Third quarter earnings season has now officially concluded for Canadian Edge Portfolio trusts. Last but not least to report were the Conservative Portfolio’s Atlantic Power Corp (ATP.UN, ATPWF) and the Aggressive Portfolio’s Advantage Energy Income Fund (AVN.UN, NYSE: AAV).

The long and short of the news is results for both trusts were solid. Atlantic Power reported a 15 percent increase in cash flow, as measured by earnings before interest, taxes, depreciation and amortization (EBITDA). The key was the strong performance of recently added assets, including the Path 15 power link in California. The Chambers plant also ran well and reaped the benefit of rising wholesale power prices.

The headline payout ratio number ticked up to 104 percent for the third quarter, reflecting a 13.9 percent increase in outstanding shares to finance growth and a commensurate boost in debt. The company’s securities are “staple shares”—combining a high-yielding debt security with equity—so new issues boost both dilution and interest owed.

However, the trust’s nine-month payout ratio—which factors out seasonality—came in at a conservative 84 percent. Moreover, the trust has increased its portfolio of fee-generating assets, adding another 50 percent stake in the Pasco project that will add to income the rest of the year.

As a result, Atlantic still looks on target for solid growth in its now 10 percent-plus distribution in the next few years. Atlantic Power Corp remains a buy up to USD12.

Advantage’s earnings report yesterday initially got a chilly reception, with the stock plunging nearly 10 percent early in the trading day before rebounding sharply. Investors mistakenly interpreted the slight increase in payout ratio to 88 percent—from last quarter’s 83 percent—and drop in funds from operations as a signal of trouble with the distribution.

That’s understandable, given the other distribution cuts in the sector. But the trust actually demonstrated resiliency in the face of lower natural gas prices and the challenges completing its merger with Sound Energy.

Management stated production levels remained on target with expectations, although it planned to shift new development toward oil (now 26 percent of total output). It forecast “negligible impact” from Alberta’s increase in royalty rates in 2009. And it pointed to higher-priced hedges in the fourth quarter as reasons for expecting higher cash flow and a lower payout ratio going forward.

As was the case for all the other Aggressive Portfolio energy producers, Advantage’s realized prices for both oil and gas in the third quarter were considerably below current levels. Realized gas prices averaged just CAD6.35 per million cubic feet, while oil came in at just USD67.77.

In other words, even if oil dropped another $20 per barrel from here in the fourth quarter, Advantage’s realized price per barrel of oil sold would actually rise. And if oil and gas stay where they are now, the result should be far better cash flow and a sizeable drop in the payout ratio.

There are no guarantees here. Along with Paramount Energy Trust (PMT.UN, PMGYF), Advantage is one of my two aggressive plays on a rebound in natural gas prices in coming months. There’s always the possibility for another distribution cut with this pair, which aren’t as stable as my core energy holdings: ARC Energy Trust (AET.UN, AETUF), Enerplus Resources (ERF.UN, NYSE: ERF), Penn West Energy Trust (PWT.UN, NYSE: PWE), Peyto Energy Trust (PEY.UN, PEYUF), Provident Energy Trust (PVE.UN, NYSE: PVX) and Vermilion Energy Trust (VET.UN, VETMF).

When gas does recover, however, both will be off to the races. That’s the reason to own them and why Advantage Energy Income Fund remains a buy up to USD14 and Paramount Energy Trust remains a buy to USD10.

Postscript

Now that earnings season is over, it’s time to take stock of what we’ve learned. First, despite a very challenging environment—including a credit crunch, still weak natural gas prices, the slumping US economy and the cross-border impact of the soaring Canadian dollar—only five of the 28 trusts in the Conservative and Aggressive portfolios failed to cover their distributions comfortably with distributable cash flow in the third quarter.

Moreover, each of the five laggards had very good reasons for it, and odds strongly favor a robust cash flow recovery in coming quarters. As mentioned above, Atlantic Power’s third quarter shortfall was very small and caused by share issues to finance future growth.

Boralex Power Income Fund (BPT.UN, BLXJF) suffered its shortfall because of 33 percent lower river flows to its hydro plants. We’ve seen this happen before to Boralex, and investors have sold off the shares only to see them rebound strongly when the rivers rose again.

With the trust is already pricing in a distribution cut, there’s little risk to bet on it happening again. And that’s even if a dispute regarding its wood waste plant isn’t resolved soon. Boralex Power Income Fund is a buy up to USD10 for those who don’t already own it.

Macquarie Power & Infrastructure’s (MPT.UN, MCQPF) cash flows lagged its third quarter distribution largely for seasonal reasons. The high payout ratio was right in line with previous summer quarters, and the trust expects a bounce-back in the fourth quarter.

Wholly unaffected by the supposed troubles of its parent Macquarie Bank—which reported a big earnings gain in the third quarter— Macquarie Power & Infrastructure is a buy for those who don’t own it up to USD12.

The only Portfolio holding that has me a little worried at this point is TimberWest Forest Corp (TWF.UN, TWTUF). The trust appears to have settled the strike against its contractors, as I pointed out in the November Canadian Edge. But it’s still challenged by a weak US dollar, which cripples its exports to the US, and competition from US timber producers.

It’s asset-rich, both for resources and real estate. But until cash flow bounces back, TimberWest Forest Corp rates a hold.

As for the rest of the recommended trusts, they covered their distributions by a substantial margin in some very tough times. That means they’re now officially stress tested. We can own them with a great deal of confidence, knowing their businesses can handle a lot rougher seas than most US companies have had to endure in memory.

That doesn’t mean their share prices won’t continue to be volatile. The past couple days, the intense selling pressure on Canadian trusts has let up, and we’ve seen some of the more battered trusts bounce back substantially.

Should investor fears about credit markets flare up again, however, the selling could resume. And despite the fact that our picks trade at low prices, pay safe distributions and are making it as businesses in a highly stressed environment, they could take hits again as well.

At times like these, it’s fair to ask yourself a very important question: What are you in this for? If you’re fundamentally a trader, you may have a different idea. But I suspect most Canadian Edge readers will say their goal is a secure, rising source of income from stable companies that will build wealth over a period of years.

If that’s the case, you have no business thinking about selling good trusts–that is, those that have demonstrated the ability to sustain businesses and grow distributions in a stress-tested environment like this one.

I can’t promise there won’t be a lot of ups and downs along the way. That’s certainly been the history. But good businesses are eventually recognized in the market and make up ground lost in selloffs with a vengeance.

That means strong trusts are headed to a lot higher prices, and we’ll reap the highest dividends in the world while we wait for that to happen, no matter what happens in Ottawa in the next three years on the trust taxation issue.