Advantage is strategically positioned to weather a number of
risk factors, including the proposed taxation of income trusts
and continued weakness in natural gas prices. That said, the
company still needs to work on boosting its bottom line.
Although the firm's 12.5% yield is juicy, we feel it is only
suitable for risk-tolerant investors.
Carla Pasternak
Editor
High-Yield
Investing
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