Published:
September 28, 2007
Zargon Energy Trust (ZAR-UN.TO,
$26.80) --
This Canadian royalty trust explores for, develops, and produces
oil and gas reserves in Western Canada. For the first six months
of 2007, it produced 8,474 barrels of oil equivalent a day. That
puts it in the ranks of a small to intermediate producer.
The stock is listed on Canada's Toronto Stock Exchange (TSX), as
well as on the U.S. pink sheets as ZARFF.PK.
Zargon has paid a monthly dividend of $0.18 (Canadian) per share
like clockwork since November 2005. With the Canadian dollar
currently trading at around parity to the greenback ($1.00
Canadian equals $1.00 U.S.), the dividend is worth just about
the same in U.S. dollars. That works out to $2.16 a year, which
at today's share price generates a yield of 8.1%.
Since the Canadian dollar should strengthen if the U.S. dollar
continues to weaken, the dividend could be worth even more in
the months ahead. Better yet, the payout is sustainable.
Management pays out only about half its cash flow, leaving ample
funds for growing the business.
You've likely never heard of Zargon, but take note of its name.
Zargon is the top performer among 29 major Canadian oil and gas
trusts. It has generated share price gains of +11.7% so far this
year through August 31st. In contrast, the sector has lost an
average of -12.2%. Given the firm's conservative operating
strategy, strong balance sheet, and opportunity to expand
production through acquisition, we expect this outperformance to
continue.
We calculate production is about 44% oil and 56% gas. This
balanced approach means the company doesn't have all its eggs in
one basket. Although it may not benefit as much from today's
record high oil prices, it also won't suffer from depressed
natural gas prices. In other words, its distributions and share
price tend to be more stable and less vulnerable to commodity
price fluctuations than some of its peers that focus exclusively
on oil or gas.
Going forward, Zargon is well positioned to sustain production
and hence its generous distribution. The company replaced 122%
of its production last year. Its conservative operating strategy
of exploiting existing oil pools instead of trying to find new
oil wells resulted in a 95% success rate on the 76 oil wells it
drilled last year. Its existing oil and gas reserves should last
another nine years, or until 2016. With 50% of its cash flow
targeted to activities which replace existing reserves, the
company gets a big "thumbs up" for sustainability of its
production, cash flow, and distribution.
Zargon is conservatively financed, with a cash flow to debt
ratio of 0.5. In other words, it could pay off its long-term
debt with just two year's worth of cash flow. This strong
balance sheet, combined with untapped bank lines of credit,
gives the company the financial flexibility to acquire
undervalued assets of competing companies. Cash flows from these
purchases would flow directly to the bottom line.
Like other Canadian energy trusts, Zargon's future beyond 2011
is unclear. That's when the Canadian government will phase out
oil and gas income trusts, at which point they will likely
either go private, get taken over, convert into ordinary
dividend-paying corporations, or possibly into U.S. Master
Limited Partnerships (MLPs).
Action To Take --->
Zargon remains one of the more conservatively managed Canadian
income trusts, and until 2011 the company should continue to
provide a secure income stream and a relatively stable share
price.
Carla Pasternak
Editor
High-Yield
Investing
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