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When an income trust begins to pay out close to all its cash flow in the form of cash distributions, should investors be concerned?

In the case of Canadian Oil Sands Trust COS-UN.TO, which raised its quarterly distribution to 75 cents from 55 cents, the answer according to the market appears to be no: The units rose 5.5 per cent in Toronto yesterday, as investors embrace the prospect of rising cash flows in the future.

The trust produced cash flow of $3.22 a share in 2007, but the new-and-improved distribution means that investors are receiving $3 of this income, a potentially dangerous distribution level if business conditions shift. The shift could come from lower oil prices. They could also come from rising production costs and uncertainty over royalty rates in Alberta.

In other words, Canadian Oil Sands Trust does not look exactly bullet-proof as an investment these days. Executives there expect 2008 cash flow will rise to $3.31 per unit in 2008, up just 3 per cent from 2007. True enough, the forecast is based on somewhat conservative expectations, such as oil trading at $80 (U.S.) a barrel, which is about 11 per cent below the current price. As well, it assumes the Canadian dollar will trade at par with the U.S. dollar, whereas it could easily tumble.

Here’s what a couple of analysts were saying yesterday. This from TD Newcrest analyst Mark J. Friesen: “We expect the increased distribution to be received positively by investors,” he said in a research note. “However, we remind investors that the trust is increasing distributions by way of the balance sheet in order to rebuild tax pools and should oil prices fall, distributions may also need to be reduced. We forecast another distribution increase later this year to $0.85/unit/quarter.”

And this from UBS analyst Andrew Potter: “Over all we are pleasantly surprised with the large move,” he said in a research note. “At a 75-cent per quarter distribution COS.UN will pay out 100 per cent of our 2008 and 95 per cent of our 2009 free cash flow forecasts (we forecast US$85 a barrel in 2008 and US$78 in 2009). At current forward commodity prices we could see further distribution increases.”

In an era of uncertainty about the global economy and its thirst for oil, you have to wonder if investors should be so aggressive with Canadian Oil Sands here.

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Filed under: (DRIPS) Canadian Dividend Reinvestment Plans, Canadian Income Trust, Easy Money, Finance, Financial News, Global Economy, High Dividend Stocks, Income Trust, Income Trusts To Purchase, Investing, Stocks Tagged: Canadian Oil Sands, Canadian Oil Sands Income Trust, Canadian Oil Sands Royalty Trust, Canadian Oil Sands stock, Canadian Oil Sands Trust, cos, cos.to