PENGROWTH ENERGY TRUST $7.13 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 256.1 million; Market cap: $1.8 billion; Price-to-sales ratio: 1.0; SI Rating: Average) is one of North America’s largest energy royalty trusts. It owns all or part of several oil and natural-gas properties in Alberta, British Columbia and Saskatchewan.

Properties that Pengrowth operates account for 63% of its production. The remaining 37% comes from minority investments in other energy projects, including an 8.4% interest in the Sable Offshore Energy Project south of Nova Scotia.

Natural gas provides 60% of Pengrowth’s production. Oil supplies the remaining 40%. Pengrowth prefers to focus on proven properties with sizeable reserves and predictable production rates. It has interests in six of western Canada’s top nine oil-producing areas.

The trust is slowly moving into more risky areas, like coalbed methane (a type of natural gas that does not flow easily to the surface). It’s also developing the Lindbergh oil-sands project in northern Alberta, which could begin operating within two years.

Most of Pengrowth’s recent growth has been driven by acquisitions. A key purchase was $1 billion worth of properties in western Canada from ConocoPhillips in January 2007. This let it take advantage of rising energy prices at the time.

As a result, Pengrowth’s revenue jumped from $669.6 million in 2004 to $1.9 billion in 2008. Earnings rose 157.6%, from $153.7 million in 2004 to $395.9 million in 2008.

Pengrowth typically issues new units to pay for its acquisitions. This helps the trust keep its interest payments low and conserves cash. However, because of a 67% increase in the number of units outstanding, per-unit earnings rose just 37.4%, from $1.15 in 2004 to $1.58 in 2008. Cash flow per unit rose from $3.03 in 2004 to $3.93 in 2005, but fell to $3.15 in 2006. It then rose to $3.26 in 2007, and to $3.65 in 2008.

Pengrowth had proven reserves of roughly 235.2 million barrels of oil equivalent at the end last year (this measurement includes both crude oil and natural gas). This is a 2.5% drop from 2007. If you include probable reserves, which are less certain than proven reserves, Pengrowth’s reserves rose 1% in 2008.

High replacement rate a good sign

The trust replaced 112% of its production last year. Replacing so much in one year reduces Pengrowth’s need to find new reserves, particularly in today’s tight credit market. New drilling and better recovery from its current properties accounted for 71% of the replaced production. The rest came from acquisitions, particularly Pengrowth’s purchase of Accrete Energy Inc. last September. Accrete owned oil properties in Alberta’s Harmattan region. Buying Accrete increased Pengrowth’s reserves by 3% at the time of the deal.

Due to falling energy prices, Pengrowth cut its 2008 production by 6%. It will probably cut it by a further 5% this year.

The trust has locked in prices for 63% of its likely 2009 oil production at $67 U.S. a barrel. That’s 37% above today’s price of $49 U.S. Pengrowth has also hedged 43% of its 2009 natural gas production at $6.50 U.S. per thousand cubic feet, or 76% over the current price of $3.70 U.S.

Still, lower energy prices will force Pengrowth to reduce capital spending by 44% in 2009, to $215 million, or $0.85 a unit. It is prepared to spend an additional $35 million on capital projects if oil and gas prices rise.

Yield still high despite cuts

Falling energy prices have also prompted Pengrowth to lower its monthly distribution twice in the past six months. It now pays $0.10 a unit, for an annualized yield of 16.8%. Pengrowth paid out 71% of its cash flow to its unitholders in 2008, down from 88% in the prior year.

Lower distributions will let Pengrowth pay down its $1.5-billion long-term debt. That seems high at 80% of its market cap, but it’s less than two years worth of cash flow.

Ottawa’s new tax on income trusts in 2011 will raise the tax burden on all trusts to 26.5%. The 2012 rate will fall to 25%. However, Pengrowth qualifies for deductions that will hold its effective tax rate at 15% for a few years.

Because of falling oil prices and production, the Alberta government recently lowered its royalty rates. Alberta accounts for around 75% of Pengrowth’s production, so this will lower the trust’s operating costs.

Pengrowth sells its oil and natural gas in U.S. dollars. It stands to gain from a lower Canadian dollar, as these sales now translate into more Canadian dollars.

Cheap in relation to its prospects

Pengrowth’s 2009 earnings will probably fall to $1.07 a unit because of lower energy prices and production. Pengrowth’s units trade at 6.7 times that estimate. They’re also attractive at just 2.4 times the trust’s likely 2009 cash flow of $3 a unit.

Pengrowth is a buy.