Global markets are, of course, responding to what seems to be a bottomless pit of bad economic news. Canada’s fourth quarter gross domestic product (GDP) shrank at an annual rate of 3.4 percent, its worst showing since 1991. And that was a dramatic outperformance relative to the US (a 6.4 percent annualized contraction), European Union (5.9 percent) and Japan (12.7 percent).

In North America the unfolding credit and economic crisis has taken on a new dimension: waning investor confidence that the Obama administration will make the right moves in time to head off a second Great Depression. Faith in good government is lower still elsewhere in the world. And good news from the US housing and finance industries–whose meltdown started it all–is still in short supply.

As with any dark cloud, however, there are silver linings. Front and center in this one are the solid business numbers still being posted by our favorite trusts.

We’re still waiting on several Canadian Edge Portfolio recommendations to release their fourth quarter 2008 earnings and 2009 guidance. But all of the Conservative Holdings to report thus far have shown little if any weakness in the face of the worst global economic crisis in decades. More important, management remains confident they’ll be able to maintain business health and distributions this year.

Cash flow at all of the Aggressive Holdings is tied to commodity prices. As a result, falling energy and other raw materials prices have directly hit the bottom line, and dividend cuts have been fast and furious. At this juncture, only February High Yield of the Month Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) has avoided a cut during this down cycle. Management currently expects to maintain its payout in 2009, but a plunge to USD20 a barrel oil would almost certainly force a review.

Even USD40 oil and USD4 natural gas are well below global reserve replacement costs, estimated at USD80 and USD8, respectively. They’re also below production costs for many non-conventional sources, such as Canada’s tar sands, shale and sub-oceanic drilling.

My view remains that the unprecedented and ongoing global destruction of future supplies has made new highs in oil and natural gas inevitable. And the longer prices remain depressed now, the greater the eventual price spike will be. But any price rebound will send Canadian producer trust distributions right back up again.

We don’t know when that rebound will come, as it depends wholly on what the global economy does. There’s no supply-side case for oil falling to USD20 and staying there long-term. But there’s certainly a demand-based argument that a short term glut could send black gold even lower than that, the last straw for weak and leveraged producers.

The good news coming from our Canadian trusts’ fourth quarter numbers is they’re geared both to survive the worst near-term case and to take advantage of the ultimate rebound. That hasn’t spared them dividend cuts and capital losses in recent months, and it won’t prevent more of the same if energy prices plunge further.

Those strengths, however, mean our producers are still worthy bets for an energy comeback. Moreover, even proven survivors like High Yield of the Month Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF) sell at sharp discounts to book value and net asset value. That makes them takeover targets as well.

To be sure, our investment returns depend on our trusts’ business numbers eventually being reflected in their market value. In the long term the stock market is a weighing machine. Healthy, growing businesses eventually command higher market values.

Near-term performance, however, is more of a popularity contest. And in this fear-driven, bad-news-battered market, only cash is truly well-loved.

I can’t tell you when the market mood will change. And as long the economy is this uncertain, my patience for underperforming businesses will be non-existent. As you’ll see below, more than a few companies and trusts did turn in rotten fourth quarter numbers. And despite the red ink their shares have already spilled, they should be sold now.

But I do know this: When there is a turn, healthy and growing businesses are going to command much higher values than the pittances they do today. Some will be taken over. But even those that aren’t will recover their losses, as long as they hold it together as businesses now. Throw in dividends as high as 20 percent and that’s about as clear a case as it gets for hanging in there.

Portfolio Action

There are no changes to the Canadian Edge Portfolio this month.

All the trusts reporting thus far have posted fourth quarter numbers that have met my benchmarks. For Conservative Holdings, that’s basically showing no weakness in 2008 while guiding positively for 2009 distributions. For Aggressive Holdings, the criteria are positive reserve comparisons and no credit concerns. Again, several recommendations have yet to report, and there’s always the chance some will slip up.

I’ll be rounding up most of them in a mid-March Flash Alert. Note that Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) won’t come in with numbers until March 30, owing to the complex nature of accounting for its asset ownership stakes. The late-2008 distribution increase, however, should set investors’ minds at ease regarding dividend safety, despite its volatile share price.

High Yield of the Month

The March High Yield of the Month entries are hardened veterans of past Canadian slowdowns. The Conservative Portfolio pick is Northern Property REIT (TSX: NPR-U, OTC: NPRUF), which posted 18.3 percent fourth quarter growth in funds from operations per unit and yields nearly 10 percent. The Aggressive Portfolio pick is Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF), the two-decades-old producer trust that last traded at levels this low in November 2000.

How They Rate

How They Rate lists trusts and high-yielding corporations by the following sectors:

• Oil and Gas–All producer trusts are included here.
• Electric Power–Power generators.
• Gas/Propane–A mixture of distributors, from propane to packaged ice.
• Business Trusts–A range of businesses involved principally with consumers.
• REITs–All qualified real estate investment trusts.
• Trust Mutual Funds–Closed-end funds holding portfolios of individual trusts.
• Natural Resources–Trusts and corporations that produce resources and raw materials other than oil and gas.
• Energy Services–Trusts and corporations whose main business is providing drilling, environmental or other services to energy producers.
• Energy Infrastructure–Trusts and corporations that own primarily pipelines, processing facilities and other fee-generating assets.
• Information Technology–Trusts and corporations that provide communications, newspaper, directory and other information services.
• Financial Services–Canada’s banks, investment houses and other trusts and corporations feeding that business.
• Food and Hospitality–Trusts and corporations that franchise restaurants, own and operate hotels and manufacture and distribute food and beverages.
• Health Care–Trusts and corporations involved in the medical care and/or supply business.
• Transports–Trusts and corporations that ship freight and move passengers by bus, truck, rail or air.

Here are advice changes. Note I’ve changed buy prices on a number of trusts this month to reflect the fall in the Canadian dollar, dropping energy prices and slower global growth.

See How They Rate as well as for changes in buy targets. Price and yield information is updated every 15 minutes. Use this service as a reality check when errors occur with US-based quote services. Note that it sometimes takes several days for a dividend cut to be updated in the live feed.

Column four of the table shows dividend frequency and the most likely way each trust will minimize 2011 taxation. “Foreign” indicates non-Canadian income, which is not taxed. “Pools” indicate tax pools used primarily by energy producers, which shield income dollar for dollar. “Depreciation” indicates businesses with large non-cash expenses that can be used to shelter cash flow. “None” indicates no visible method of avoiding 2011 taxes, though some trusts have stated their intention to simply outgrow their future liability and maintain distributions.

Acadian Timber Income Fund (TSX: ADN-U, OTC: ATBUF)–Hold to Buy @ 5. Solid fourth quarter results demonstrate parent Brookfield Asset Management (NYSE: BAM) is still providing the support needed for success. Timber conditions are tough, but this is a survivor and a comeback play.

Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF)–Hold to Sell. The restaurant royalty trust posted just 0.1 percent same-store growth in the fourth quarter, a sharp deceleration that may signal real vulnerability to a weaker economy.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Hold to Buy @ 5. Fourth quarter earnings again showed management is doing a good job projecting cash flows with plant performance and cost controls. The wood waste facilities are still challenged by a lack of supply and the risk the AbitibiBowater (NYSE: ABH) steam contract will be abridged or abandoned. But at a 17 percent yield and 79 percent of book value, that’s reflected in the price of this former Portfolio holding.

Brookfield Real Estate Services (TSX: BRE-U, OTC: BREUF)–Buy @ 10 to Hold. Canada’s leading real estate agent franchiser is on solid ground with parent Brookfield. But if the country’s residential property market should slow further, it will suffer.

Contrans Income Fund (TSX: CSS-U, OTC: CSIUF)–Buy @ 7 to Hold. The trust is hanging in there, but declining fourth quarter revenue and a rising payout ratio indicate industry weakness may be catching up.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF)–Hold to Buy @ 3. This former Portfolio holding appears to be finally adopting the pro-shareholder policies of other closed-end funds, including easier share buybacks to close the discount to net asset value and moving beyond trusts to other high-yielding investments.

Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF)–Hold to Sell. It looks like 2009 will be even worse than 2008 for the energy services industry in Canada. The dividend looks like a near-certain casualty.

Eveready Income Fund (TSX: EIS-U, OTC: EVDRF)–Hold to Sell. Insider selling in stocks that have already taken a beating is not a good sign, particularly in an industry (energy services) that looks headed for more pain.

New Flyer Industries (TSX: NFI-U, OTC: NFYIF)–Buy @ 8 to Hold. I was ready to add this one to the Portfolio until a major order cancellation provided a clear warning sign that its business may be more economically sensitive than I thought. The jury is still out with the fourth quarter numbers, but caution is sometimes the better part of valor.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Buy @ 6 to Sell. The zinc market is far worse than advertised, and parent Xstrata (London: XTA, OTC: XSRAF) is pulling back production for the facility, which contributes substantially all of the trust’s cash flow. The dividend has been halved, but this one isn’t going anywhere until the economy picks up.

Parkland Income Fund (TSX: PKI-U, OTC: PKIUF)–Hold to Buy @ 8. This energy refiner, retailer and transporter posted a strong fourth quarter, and management has guided toward a solid first quarter 2009 with strong statements about the first two months of the year. It’s a simple business that appears to be weathering the economic turmoil well thus far.

Precision Drilling (TSX: PD-U, NYSE: PDS)–Buy @ 12 to Sell. I severely underestimated the risk of debt taken on to buy Grey Wolf, but that’s something Precision will have to work through before it becomes a worthy holding again. There’s no dividend for now in any case.

Priszm Income Fund (TSX: QSR-U, OTC: PSZMF)–Hold to Sell. Weak restaurant royalty trusts aren’t worth sticking with.

Rogers Communications (TSX: RCI.B, NYSE: RCI)–Buy @ 38 to Hold. Disappointing fourth quarter results showed more vulnerability to the recession than I thought, though the communications side of the business stayed strong. The company boosted its dividend 16 percent and enjoys solid Bay Street support. But I want to see another quarter before calling it a buy again.

Russell Metals (TSX: RUS, OTC: RUSMF)–Buy @ 20 to Hold. The company has slashed its distribution and admirably cut costs, including executive pay by 10 percent. But conditions are tough for the industries that are its traditional customers, and may weaken more.

SFK Pulp Fund (TSX: SFK-U, OTC: SFKUF)–Hold to Sell. Fourth quarter cash flow was strong, and the trust looks geared for survival. But with no dividend and facing tough conditions, there’s no reason not to take the loss and look for a future entry point when the environment improves.

Sun Gro Horticulture Income Fund (TSX: GRO-U, OTC: SGHRF)–Hold to Sell. This is a solid, niche-focused company that faces tough industry conditions and pays no dividend.

TransForce (TSX: TFI, OTC: TFIFF)–Buy @ 6 to Hold. Earnings come out on March 12. Until then, I don’t want to recommend a company in a weakening industry.

Tree Island Wire Income Fund (TSX: TIL-U, OTC: TWIRF)–Hold to Sell. This trust is apparently having problems negotiating forbearance with its lenders, even as its core business is on the ropes, and it pays no dividend.

Trilogy Energy Trust (TSX: TET-U, OTC: TETFF)–Hold to Buy @ 4. The trust posted fourth quarter earnings, debt coverage and reserve numbers that provide solid dividend protection at current energy prices. It also has a successful Montney Shale property and sells for roughly book value and half assessed net asset value, making it a likely takeover target.

Wajax Income Fund (TSX: WJX-U, OTC: WJXFF)–Buy @ 20 to Hold. Disappointing fourth quarter earnings showed this trust is more vulnerable to economic woes than I expected. The lowered distribution looks well protected. But until we get another quarter of numbers to look at, I don’t advise buying.

Feature Article

Canada: Buy, Hold or Sell? That’s the question I address in this article, which highlights the major sectors of the country’s economy and their prospects. Not surprisingly, there are screamingly attractive areas, selling cheaply and resisting the recession while paying big dividends. Other sectors, meanwhile, should be avoided like the plague.

Canadian Currents

This tax season is colored a bit by the fact that many trusts have converted to corporations ahead of the 2011 implementation of Finance Minister Jim Flaherty’s Tax Fairness Plan. Canada’s government has made every effort to ensure such transitions are tax-free events, but we also need to understand the implications in light of US law.

Tips on Trusts

This section features short bits on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide “Subscriber Tips” section.

Dividend Watch List–Last month, 18 more How They Rate entries brought the axe down on their distributions. Not surprisingly, 11 were either energy producers or energy service companies, whose cash flows have been sliced and diced by falling energy prices: Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV), Baytex Energy Trust (TSX: BTE-U, NYSE: BTE), Bonterra Oil & Gas (TSX: BNE, OTC: BNEFF), Cathedral Energy Services Income Trust (TSX: CET-U, OTC: CEUNF), Harvest Energy Trust (TSX: HTE, NYSE: HTE), Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH), Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF), Precision Drilling (TSX: PD-U, NYSE: PDS), Provident Energy Trust (TSX: PVE-U, NYSE: PVX), Trinidad Drilling (TSX: TDG, OTC: TDGCF) and True Energy Trust (TSX: TUI-U, OTC: TUIJF).

The rest of the cuts were due to exposure to economic weakness and/or high leverage: Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF), GMP Capital Trust (TSX: GMP-U, GMCPF), Noranda Income Fund (TSX: NIF-U, OTC: NNDIF), Russell Metals (TSX: RUS, OTC: RUSMF) and Wajax Income Fund (TSX: WJX-U, OTC: WJXFF).

Note two closed-end mutual funds also made long-awaited cuts: Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF) and EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF).

For advice on all of these trusts, companies and funds, see the Dividend Watch List and How They Rate.

A System to Bank On–Leaders from the G20 will gather in London in April to discuss the reform of the global financial system. Among many other observers, former US Federal Reserve Chairman and current advisor to President Obama Paul Volcker has recommended the G20 take a long, hard look at Canada’s banking system as a model.

Bay Street Beat–How the Canadian analyst community views trusts, including our favorite trusts.

More Information

The following is a regular repeat from prior issues.

Use our live quote feed in How They Rate for intraday US dollar prices and yields for trusts and high-yielding corporations. For other information, go directly to a trust’s Web site by clicking on its name in the table. Clicking on the Toronto symbol (suffix “.UN”) will take you to http://www.adviceforinvestors.com/, the Web site of our Canadian partner, Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8). The site features price charts and access to press trust releases.

For questions and comments, drop us a line at canadianedge@kci-com.com.

Check out the Toronto Stock Exchange Web site for a range of information on income and royalty trusts.

The Web site http://www.sedar.com/ is an online library of documents filed by trusts with the Canadian equivalent of the US Securities and Exchange Commission.

The Toronto Globe & Mail features the “Globe Investor” section, with all the latest news on trusts.

Dominion Bond Rating Service is the pre-eminent credit rater for trusts.

The Bank of Canada Web site features a handy currency converter for Canadian dollars and US dollars into 50 other currencies around the world, and it’s a great source of free information on the Canadian economy.

Note the Income Trust Tax Guide has backup to file distributions as “qualified dividends.”

Roger Conrad
Editor, Canadian Edge