Hold Your Ground

Sometimes, the best investment strategy is simply to do nothing. That was certainly the case last week, as the US and Canadian markets thrashed around and basically ended flat.

In my view, the poster child for the volatility was Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF). As Canadian Edge readers are now well aware, this company’s basic business is controlling risk to maximize the cash flow from a portfolio of ownership interests in US power plants and power lines. And it’s done a very good job of it quarter after quarter, including the first half of this year.

Over the past two weeks, however, the stock has behaved like anything but an ownership stake in an inherently stable business. Rather, plagued by vague rumors of being the target of a mysterious conspiracy of short sellers, the stock has been sold off sharply. The action reached a crescendo last week, with a double-digit drop Monday followed by an upper-single-digit drop Tuesday.

Then came Friday and the company’s announcement of a buyback and cancellation of 8 percent of its outstanding income deposit securities (IPS). Quoting Barry Welch, president and CEO:

“Recent activity in the trading of our IPSes has resulted in a current market price that is significantly lower than the value of the Company. Our assets are operating as expected, and there have been no changes in our underlying business that justify the recent decline in the market price of our IPSes. In addition, the Company has a very strong current cash position that is adequate to support this issuer bid and our stated strategy of growing shareholder value through acquisitions. As a result, the purchase of our IPS for cancellation under this issuer bid represents an attractive investment opportunity and an appropriate use of the Company’s available cash.”

The underlying business strength to do a buyback has, of course, been demonstrated in earnings quarter after quarter since the company’s inception in late 2004. And this announcement makes it pretty certain that we’ll see it again in the second quarter numbers, due out Aug. 13.

I wouldn’t like to see management make a move just to placate skittish investors. In this case, however, the buyback also makes extremely good business sense.

For one thing, it will retire debt immediately and reduce interest expense. And buying back now will reduce the cost of retiring the bond portion of the IPSes, which remains entirely at management’s discretion and can be done as early as November 2009 or as late as November 2016.

Sharp drops in equity value have speeded up the blowups of several companies over the past year, notably high-end mortgage meltdown Thornburg Mortgage. As this buyback demonstrates clearly, however, Atlantic relies on outside capital for the sole purpose of buying more assets. That was previously shown by the fact it issued no new IPSes over the past year, while interest expense fell for the 12 months ended March 31.

Admittedly, the ups and downs of Atlantic’s share price the past few weeks have been a gut check for all of us. But a falling share price alone was never a threat to its dividend or solvency. That could only come from a big drop in internally-generated cash flow, which, in turn, is only possible if the companies who buy the power from its plants default in large numbers. And as CE readers know, these are all investment-grade credits and mostly regulated utilities. Southern Company, for example, is effectively Atlantic’s largest customer.

Not surprising, Atlantic’s shares responded to the buyback news by surging 20 percent-plus Friday. That wiped out the losses and then some in what had been a particularly trying week for shareholders. Conversely, any short sellers suffered losses of more than 40 percent in just a few hours trading, a sobering reminder than you can lose heavily shorting even a falling stock in a bear market.

On a larger point, I’m deeply skeptical of any market theories that blame share price drops purely on short sellers. Short selling is ultimately only profitable when something is really rotten or bid up to an unsustainable height.

Like those who buy stocks, short sellers are in it to make money. But they also provide needed liquidity to markets. They’re not inherently evil, nor do they operate as some kind of conspiracy to destroy good companies. That’s only possible when the company itself is skating on thin ice and is unlucky enough to fall in.
 
The Big Picture

As we look ahead, it’s important to remember that Atlantic is only one of many trusts I recommend in Canadian Edge. Our success depends on diversifying and not getting too caught up in the fortunes of any one trust, no matter how attractive it may look. That’s why I’ve repeatedly cautioned against “doubling down” in Atlantic or any other trust.

In addition, Atlantic’s not the only cheap trust now. In fact, over the past week, most took on water to some extent. Even Daylight Resources Trust (TSX: DAY.UN, OTC: DAYFF) had real ups and downs, despite announcing a 30 percent distribution increase.

The key, just as with Atlantic, is business fundamentals. And until there’s reason to doubt them, you’ve got to hang in there.

Over the next several weeks, our recommendations will get their next real test, as they announce second quarter earnings. We’ll be tracking them in the weekly Maple Leaf Memo, the upcoming August issue of Canadian Edge (e-mailed Aug. 8) and in flash alerts.

As I’ve said, I’ll sell any trusts that show their businesses aren’t standing up to the challenges of a weaker US economy, tight credit conditions (though Canada’s have loosened a bit) and rising raw materials prices. But if trusts are holding the line, there’s no reason not to keep holding onto their shares and riding out the volatility in the market place.

Here are some of the dates for announcements, as noted in last week’s Maple Leaf Memo:

Conservative Portfolio

Algonquin Power Income Fund (TSX: APF.UN, OTC: AGQNF) Aug. 14

AltaGas Income Trust (TSX: ALA.UN, OTC: ATGFF) Aug. 8

Artis REIT (TSX: AX.UN, OTC: ARESF) Aug. 13

Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF) Aug. 13

Bell Aliant Regional Communications Income Fund (TSX: BA.UN, OTC: BLIAF) Aug. 5

Canadian Apartment Properties REIT (TSX: CAR.UN, OTC: CDPYF) Aug. 13

Energy Savings Income Fund (TSX: SIF.UN, OTC: ESIUF) Aug. 8

GMP Capital Trust (TSX: GMP.UN, OTC: GMCPF) Aug. 7

Keyera Facilities (TSX: KEY.UN, OTC: KEYUF) Aug. 8

Macquarie Power & Infrastructure Income Fund (TSX: MPT.UN, OTC: MCQPF) Aug. 8

Northern Property REIT (TSX: NPR.UN, OTC: NPRUF) Aug. 7

Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) Aug. 1

RioCan REIT (TSX: REI.UN, OTC: ROICF) July 28

TransForce (TSX: TFI, OTC: TFIFF) Aug. 8

Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) Aug. 8

Aggressive Portfolio

Advantage Energy Income Fund (NYSE: AAV, TSX: AVN.UN) Aug. 14

Ag Growth Income Fund (TSX: AFN.UN, OTC: AGGRF) Aug. 8

ARC Energy Trust (TSX: AET.UN, OTC: AETUF) Aug. 1

Arctic Glacier Income Fund (TSX: AG.UN, OTC: AGUNF) Aug. 14

Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF) Aug. 4

Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) Aug. 7

Enerplus Resources (NYSE: ERF, TSX: ERF.UN) Aug. 1

Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) Aug. 8

Paramount Energy Trust (TSX: PMT.UN, OTC: PMGYF) Aug. 8

Penn West Energy Trust (NYSE: PWE, TSX: PWT.UN) Aug. 7

Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF) Aug. 28

Provident Energy Trust (NYSE: PVX, TSX: PVE.UN) Aug. 8

Trinidad Drilling (TSX: TDG, OTC: TDGCF) Aug. 7

Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) Aug. 7