A dozen Oil and Gas producers, two Natural Resource trusts, a Business Trust and an Energy Services trust slashed distributions last month. That was a few less than December’s record level of 19 cuts. But it’s a sure indicator that some pretty ugly earnings numbers lay ahead for the fourth quarter of 2008, as well as the rest of 2009.

Tread with care.

Five Canadian Edge Aggressive Portfolio oil and gas producers cut distributions last month. I review all five in the Portfolio section: ARC Energy Trust (TSX: AET-U, OTC: AETUF), Daylight Energy Trust (TSX: DAY-U, OTC: DAYYF, Enerplus Resources (TSX: ERF-U, NYSE: ERF), Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) and PennWest Energy Trust (TSX: PWT, NYSE: PWE).

As noted there, all five were already priced for at least one deep dividend cut, evidenced by the lack of a market reaction to their moves. All five are taking positive action to weather this downturn and to take advantage when the cycle shifts in a more positive direction. All five are buys.

Bonavista Energy Trust (TSX: BNP-U, OTC: BNPUF) has cut its distribution by a third to CAD0.20 per unit per month. The trust has also cut capital spending by 39 percent from 2008 levels, though that level is subject to regular review. The lower dividend and capital spending rates are expected to be fully covered by cash flow in 2009, projections for which now take into account the dramatic drop in commodity prices since mid-2008.

At the new rate, Bonavista’s dividend yield is still well over 13 percent. Insiders and Bay Street remain universally bullish and the trust also has the flexibility to ramp up output if market conditions improve. Bonavista Energy Trust is still a buy up to USD20.

Bonterra Oil & Gas (TSX: BNE, OTC: BNEFF) avoided a dividend cut when it converted to a corporation earlier this year. That was a clear indication that there’s life well beyond 2011 for well-run oil and gas companies committed to paying outsized dividends.

Unfortunately, the company has since run into the stark reality for all oil and gas producers, both trusts and high-yielding corporations: Lower energy prices hurt cash flows and therefore reduce ability to pay dividends. As a result, the monthly distribution has been cut to CAD0.16 a share, half the mid-summer level of CAD0.32 and well below the CAD0.27 paid before the conversion announcement.

The new dividend level is still generous at around 11 percent. And this well-managed company boasts very long-life and predictable reserves–weighted toward oil–that guarantee a huge cash flow recovery when energy prices turn up again. The lack of 2011 tax issues and management’s commitment to pay out 75 to 80 percent of cash flow means dividends will rise along with energy prices as well.

That’s plenty of reason to stick around, despite the hit to the share price. Bonterra Oil & Gas remains a buy up to USD20.

Canadian Oil Sands Trust’s (TSX: COS-U, OTC: COSWF) 80 percent haircut to its quarterly dividend comes on the heels of a 40 percent reduction in the prior period. That leaves the current rate of CAD0.15 some 88 percent off the summer highs, not counting the negative impact of the erosion in the Canadian dollar/US dollar exchange rate.

Those who’ve held on through that carnage may be surprised that I continue to support the upgrade to a buy I made last month for the trust’s shares. And to be sure, the cuts–combined with the big drop in oil prices the past six months–have spooked some on Bay Street, where there are now more hold and sell recommendations than buys for the first time in quite a while. Dominion Bond Ratings Service has even cut the trust’s stability rating to STA-4 (low), reflecting the impact on profits from the dramatic drop in oil prices, which has offset for now the trust’s unmatched financial backing on credit quality.

Ultimately, however, it’s that backing that separates Canadian Oil Sands from all of its rivals. Mainly, its only asset is 37 percent of the Syncrude partnership, a venture among several of North America’s biggest oil and gas players operated by ExxonMobil’s (NYSE: XOM) Canadian unit Imperial Oil (TSX: IMO, NYSE: IMO). As long as ExxonMobil and its partners are committed to Syncrude, its projects will run and its expansion will continue.

To be sure, the profitability of Syncrude’s facilities–which basically “mine” the tar sands to extract bitumen to produce heavy oil–has taken a huge hit from falling oil prices. Further, Canadian Oil Sands reports operating costs of CD35.26 per barrel of oil produced in the fourth quarter. And that was despite a backing off of the price of natural gas used to generate electricity to run the mines, one of the single largest costs of the operation.

Throwing in crown royalties, interest costs and other expenses, that leaves very little profitability at current energy prices. Even at an average realized price of nearly CD70 per barrel (roughly USD60) in the fourth quarter, net income per barrel of oil produced was barely one-quarter what it was a year ago. And selling prices are likely to be a lot lower in the first quarter as the trust is currently unhedged for future output. That could make it very difficult to cover even the reduced distribution with cash flow.

On the other hand, Syncrude is as sure a bet to survive this downturn as there is in the oil sands. Even in a worst case for oil prices, the financial power of ExxonMobil and its partners will be scarcely dented by absorbing losses from Syncrude this year. In fact, the partners continue to proceed with several major capital projects to expand capacity, enhance efficiency and reduce environmental pollution from the facilities. ExxonMobil is rumored to be considering increasing its stake in the venture.

Since I’ve been writing this advisory, Canadian Oil Sands has been easily the most hyped play in the energy trust universe. It flew the highest when oil prices were hitting record levels and every institutional money manager on either side of the border wanted a piece of it. Now it’s crashed back to earth in a big way and few want to touch it–and that’s the time for value investors to strike.

Certainly, Canadian Oil Sands’ executives and directors feel that way, as insiders have stepped up buying. And despite the very high trading volume following the latest dividend cut, the shares have basically held firm, a pretty good sign the downside in the distribution was already in the stock.

Again, a further drop in oil prices–say to USD20 or so–would make Syncrude’s output distinctly unprofitable. Should that happen, it’s certainly possible that the players would then shut in at least some of the output, which would cut further into Canadian Oil Sands’ cash flow and would likely force at least the temporary suspension of all dividends.

Should that happen, however, no other player in the oil sands would be left standing. And since nearly a quarter of Canadian energy exports are from oil sands, the result would be a dramatic contraction of supply in the US. Barring a full-scale depression, lower supply will trigger a recovery in energy prices, and oil sands producer profits. And in any case, the dividend cut to CAD0.15 a unit ensures the fund will have cash to cover CAD500 million in debt maturities, even if conditions worsen and capital markets remain difficult.

There are a lot of unknowns here, and many of the answers depend on the fate of the global economy. Long-term, however, Canadian Oil Sands is a valuable asset and up to USD22 is a good price for patient value-hunters to pick up shares.

Freehold Royalty Trust (TSX: FRU-U, OTC: FRHLF), unlike the other trusts in How They Rate, doesn’t operate the majority of the wells on its lands. That minimizes direct operating costs but means it’s vulnerable in two ways: to falling oil and gas prices, as cash royalties depend both on actual prices; and other producers’ decisions on drilling, which in turn depend heavily on prices.

Until last month, the trust was able to dodge the worst of the down cycle, and actually paid out a special distribution of CAD0.35 a unit on Jan. 15 in addition to the regular payout of CAD0.25. A few days later, on Jan. 20, management announced the payout would fall to just CAD0.10, as it scaled back its price forecasts to just USD38 per barrel of oil and CAD6 per thousand cubic foot for natural gas.

The good news is these appear to be pretty conservative forecasts. Moreover, the trust will be able to cover capital spending and distributions with cash flow, if that price range holds. And management is certain to ramp up distributions if energy prices bounce back.

Freehold has never been among my favorite trusts, as its royalty structure means its distributions are taxed as ordinary income in the US. That wouldn’t apply to IRAs, however. Hold Freehold Royalty Trust.

NAL Oil & Gas Trust (TSX: NAE-U, OTC: NOIGF) was also able to avoid a distribution cut last year, thanks to a generally conservative financial strategy and the successful acquisition of properties from Dominion Resources (NYSE: D) in 2007. Last month, however, management reduced the monthly payout by 31.2 percent to CAD0.11 a unit, reflecting its revised lower forecast for realized energy prices and desire to continue covering capital expenditures and dividends without adding to debt in a hostile environment.

The new budget forecast is for oil to average USD45 the first six months of 2009 and USD55 the second half of the year. Natural gas is expected to average CAD6.50 for the year. Those target prices are slightly above current levels, but could easily be surpassed. Meanwhile, they’re close enough to current levels to allow management significant flexibility to adjust operating plans to stay in line with financial goals.

NAL has significant development opportunities, thanks largely to the Dominion purchase and should have no problems holding output roughly flat with 2008 levels and at a reasonable cost. The trust has hedged roughly 42 and 36 percent of oil and gas output, respectively, at attractive prices.

And even after the reduction it still yields more than 17 percent. NAL Oil & Gas Trust remains a buy for patient investors up to USD10.

Trilogy Energy Trust (TSX: TET-U, OTC: TETFF) cut its dividend in half last month, effective with the Feb. 17 payment.

As with other producer trusts, the move was made to ensure sufficient cash flow to continue development of reserves without taking on more debt in a tough environment. For Trilogy, it’s a potentially prolific play in the Montney shale region, where CE favorites such as ARC Energy Trust (TSX: AET-U, OTC: AETUF) and Advantage Energy Trust (TSX: AVN-U, NYSE: AAV) have very promising developments.

Trilogy’s small size and higher debt load have long made me less than enthusiastic about its shares. But after the distribution cut and selling for barely book value, Trilogy Energy Trust certainly rates a hold.

Finally, True Energy Trust (TSX: TUI-U, OTC: TUIJF) has also cut its distribution in half, this time to just CAD0.02 a month. The move was announced along with an “operational update,” which cited a shut-in of some production due to extreme weather conditions as well as falling natural gas prices as reasons to conserve more cash.

The trust now expects to be able to fund its 2009 capital program through internally generated cash flow and continues to target steep reductions in operating costs. That’s partly from necessity, as management has already drawn CAD133 million of its CAD152 million credit facility.

The trust has hedged roughly a quarter of its natural gas output for 2009 and 12 percent for the first quarter of 2010, with none of its expected liquids output hedged. That leaves True vulnerable to a further decline in energy prices. In fact, with the shares selling for just CAD1 and the trust pushed up against its debt limits, it remains the most exposed to a potential bankruptcy of any trust except dividend-less Enterra Energy Trust (TSX: ENT-U, NYSE: ENT).

On the other hand, True is also extremely leveraged to a recovery in energy prices. And selling for just 19 percent of book value and 35 percent of sales, it’s definitely a possible takeover target. That’s likely one reason insiders have been buyers, particularly now there’s a new CEO with extensive industry contacts.

Given True’s low reserve life and high debt, I’m not comfortable rating it a buy in this environment. But those who’ve stuck with True Energy Trust for this long should hold.

The continuing slide of the North American housing market forced two natural resource trusts to eliminate distributions: SFK Pulp Fund (TSX: SFK-U, OTC: SFKUF) and Tree Island Wire Income Fund (TSX: TIL-U, OTC: TWIRF).

SFK had been steadily rebuilding its cash reserve position in recent months, following a previous distribution cut. The latest move is in response to weakness among the company’s primary customers on both sides of the border. The extension of maintenance shutdowns at its US recycled mills will help “balance inventories” by taking some 10,000 metric tons of pulp from production in the first quarter. That will cut costs and perhaps relieve some of the current supply glut.

Encouragingly, SFK’s mills appear to be running efficiently, including the Saint-Felicien facility that had been problematic last year. Management’s move to shepherd cash at this time won’t make many of its investors happy, but it should ensure its survival during an exceptionally difficult time.

The shares have now definitively broken a buck, often a very real danger sign. Bay Street is distinctly bearish on its prospects, in marked contrast to rival Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF). And there’s no distribution to keep investor interest. On the other hand, the shares now trade at just 8 percent of book value, the kind of thing that often attracts suitors. Hold SFK Pulp Fund.

Tree Island Wire is right at the critical CAD1 mark after eliminating its payout last month. Management’s main reason for the cut was an “unprecedented decrease in global steel prices” that caused its inventories to be overvalued on its books by CAD27 to CAD30 million and will force it to take a stiff writedown of that value this year.

The writedown is non-cash. It will, however, have a “material negative impact on fourth quarter results of operations, EBITDA and distributable cash flow.” It will also, in management’s words, “put the fund out of compliance with its current debt services ratio covenant.”

On the other hand, the fund has been working with lenders regarding the covenants and has been able to renegotiate payment terms with raw materials suppliers as well. Management has also “worked aggressively” to cut inventories and operating expenses organization-wide. A new round of layoffs will bring the total to 34 percent of the July 2008 workforce sometime this quarter.

Again, eliminating the dividend is sure to eliminate investor interest in Tree as well. But selling for just 16 percent of book value and 7 percent of sales, there’s a lot in the price of this one already, and a lot to attract a potential takeover as well. Hold Tree Island Wire Income Fund.

Somerset Entertainment Income Fund (TSX: SOM-U, SOEIF) cut its monthly payout by two-thirds last month, confirming what the stock market had long priced in: the basic weakness of its underlying business of distributing and producing specialty music for global markets, using non-traditional retailers and interactive displays as the medium.

The good news from the cut is the trust was able to restructure its primary credit facility, enabling management to continue its growth strategy in a very difficult operating environment. And the trust was clearly already pricing in a dramatic reduction as well.

Going forward, my biggest problem with Somerset is its basic business, which has proven less than conducive to a flow-through structure. That remains my contention today, and the primary reason why I consider it a sell even at a price of just 56 percent of book value.

Last but not least, Mullen Group Income Fund (TSX: MTL-U, OTC: MNTZF) has cut its payout in half to a monthly rate of CAD0.075 as part of its decision to convert early to a corporation. The plan is to reduce the dividend again to a quarterly rate of CAD0.125, with a first payment in September of 2009. The ultimate distribution rate is very attractive for a corporation at around 5.5 percent, as is the share price of just 77 percent of book value and 71 percent of annual sales.

As a corporation, the transportation and logistics trust will be better able to shepherd cash flow in a difficult period for its core market, the oil and gas production industry. Management does expect 2008 results to be substantially improved from 2007 tallies, due mostly to a series of well-time acquisitions. And early conversion puts it in prime position to do a lot more, as well as to meet management’s goal of considerable debt reduction.

The next step is a vote by shareholders in a vote slated for April. If the decision is affirmed, unitholders of the trust will receive one share of the converted corporation. Meanwhile, for the next several months, Mullen will pay the CAD0.075 monthly distribution. I view the move as a positive for the trust, as it will allow it to keep growing in what’s shaping up to be a weak 2009.

Mullen Group Income Fund remains a buy up to USD12 to hold through the conversion and beyond. Note my advice for those who already own Mullen is to vote for the conversion.

Here’s the rest of the Dividend Watch List. Third quarter payout ratios are now shown in How They Rate for all listed trusts and corporations.

Again, note that all energy producer trusts should be considered on the Watch List, should oil and gas prices resume their downward spiral of recent months.

• Acadian Timber Income Fund (TSX: ADN-U, OTC: ATBUF)
• Big Rock Brewery Income Fund (TSX: BR-U, OTC: BRBMF)
• Calloway REIT (TSX: CWT-U, CWYUF)
• EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF)
• Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF)
• FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)
• GMP Capital Trust (TSX: GMP-U, OTC: GMCPF)
• Harvest Energy Trust (TSX: HTE, NYSE: HTE)
• Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF)
• Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF)
• Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF)
• Westshore Terminals Income Fund (TSX: WTE-U, OTC: WTSHF)

Bay Street Beat

Last month was the biggest January ever for the North American box office, as movie-goers generated total revenue of USD1.03 billion.

That’s good news for Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF) and illustrates why Canada’s largest movie theater operator was included in the December 2008 CE Feature article, Recession-Proof Trusts.

Cineplex Galaxy, which runs 129 theatres and 1,317 screens in Canada, also scored well on Bay Street in Bloomberg’s most recent survey of analyst opinion: The trust once again notched a perfect 5.000 average rating.

January 2009 box office was up nearly 19 percent from January 2008 levels, even as job losses mount and disposable income would seem to be evaporating. Apparently, people are dying to be distracted from their troubles. When times are hard, heading off to the movies for two hours is a great escape. As Media by Numbers box office guru Paul Dergarabedian put it, “Going to the movies is the new vacation.”

Cineplex Galaxy will release fourth quarter and full year earnings Feb. 12. Third quarter attendance was strong, revenue per patron actually rose and the trust’s payout ratio still came in at just 47 percent, providing a tremendous cushion to the distribution for safety. The trust has also made great strides diversifying revenue streams via on-screen advertising and is increasingly the dominant player in Canada movie-going.

Cineplex’s credit facilities extend to 2012, and the trust has hedged out interest rate risk as well.

Yielding more than 9 percent, Cineplex Galaxy Income Fund is a buy up to USD18.

High Yield of the Month Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) posted a 4.714 average rating. Portfolio holdings AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF, 4.667), Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF, 4.538) and Enerplus Resources (TSX: ERF-U, NYSE: ERF, 4.385) also scored well.

Canadian Hydro Developers (TSX: KHD, OTC: CHDVF), a non-trust included in CE’s How They Rate coverage universe, continues to attract analysts and investors alike. Bay Street gave it a 4.818 average rating, and the stock is up nearly 9 percent in 2009.

Canadian Hydro will receive about CAD59 million in government funding for its CA450 million wind farm being constructed on Wolfe Island in eastern Ontario.

The 86-turbine, 198 megawatt Wolfe Island wind farm is expected to begin commercial production March 31. Wolfe Island, combined with Canadian Hydro’s Melancthon project, will more than double its revenue base. Canadian Hydro Developers is a buy up to USD3.

Iggy Pop

During last fall’s federal campaign, the Stephane Dion-led Liberal Party pledged to roll back the tax on income trusts introduced by the Conservative government in 2006. In late September, announcing his party’s platform, Dion said that, if they gained control of Parliament, the Liberals would introduce an immediate 10 percent tax on trusts to replace the 31.5 percent tax introduced by the Conservatives, which goes into effect in 2011.

And there was much speculation leading up to the Jan. 27 federal budget announcement that Prime Minister Stephen Harper and Finance Minister Jim Flaherty would back down from the tax. The most delicious rumor was that Mr. Flaherty would extend the transition period to 2017, giving trusts another six years to convert or begin paying the 31.5 percent rate.

A Canaccord Capital report said that it believes “it is very likely the government is having conversations about the possibility of making changes to the trust taxations rules.” But in the same sentence, the report conceded that Canaccord is “not convinced they will actually implement any changes.”

Comes now new Liberal Party leader Michael Ignatieff. Appearing on CBC Television’s “Peter Mansbridge One on One,” Ignatieff said the energy companies in Alberta are still very much reeling from the Conservative government’s switcheroo on trust taxation. Igantieff went on to say that the income trust vehicle was/is a critical investment vehicle in Canada’s energy sector.

You can view the show here; the relevant comment appears about halfway through the interview.

Canada-based owners of trusts in non-registered accounts pay tax on the distributions they receive except for the return of capital component. No credible proof has yet been produced by Canada’s Dept of Finance that trusts represented a loss of tax revenue for Canada. In fact, there are several reports that show tax revenue from trusts is greater than the tax would be if these trusts were corporations. In many cases, including BCE (TSX: BCE, NYSE: BCE), for example, corporations, although they’re eligible to pay tax, pay little if any because of their ability to effectively use their writeoff capacity.

The energy trusts are an integral component of Canada’s energy business. They provide an option for keeping lower producing assets active rather than having them abandoned. Penalizing the energy trusts in effect means penalizing the economy through the loss of jobs directly and the loss of business in the hospitality sector in the small communities in western Canada. An argument can be made that rescinding the trust tax would increase tax revenues, create jobs and be stimulatory to the Canadian economy.