Dividend-cut casualties tallied 18 last month: eight oil and gas producers, three oil service trusts, three producers/processors of other commodities, one diversified manufacturer, a financial services company and two closed-end funds. Roughly half were repeat offenders, having already cut their distributions at least once during this down cycle.

All of the oil and gas cuts were part and parcel of the waterfall drop in energy prices since last summer. Simply, lower energy prices mean less revenue for trusts, forcing management to either sell shares, borrow money or cut capital spending and/or distributions.

Selling shares has been prohibitive for most trusts for some time. For one thing, trusts are restricted under the 2007 Tax Fairness Act in how many shares they can issue without provoking an immediate tax on all of their income. For another, with many trusts priced at or below book value, it’s expensive and dilutive to issue shares.

Trust management has also been loath to borrow. That’s a big plus for their longevity, as most currently have low debt burdens. But it leaves cutting cash outlays as the only other option. And since trusts’ sustainability is also threatened when they don’t replace reserves, the only real alternative is to cut distributions.

Here’s a brief prognosis for this month’s cutters.

Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV) halved its payout again last month, this time to a monthly rate of CAD0.04 a unit. That’s still enough for a mid-teens yield.

Falling gas prices are always a worry, but with more than half of projected 2009 output hedged at prices nearly twice spot levels, the Montney Shale play continuing to produce, and management focused on debt reduction, Advantage looks well positioned to survive further weakness in energy prices as well as to ride the recovery.

Many forget now that Advantage was one of the biggest winners in the first half of 2008 when energy prices were soaring, just as it’s been among the biggest losers since. That’s the nature of any leveraged play on energy, and it’s why Advantage Energy Income Fund continues to rate a hold for those who already own it, and a buy up to USD5 for those who don’t. Note the shares currently trade at just 28 percent of book value.

Baytex Energy Trust (TSX: BTE-U, NYSE: BTE) turned in a solid reserve report for 2008, posting an 8 percent jump in proven barrel of oil equivalent (boe) reserves and extending proved reserve life (RLI) to 8.6 years. Proved reserves have a 90 percent or better chance of development, while probable reserves have only a 60 percent chance. Moreover, it accomplished that at a relatively low finding, development and acquisition (FD&A) cost of CAD13.11 per boe. That’s a big plus for the trust’s longevity and sustainability.

The 33 percent dividend cut last month–effective with this month’s payment–is the second in three months and could be followed by another if oil prices crash again. But for now it should provide enough cushion to keep the trust healthy. Baytex Energy Trust is still a buy for those who don’t already own it, though I’m lowering the buy target to USD15 to reflect the dividend cut.

Bonterra Oil & Gas (TSX: BNE, OTC: BNEFF) has cut its distribution for the fourth time since summer 2008, this time to a monthly rate of CAD0.12 a share.

The trust converted to a corporation last year, without cutting its distribution in the process. Since then, however, it’s demonstrated that producer trusts and corporations are both ruled by energy prices, and that energy prices are far more important than taxation to valuation and distributions.

The good news for Bonterra is strong reserve development, as the company boosted its proven RLI to 14.4 years, a level better than several Super Oils. If oil prices hold this level, Bonterra should be able to maintain the reduced payout. But Bonterra Oil & Gas is hunkered down for survival and is a buy up the USD15 for those who don’t already own it.

Harvest Energy Trust’s (TSX: HTE-U, NYSE: HTE) distribution cut shouldn’t have surprised anyone, based on the pre-cut yield of 50 percent-plus alone. The magnitude of the cut (83.3 percent), however, was somewhat disturbing, as were at least some of the numbers behind it. The new payout ratio is just 13 percent based on fourth quarter cash flow. That number, however, looks likely to rise this year–possibly sharply–due to falling energy prices.

Operating costs of CAD16.19 per boe and FDA costs of CAD20.60 per boe are both in a rising trend. And while overall proved plus probable reserves were basically flat, proven reserves alone fell 24 percent from 2007 levels. That’s a truly alarming trend that, if unchecked, is also a threat to the trust’s long-run sustainability.

The refinery got a reprieve from falling oil prices, which padded profit margins despite the slowing economy. But shutdowns for maintenance in 2009 will crimp margins again by the second quarter. It’s these details that have driven Harvest’s share price down so sharply in the wake of the earnings announcement, despite surface numbers that appeared relatively benign.

And they’re why I don’t see any bargain here, despite a share price at 27 percent of book value. Harvest Energy Trust is a hold for speculators only.

Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH) cut its distribution 41 percent, as fourth quarter oil and gas sales dropped 24 percent from third quarter levels. Revenue should dip further in 2009, as realized prices further decline from the relatively high levels enjoyed in the fourth quarter due to hedging. This the trust aims to offset with systematic organization-wide cost-cutting, including a plan to internalize management.

Importantly, Pengrowth maintained a steady reserve base, paced by a proven reserve RLI of 8 years and moderate FD&A costs of CAD16.29 per boe.

On the negative side, operating costs are still on the high side at CAD14.15 per boe and long-term debt is 2.5 times annualized cash flow, based on fourth quarter figures. Part of that is due to the jump in Pengrowth’s capital spending in 2008, up 30 percent from 2007. But that’s a level that could pressure operations in 2009, should energy prices sink further. It’s hard to be too negative on a trust selling for 64 percent of book value and with a solid record of surviving market ups and downs. But I continue to rate Pengrowth Energy Trust a hold.

Peyto Energy Trust’s (TSX: PEY-U, OTC: PEYUF) 20 percent distribution cut to a monthly rate of CAD0.12 a unit is its first for this cycle and isn’t nearly as severe as others in the industry. That begs the question of whether or not there’s more pain ahead.

But the trust’s reserve report should lay to rest any worries about its long-run survival. Proved reserves, for example, rose 16.9 percent, while the net present value of those reserves per unit was increased by 10 percent. Proved RLI is now 17 years, the longest in the industry.

Peyto did take on more debt to get the job done, but overall levels remain modest, and operating costs are the lowest in the industry as well. The trust’s heavy reliance on natural gas sales adds some volatility to its cash flow. But well-managed Peyto Energy Trust remains a solid buy up to USD10.

Provident Energy Trust (TSX: PVE-U, NYSE: PVX) won’t announce its fourth quarter earnings in full until March 12. But the 33 percent distribution cut should give investors a pretty clear indication of what to expect.

Along with the cut, the trust also announced a 30 percent reduction in planned capital spending for 2009. There will still be funding for the trusts’ major projects, such as two more energy storage caverns constructed by the midstream segment. And management’s moves indicate a strategy of balancing growth initiatives with dividends that augurs well not only for the duration of this downturn, but when Provident converts to a corporation in 2011.

The trust has CAD620 million left under its credit line of CAD1.125 billion, and the nature of its projects means it can still ramp up capital spending in 2009 if conditions improve. Again, we won’t have a full read until after earnings are released. But at just 47 percent of book value and 24 percent of sales, Provident Energy Trust still on my buy list for those who don’t already own it, up to USD6.

True Energy Trust (TSX: TUI-U, OTC: TUIJF) may have finally reached the end of its rope after eliminating its distribution last month.

In recent months, the trust has systematically cut back capital spending and output with asset sales and now plans to produce just 10,000 boe per day from its properties in 2009. The good news is management has succeeded in cutting net debt by 14.4 percent over the past year, despite basically no access to equity capital. Management also reports a 30 percent cut in operating costs and a 50 percent-plus hedged position for 2009, locking in a great deal of cash flow to fund its survival. As a result, there’s not much reason for those still in the trust to sell at this point, and at least some possibility of partial recovery when energy prices revive.

Alternatively, a trust selling at just 11 percent of book value could spur some takeover interest. True Energy Trust is a hold, but for speculators only.

Energy services providers’ health depends on that of their customers, namely producers. Consequently, it’s no surprise that nearly every services company has slashed distributions at least once during this down cycle, including three in the past month.

Cathedral Energy Services Income Trust (TSX: CET-U, CEUNF) cut its dividend by 42.9 percent to a monthly rate of CAD0.04 a share, effective with the March payment. Management also reduced a CAD20.6 million projected 2009 capital budget–CAD17 million plus CAD3.6 million deferred from 2008–to CAD11.1 million. Importantly, only CAD500,000 is slated for maintenance of the trust’s advanced horizontal drilling rigs, with the rest to expanding the fleet. That should keep cash flow growing going forward, though at a lower rate than before.

We’re still waiting on the trust to file its fourth quarter earnings to get a baseline payout ratio for the lower rate. But for those who want to bet on this leveraged sector, which enjoys a universally bullish consensus on Bay Street, Cathedral Energy Services Income Trust remains a solid bet up to a reduced buy target of USD5.

Precision Drilling (TSX: PD-U, NYSE: PDS) has now completely eliminated its distribution. The last cut was the fourth since early 2007, when Canada’s energy service sector began a long-term decline that has yet to abate.

The latest cash crunch is due to debt taken on to complete the trust’s merger with US-based Grey Wolf, the cost of which rose sharply during the credit crisis in part because Grey Wolf management kept dancing around before finally agreeing to a deal.

On the positive side, Precision has now achieved its long-term goal of diversifying operations into the US and out of the depressed Western Sedimentary Basin of Canada. That should help the company compete over the long term in North America. In the near term, however, cash will be tight, as management deals with refinancing amid horrific continent-wide industry conditions.

With no dividend, it’s not worth holding. Sell Precision Drilling.

Trinidad Drilling’s (TSX: TDG, OTC: TDGCF) focus on building and leasing deep drilling rigs under long-term contracts with major producers in both the US and Canada has kept it very profitable to date. Fourth quarter 2008 was no exception, as revenue rose 40.8 percent and cash flow from operations surged 79.8 percent from last year’s levels.

The company continued to execute its strategy of applying cash saved from this year’s conversion from trust to corporation, with fourth quarter overall rig capacity utilization reaching 61 percent in Canada and 80 percent in the US and Mexico. That compares to a rate of barely 40 percent for the overall industry in Canada.

The bad news, of course, is drilling activity all over North America is declining sharply in 2009. The company is protected by take-or-pay contracts for 60 percent of its rig fleet, which compel the buyers to pay for the rental even if they don’t use the rigs. The company has also deployed nearly half its fleet in shale plays, which continue to go ahead in the tough environment. And it’s scaled back its capital program in tandem with its customers, reducing need for more borrowing to build.

Unfortunately, under these industry conditions that’s not enough. Consequently, management announced a 67 percent distribution cut last month to further shelter capital and to provide funds to complete needed capital spending on growth with minimal use of capital markets. That’s more than enough to ensure Trinidad’s survival and ability to profit from an upturn that could well give investors a 10-to-1 shot from current levels.

The company is in the Aggressive Holdings for a reason, as it’s proven on the downside in recent months. But still in position for recovery, Trinidad Drilling is a buy for the more aggressive who don’t already own it up to USD3.

Falling prices for non-energy related commodities are at the root of dividend woes at Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF), Noranda Income Fund (TSX: NIF-U, NNDIF) and Russell Metals (TSX: RUS, OTC: RUSMF).

Canfor’s pulp processing operations have been wholly upended by the depression in the forestry industry, which has made supplies of pulp harder to come by. Forestry, in turn, is perhaps the hardest hit commodity sector from the collapse of US home building. The trust has also been damaged by the drop in global demand for finished pulp-based products.

It all came home to roost in the fourth quarter of 2008, as rising costs and falling demand forced a shut-in of capacity and the trust swung to a net loss, partly on foreign exchange. That, in turn, triggered a 75 percent cut in the trust’s distribution to a rate that’s still equal to 150 percent of fourth quarter distributable cash flow.

On the one hand, all of Canfor’s facilities are sound. Long-term demand for pulp products is not in doubt, and in fact may be rising in Asia again. The US housing market will eventually recover, though probably to a lower level than before the crash, and the forestry industry will revive and eliminate pressure on raw materials. Meanwhile, Canfor appears to be the best prepared in its industry to survive this downturn, and the shares sell for just 24 percent of book value.

On the other hand, there’s not going to be much recovery for either the share price or dividends until the North American economy begins to show at least some signs of life. And that could be a while. Hold Canfor Pulp Income Fund.

Noranda Income Fund has cut its distribution by 53 percent to a monthly rate of just CAD0.04, beginning with the March payment.

The trust’s sole source of cash flow is a zinc processing facility owned and operated by parent Xstrata (London: XTA, OTC: XSRAF). The distribution has long been protected by the parent’s size and access to global markets, its efficiency and key geographic location as a facility and provisions that prevent Xstrata from being paid a dime if the distribution is cut below a certain level.

Looking ahead, Xstrata’s global resource producing empire faces challenges, but the company is in no danger of going belly up. Meanwhile, the Noranda facility remains key to North American industry. That speaks well for the income fund’s ability to survive the downturn, particularly with no debt maturities this year.

On the other hand, since the dividend cut, the rapid drop in industrial activity of recent months has severely curtailed demand for zinc and sulphuric acid, the key products of the processing facility. As a result, Xstrata has shut in 20 percent of capacity. That could force an even deeper cut in Noranda’s royalties and possibly another distribution cut.

The post-cut payout ratio is just 38 percent based on fourth quarter cash flow. Unfortunately, we won’t really know how it measures against future quarters until we see some results or management provides more guidance. Until then, everyone is better off out. Sell Noranda Income Fund.

Russell Metals’ 44.4 percent dividend cut is a direct result of the extreme weakness of the North American steel industry. Rarely has a sector hit the skids as dramatically as steel, with US raw output basically falling by half over levels of a year ago. That’s directly impacted the company’s sales and profit margins, forcing dramatic action.

One fact I find particularly encouraging about Russell is the way management is sharing the pain, cutting executive salaries by 10 percent even as it slashes jobs and puts operations under the microscope for further cost cutting. It remains a solid company with a lot of great assets that will shine the next time the economy turns up. Until that happens, however, investors should not expect too much. Hold Russel Metals.

GMP Capital Trust (TSX: GMP-U, OTC: GMCPF) faced some pretty low expectations coming into fourth quarter earnings season. Unfortunately, it failed to meet even them, as transaction and wealth management income both plunged, sending revenue down 67 percent, and the trust to its first quarterly loss ever. As a result, management cut the distribution for the third and final time in recent months, this time to zero.

GMP also announced it will convert to a corporation, with the objective of shepherding more cash flow. No dividend will be paid until the conversion. But at that time, management intends to begin paying a quarterly disbursement of CAD0.05 a share, a rate 67 percent below the recent monthly rate.

Ultimately, GMP’s fate depends on what happens to Canadian investment markets. As has been the case in recent quarters, the company maintained strong market positions in block trading and underwriting, providing a solid base for eventual recovery. Unfortunately, timing that is another matter. Now paying no dividend, GMP Capital Trust is a hold for aggressive investors only.

Wajax Income Fund (TSX: WJX-U, OTC: WJXFF) has cut its distribution 44 percent, effective with the April payment. The diversified manufacturer posted solid growth in fourth quarter revenue, earnings and distributable cash flow. And rising profit margins at power systems far offset slightly lower ones at mobile components.

Looking ahead, however, the trust expects lower results for all of its product line, which is basically economic sensitive. And as precautionary measure to shepherd cash flow, management has elected to take down its payout ratio to a level less than half fourth quarter distributable cash flow. I view this as a conservative move and, combined with organization-wide cost cutting, it should safeguard the trust’ fortunes. The dividend cut has taken down the share price since. But at this point, those who still own Wajax Income Fund should hold on.

With so many of their holdings cutting distributions, it was only a matter of time before closed-end mutual funds holding trusts would as well. That’s particularly true of those that employed a lot of leverage to jack up yields and attract investors.

The good news on funds is that the leverage crisis appears to have played itself out. Tumbling prices of holdings–and funds’ net asset value (NAV)–have long since forced management to unwind debt and fundamentally reexamine strategies to improve sustainability. It may be awhile before fund prices return to former levels. But more are now worth a look for yield as well as their discounts to NAV.

Brompton VIP Income Fund (TSX: VIP-U, OTC: BVPIF) cut its distribution by 20 percent last month, likely the result of oil and gas holdings trimming their payouts. Meanwhile, EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF) trimmed its payout a slightly deeper 28.6 percent, as part of a comprehensive overhaul of policies to improve long-term shareholder value.

In Brompton’s case, the new rate looks sustainable, given its relatively low level of leverage and heavier focus on trusts that don’t produce energy. Still selling for a 9 percent discount to NAV, Brompton VIP Income Fund remains a good choice for income up to USD6.

EnerVest’s recent moves include cutting its credit facility, and therefore its future ability to use leverage to boost yield as well as risk. It’s also limiting its use of share exchanges, which prior management used to boost assets and fees often on dilutive terms. And it’s eased terms of redemptions and share repurchases, which already appears to be closing the still-wide 17 percent discount to NAV.

It will likely be a while before EnerVest regains its lost luster, and much will depend on what happens to trusts and the markets in general. But this is definitely a step in the right direction for this former Portfolio holding. Accordingly, I’m again rating EnerVest Diversified Income Trust a buy up to USD3, though with the caveat that I prefer buying individual trusts to such large agglomerations.

Here’s the rest of the Dividend Watch List. Fourth quarter payout ratios are now shown in How They Rate for most listed trusts and corporations, with the rest to be updated as earnings are released this month. 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: AND-U, OTC: ATBUF)
• ACTIVEnergy Income Fund (TSX: AEU-U, OTC: ATVYF)
• Big Rock Brewery (TSX: BR-U, OTC: BRBMF)
• Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)
• Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF)
• Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)
• Citadel Diversified Income Trust (TSX: CTD-U, OTC: CTDXF)
• DiversiTrust Income Fund (TSX: DTF-U, DVTRF)
• EnerVest Energy & Oil Sands (TSX: EOS-U, OTC: EOSOF)
• Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF)
• FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)
• Harvest Energy Trust (TSX: HTE, NYSE: HTE)
• InnVest REIT (TSX: INN-U, OTC: IVRVF)
• Jazz Airline Income Fund (TSX: JAZ-U, OTC: JAARF)
• Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)
• Primaris REIT (TSX: PMZ-U, OTC: PMZFF)
• Primary Energy Recycling (TSX: PRI-U, OTC: PYGYF)
• Select Diversified Income Trust (TSX: SDT-U, OTC: SSDUF)
• Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF)
• WestShore Terminals (TSX: WTE-U, OTC: WTSHF)

A System to Bank On

A panel of former central bankers, finance ministers and academics chaired by former US Federal Reserve Chairman Paul Volcker released a report in January advising regulators to impose capital limits on proprietary trading and to bar large banks from running hedge funds and private-equity firms that mix their own and their clients’ money. The Group of Thirty also urged governments worldwide to tighten supervision of insurance companies, investment banks and large broker-dealers.

Mr. Volcker, now chairman of the President’s Economic Recovery Advisory Board, said during a mid-February talk in Toronto that the global framework imagined by the Group of Thirty has much in common with Canada’s financial system.

“It’s interesting that what I’m arguing for looks more like the Canadian system than the American system,” Volker said. Here’s a longer excerpt from the Toronto speech:

So what are we aiming for? I mention this because I recently chaired a report on this. It was part of the so-called Group of 30, which has got some attention. It’s a long and rather turgid report but let me simplify what the conclusion is, which I will state more boldly than the report itself does.

In the future, we are going to need a financial system which is not going to be so prone to crisis and certainly will not be prone to the severity of a crisis of this sort. Financial systems always fluctuate and go up and down and have crises, but let’s not have a big crisis that undermines the whole economy. And if that’s the kind of financial system we want and should have, it’s going to be different from the financial system that has developed in the last 20 years.

What do I mean by different? I think a primary characteristic of the system ought to be a strong, traditional, commercial banking-type system. Probably we ought to have some very large institutions–or at least that’s the way the market is going–whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system.

This kind of system was in place in the United States thirty years ago and is still in place in Canada, and may have provided support for the Canadian system during this particularly difficult time. I’m not arguing that you need an oligopoly to the extent you have one in Canada, but you do know by experience that these big commercial banking institutions will be protected by the government, de facto. No government has been willing to permit these institutions, or the creditors and depositors to these institutions, to be damaged. They recognize that the damage to the economy would be too great.

What has happened recently just underscores that. And I think we’re at the point where we can no longer fool ourselves by saying that is not the case. The government will support these institutions, which in turn implies a closer supervision and regulation of those institutions, a more effective regulation than we’ve had, at least in the United States, in the recent past. And that may involve a lot of different agencies and so forth.

The Group of Thirty report, Financial Reform: A Framework for Financial Stability, is available here in pdf format.

Finance ministers from the G20 will gather in London March 14 to begin a process of designing regulatory and risk-management systems that could prevent another financial collapse. Tiff Macklem, an official in Canada’s Ministry of Finance, will co-chair a G20 working group tasked with enhancing the regulation of financial services and improving transparency. The March meeting is intended to lay the groundwork for an April 2 G20 leaders’ summit, also in London.

In his letter inviting his colleagues to the March 14 meeting, UK Chancellor of the Exchequer Alistair Darling wrote, that the first objective before G20 ministers must be “to return trust and confidence to financial markets.”

Canada’s prominence on this issue strongly suggests outgoing US Treasury Secretary Henry Paulson’s observation that certain segments of the financial sector should be more “utility-like” will become reality. The ability of Canada’s Big Five banks to endure, thus far, the economic slowdown validates such a model.

Bay Street Beat

Familiar names dot the upper reaches of Bloomberg’s most recent survey of Bay Street analyst sentiment.

Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF), riding a North American box office surge, earned a 5.000 rating. We’ve discussed Cineplex Galaxy, Canada’s largest movie theater operator, in this space often in recent months, and the fund earned a spot in the December 2008 Feature Article, Recession-Proof Trusts.

Trust convert BFI Canada (TSX: BFC, OTC: BFCUF) also earned a 5.000 score.

In August 2008, BFI, one of the largest non-hazardous solid waste management companies in North America, announced its intention to convert from trust to corporation, a move that was initially panned by investors. BFI reduced its payout a staggering 73 percent to CAD0.50 per share on an annualized basis from CAD1.82, sending the unit price tumbling from the mid-20s to around CAD17. Bay Street analysts were also unhappy, with two firms issuing immediate downgrades on the news.

BFI was particularly constrained by the limitations the Tax Fairness Plan placed on new equity issuance by trusts and basically had to convert in order to position itself for acquisitions in an industry that’s rapidly consolidating. The company took another step in that direction in February via a CAD81 million bought-deal equity offering that helped reduce debt.

BFI reported revenue growth of 19.1 percent for the fourth quarter and 21.8 percent for 2008. Earnings before interest, taxes, depreciation and amortization (EBITDA) increased 19.9 percent in the three months ended Dec. 31, 2008, while full year EBITDA was up 12.6 percent. Free cash flow rose 318.9 percent in the quarter and 54.1 percent in 2008.

Yielding nearly 6 percent, BFI Canada is a high-yielding corporation with solid growth potential.

Renewable energy upstart Canadian Hydro Developers (TSX: KHD, OTC: CHDVF) remains in Bay Street’s good graces, despite a 16 percent year-to-date decline in its share price. Bloomberg’s survey returned a 4.846 average score for the company.

Canadian Hydro, which owns and operates 12 hydroelectric, seven wind, and one biomass power plants, reported a 25.5 percent increase in annual revenue to CAD80.1 million in 2008. Net income for the year was CAD931,000 (CAD0.01 per share), down from CAD8.3 million (CAD0.06 per share) in 2007, when the company realized a significant tax recovery.