Peter Schiff’s Natural Gas Plays

By Travis Johnson, Stock Gumshoe, December 15, 2009

Peter Schiff’s newsletter for his Euro Pacific Capital brokerage firm usually includes a couple “teaser” picks — of course, to get the name of the stock you’ve got to talk to one of his brokers. And what is the job of a broker? To sell you something, naturally … so if you don’t feel like chatting up a Euro Pac broker today, let’s see if we can’t identify these two stock picks for you …

If you don’t know Peter Schiff, don’t tell him that — it might bring a tear to his eye. He’s been a longtime proponent of international investing (through his high commission brokerage, naturally) and a doomsayer on the dollar, so the dollar’s continuing decline gives him some opportunity to shine. He’s also running for Senate in Connecticut, so if he gets the Republican nomination I imagine we’ll be hearing even more from him, and he might even win (Chris Dodd is very entrenched, of course, but it’s also quite possible that the firestorm of hatred over the bailouts will cause his political career great damage — he was, after all, running a lot of the hearings and at all of those TARP press conferences).

I can also tell you that the absolute best pick in the history of the Stock Gumshoe tracking spreadsheets belongs to Peter Schiff — in a newsletter similar to the one I looked at today he teased a little stock called Skyworks Digital, a Chinese TV maker, and it’s now up about 1,600%. That was a small and beaten-down stock and a rock-bottom value at the time, so it would be shocking if any of his other picks that I’ve written about perform that well in such a short time period, but it does make one pay extra attention and give his picks a closer look.

So what is he teasing today? Natural gas stocks. Not bad timing in general, what with Exxon recently agreeing to acquire XTO for its unconventional gas reserves, but of course Schiff is looking not at US companies but at foreign ones — in this case, in Canada and Australia.

Schiff’s newsletter gives a brief rundown of natural gas in general, starting with this intro:

“Natural gas is a vital component of the world’s energy supply today and it is believed by many to be the most important energy source of the future. Natural gas is abundant worldwide, has multiple applications across many sectors, and is one of the cleanest, safest and most environmentally friendly of all energy sources. Once considered largely a waste product of oil production, natural gas is currently experiencing a huge increase in demand around the world.

“As recently as 50 years ago, worldwide natural gas consumption was relatively insignificant. Today, natural gas meets more than 20% of the world’s primary energy requirements and offers great opportunities for developing economies looking for new sources of power….

“Because of its low cost and clean burning nature, natural gas has become a popular fuel for the generation of electricity. There are two primary forces at work that serve to increase today’s demand for natural gas in electric generation:

“1. The increased demand for electricity in general

“2. The retirement of old nuclear, petroleum, and coal powered generation plants

“Investing in Natural Gas

“In addition to having numerous uses, natural gas has caught the eye of investors as a result of changes in the global economy and the environment. Due to supply increases from significant natural gas discoveries, and relatively low demand caused by the state of the global economy, natural gas prices are currently low. But we don’t expect them to stay that way for long. With many governments threatening to cap industrial carbon emissions, corporations are being forced to explore alternative energy sources, and natural gas is far and away the most cost-efficient option.”

So that’s the general argument — gas is relatively and historically (recent history, anyway) cheap, and demand is expected to grow. So who are the stocks Schiff profiles as possible investments in this sector?

“The first featured company is based out of Canada, where there is a very strong market for natural gas. In addition to Canada’s abundant supply increasingly being used locally, the vast majority of natural gas imported by the U.S. comes from Canada …

“Company #1 is a natural gas exploration and production company. We like this company for its high quality assets, profitable business model, proven track record, and current yield of 12.5% (Bloomberg, Dec. 2009). With increased government regulation on carbon emissions imminent, new energy sources are coming into high demand, and we think Company #1 is well positioned to help meet that demand.

“Investment Highlights

“This company’s assets have a long reserve life and are approximately 100% natural gas and natural gas liquids. It discovered and developed practically all of the high quality natural gas assets it currently owns (Q3 Press Release, Nov. 11, 2009), generating profits that could be difficult to match through acquisition activity.

“We believe Company #1, with its ten year track record, is an excellent natural Energy Trust. We find that a solid current yield, combined with exceptionally high quality assets, gives this Company a positive outlook.”

And a few other nuggets from the tease:

“It keeps up a low payout ratio to fund its growing inventory…. Its core asset base is comprised of quality, long life natural gas reserves…. has a low operating costs because it produces from reservoirs that do not have the added cost of water or sour gas disposal. Additionally, its wells have relatively high productivity.”

That’s not a lot of specific clues, but thankfully we get that Bloomberg yield citation, and the press release mention, and, though I didn’t include it here, a Bloomberg chart that can confirm a potential match … so I can tell you that this must be …

Peyto Energy Trust (PEY-UN in Toronto, PEYUF on the pink sheets, click here for a free instant stock analysis from MarketClub)

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This is a Royalty Trust, so they will have the trust conversion issue to deal with (they’ll probably effectively need to become a corporation in another year, before Trusts become taxable), but they are a natural gas-focused trust that has a low cost profile, as teased — and they are profitable now, even with gas prices pretty low. Per their last earnings report, “Spot natural gas prices have recovered to a level where all of Peyto’s wells are generating solid positive cashflow. As a result, there is no production currently shut in which requires better gas prices.”

The Trust says this about the potential conversion to a corporation:

“Peyto has now met with its advisors and determined that, barring any unforeseen legislative changes and pending unitholder and regulatory approval, the conversion of the Trust into a corporate form will likely occur effective December 31, 2010. This new structure will afford Peyto the continued ability to return profits from the success of the business to shareholders in the form of dividends.”

So they will continue to be focused on providing investors with income, to at least some degree, after they convert next year — the level of that income will depend on their tax structure (ie, they may have tax benefits to carry over that will let them remain largely untaxed for a few years — I haven’t checked their status, but many trusts are in that position, and many companies that invest in oil and gas production are otherwise tax advantaged, too) … and, of course, on their effectiveness in maintaining production at high levels with low costs, and on the end price that their natural gas receives in the marketplace. They are continuing to invest in new production, and in techniques like horizontal drilling to increase production at existing sites.

Peyto does do some hedging and they have certainly benefitted from that this year, which is a large part of the reason that they’ve been able to maintain the distribution at the current level (12 cents/month, which at a Canadian $12 share price equals exactly a 12% yield). They are currently paying out more than 98% of their earnings, but a smaller portion of their “distributable cash.”

So if you’re looking for gas and want a company that can survive low gas prices and perhaps also grow nicely if gas prices climb significantly, Peyto may be a reasonable one to look at — they have very long-lived resources, with 17 years of proved reserves, essentially all in Western Canada. If you’ve got a feeling about Peyto (or other natural gas trusts, of which there are a large number), feel free to let us know with a comment below. Peyto was also touted by Taipan’s Safe Haven Investor back in June, so I shared some additional comments about it when I outed that pick.

Next? A look at Australian gas … here’s what Schiff tells us:

“Company #2 is a natural gas infrastructure business, owning and/or operating upwards of $8 billion in gas pipelines and distribution assets. We like this company for its unrivalled portfolio, attractive growth opportunities, stable cash flow, excellent internally managed workforce and a solid current yield of 9.4% (Bloomberg, Dec. 2009).”

And we get some little clues that come close to being detailed enough:

“This company is the biggest mover of gas in its region by pipeline length, capacity and quantity. Its integrated portfolio creates revenue through unique operating synergies. It oversees and controls all of its assets. Additionally, it manages a natural gas distribution company….

“Growth highlights for 2009 include an expansion of several natural gas pipelines, numerous attractive investments, and the construction of a new gas pipeline. In 2009, its balance sheet was strengthened by selling a portion of its assets that were showing minimal growth and also by completing its 2010 debt refinancing….

“The estimated increase in demand for natural gas in Australia, along with this company’s exceptional assets, makes a strong case for investment in Company #2. Its dividend payout is currently set at $0.16, giving it a solid yield of about 9.4% (Bloomberg, Dec. 2009). We think this is a good infrastructure option for investors looking to add natural gas to their portfolios.”

So who is this Aussie pipeline company? Schiff has touted some others in this sector in the past, and the clues here are still fairly thin, but we do get the chart that I can match up with our candidates … so today it looks like he’s teasing us about:

APA Group (APA in Australia, APAJF on the pink sheets, click here for a free instant analysis from MarketClub)

Peyto trades quite frequently on the pinks, but this one is another matter — so if you’re interested in buying the stock in that way, be careful to use the ASX closing price as a guideline and check your currency conversion, though pink sheets buyers of Australian stocks often have to pay a premium to the ASX price since the middleman takes a risk in selling to you when the Australian exchange is closed (ie, the price might shoot up or down when the stock opens in Australia the next day). Pink sheets trading for many markets that are open during overlapping hours with the US is usually far easier and more liquid (ie, London, Toronto).

But anyway, this is one of the major Australian pipeline companies, and Australia is increasing its gas production pretty significantly, including coal bed methane as well as more conventional sources — and though mining, industry, and electricity generation do take up an increasing amount of natural gas, Australia is also focused on exporting LNG to hungry neighbors, particularly Japan and Korea. The yield is around 9%, though I don’t know how taxation works for pipelines in Australia so it’s quite possible that there will be a withholding tax on that (or something similar), they are definitely not set up to appeal to US investors, so there won’t necessarily be extra handholding and tax explanations from the firm like you can often expect to receive from US MLPs or Canadian trusts.

Still, that’s a decent yield, and the company should have a similar natural gas exposure to North American pipeline companies — meaning, it’s not the precise cost of the gas that matters, but the toll they can charge for moving it, and the volume of gas that their pipes can attract and transport. Much like the DUET Group, which I wrote about for a different Schiff teaser early this year, APA Group is actually a combination of two trusts, a pipeline trust and an investment trust that holds minority positions in a gas utility, a couple other pipelines, and some associated infrastructure investments. The security is actually two different units stapled together, one share of APT (the Australian Pipeline Trust) and one share of APTIT (APT Investment Trust). This makes the explanation of the distributions fairly complicated, but here’s what they said about their last distribution:

“Your September 2009 payment of 16.0 cents per security reflects 4 distribution components:
* APT unfranked dividend of 2.7443 cents per unit (cpu) taxable in the 2010 tax year
* APTIT interest (income) of 1.7122 cpu taxable in the 2009 tax year
* APTIT tax deferred capital distribution of 11.0882 cpu recognised in the 2010 tax year
* APTIT tax deferred income distribution of 0.4553 cpu recognised in the 2010 tax year”

The distribution for December of 2008 was 15 cents (all these numbers are in Australian dollars), so that’s a total distribution for the last twelve months of 31 cents, which is actually 9.6% at the current A$3.23 share price (the stock is down a hair from when Schiff looked at it, I suppose).

So what do you think? I’ve been looking around at non-MLP pipeline companies and considering some myself, though I think I’m still more comfortable with the Canadian ones than the Australians — that might just be because the information is more accessible and the tax implications clearer. If you’ve got a feeling on APA or any of its competitors, or would like to share your thoughts on Peter Schiff, feel free to do so with a comment below. To his credit, the newsletter is not really pushing these as instant-win gazillionaire picks as many of the investment letters do, he is careful to mention many of the risks and note that “International investing may not be suitable for all investors,” since as an actual broker his firm has a much closer relationship with customers, and more responsibility to provide reasonable advice, than does an investment newsletter which doesn’t give personalized investment advice or have access to your accounts.

Oh, and though Schiff’s Euro Pacific Capital is a brokerage firm, not a newsletter, we’ve still had several of his customers review his services for us — if you’d like to see what they’ve said, or share your own Euro Pac experience, please click here for Schiff comments at Stock Gumshoe Reviews.


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