The broad S&P/Toronto Stock Exchange Income Trust Index is more than 30 percent above the all-time low it hit in 1998 and again in early 2000. But it’s also barely half the early 2006 high, which was revisited briefly last summer. And there have been 77 dividend cuts over the past six months, most by repeat offenders.

Canada’s woes still can’t hold a candle to the carnage sweeping the US. Its banking system is solid. Ottawa isn’t running up mammoth deficits with its fiscal stimulus. And Canadian consumers and businesses are still finding credit, in large part because they never abused it.

Nonetheless, Canada is suffering its worst recession in decades. The energy patch, long a source of strength, is contracting sharply, as natural gas prices crash and oil languishes. Equally crushed are industries that depend heavily on US markets, from timber and pulp to metals and transportation.

This begs a simple question: Is Canada a deal or a dud? In my view, the biggest positive is extreme value. Dozens of trusts and high-yielding corporations are selling below book value. Companies with healthy and growing underlying businesses and little risk to dividends are yielding as much as 20 percent.

Then there’s the so-called reflation play. Highlighted this week in the Wall Street Journal, this is a bet that the flood of government money pouring into the global economy will ultimately favor natural resources and the currencies of countries that produce them.

I believe the supply destruction of recent months alone guarantees sharply higher energy prices when the recession ends and global demand returns to normal levels. That will trigger a sharp recovery in the Canadian dollar. A move back to parity would lift the US dollar value of trusts and their distributions by 25 percent.

The counter argument is we have no way of knowing when global recovery will arrive, or how bad things will get before that. And until we see one, all things Canadian are going to be extremely volatile. As we saw in late March, Toronto will be off to the races when the economic news looks promising. On the other hand, return to gloom may trigger greater damage than in New York, as we saw during the selling leading up to the March 9 lows.

Over the past several months I’ve repeated my contention that this bear market will end as all others before: with a monster rally in stocks and trusts whose underlying businesses have stayed strong against the global recession and credit pressures.

What we’re seeing now may mark a real turning point. Or it might be simply a fleeting rally before another major down leg. But there’s one strong argument that we’ve seen the worst for trusts and companies whose underlying businesses have stayed strong: They’ve been noticeably holding their own in the stock market since late October. In fact, several, such as Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) have rebounded to where they traded before Lehman Brothers fell in late September.

The collapse of that once-venerable institution is the event that finally toppled the debt-imploded US financial system. It was also the catalyst that turned a long but manageable bear market into Wall Street’s worst catastrophe in 80 years. Nothing was spared from the carnage that followed, as investors feared everything would be caught up in economic Armageddon.

The best news of the last six months is businesses resisting the downturn before Lehman’s fall have generally kept doing so. In early September 2008, I noted that the Canadian Edge Portfolio was roughly flat for the bear market that began in mid-2007 because of strong underlying business performance. Lehman’s demise changed that. Now the times appear to be changing back.

It’s too early to draw conclusions about a market turning point. But companies with strong underlying businesses appear to be gathering investor support. Volatility is massive. But when it passes, the solid are standing in roughly the same places, if not a little higher.

Because they require fewer regulatory filings, first quarter 2009 earnings for trusts and high-yielding corporations are going to come much faster than fourth quarter results did. High Yield of the Month RioCan REIT (TSX: REI-U, OTC: RIOCF) will announce April 29, and by mid-May we should have numbers on most of the trust universe.

Just as with every earnings reporting season during this bear market, the numbers will be our guide for what to stick with and what to dump. On the other hand, we’re now seven quarters into the worst economy and stock market in decades. And there’s no better indication that a company will stay strong than it’s been thus far. Be patient. Better times will come, and almost certainly just when we least expect them.

Portfolio Action

Fourth quarter earnings are finally in for Canadian Edge Portfolio holdings. The first takeaway is all Conservative holdings posted numbers that strongly support distributions, and most provided positive guidance for 2009 as well. Second, all of our energy producers and services companies demonstrated their ability to survive tough times. But their dividends are under increasing pressure from the drop in natural gas prices under USD4 per million British thermal units. As a result, even though oil prices appear to be stabilizing, we may well see more cuts. Third, all of our recommendations are accessing credit on reasonable terms.

All bear markets end, eventually. And the surest and fastest to recover are stocks backed by strong underlying businesses. This recession may well worsen and extend into 2010, taking down more industries in its wake. To date, however, CE Portfolio members are still performing as businesses. As long as that’s the case, they’ll be in line for a massive recovery when the market finally turns. Our strategy remains to stick with them, collecting distributions while we wait. Note two are currently holds: Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV) has elected to convert to a corporation and no longer pays a dividend; TransForce (TSX: TFI, OTC: TFIFF) faces a very difficult operating environment.

High Yield of the Month

This month’s High Yield of the Month entries are from two extremes.

The Conservative Portfolio pick is RioCan REIT (TSX: REI-U, OTC: RIOCF). Canada’s largest REIT is using the downturn to build future prosperity, even while it pays out a secure dividend topping 11 percent.

The Aggressive Portfolio pick is Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF), easily my most leveraged bet on natural gas prices in coming years. The trust pays a yield of nearly 20 percent and has hedged more than half of projected output through March 2011. Last month, management announced both an accretive merger and trimmed the distribution again, demonstrating Paramount’s volatile fortunes. That will work heavily to our advantage going forward, however.

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.

Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV)–Buy @ 5 to Hold. As reported in a March 20 Flash Alert, Advantage has elected to convert early to a corporation and eliminate its distribution entirely for the foreseeable future. Trading at barely a fifth its net asset value of CAD14.03 per share, the stock is likely to rally, either on takeover possibilities or as speculators replace the income investors now selling. That makes Advantage a worthwhile hold, though it’s no longer attractive for income.

Aeroplan Group (TSX: AER, OTC: GAPFF)–Hold to Sell. This company’s business is heavily dependent on the economy and could take a real hit this year.

Avenir Diversified Income Trust (TSX: AVF-U, OTC: AVNDF)–Buy @ 5 to Hold. This small trust is in the midst of reorganizing with asset sales, unloading the biodiesel business at a loss last month. I’m concerned about the small size of the energy production arm and negative distributable cash flow in the fourth quarter due to restructuring.

Big Rock Brewery Income Fund (TSX: BR-U, OTC: BRBMF)–Sell to Hold. At one time, I favored Big Rock as a recession-resistant play. Now that it’s put its house in order operationally, it’s putting up numbers that are starting to convince me it’s for real.

Citadel Diversified Income Trust (TSX: CTD-U, OTC: CTDXF)–Hold to Buy @ 5. The trust has trimmed its distribution to a more conservative level, has no leverage and sells for a more than 20 percent discount to its net asset value.

Contrans Income Fund (TSX: CSS-U, OTC: CSIUF)–Hold to Sell. Last issue, I noted signs the weakening business environment was having an impact on this trucking trust’s cash flow. Management’s decision to suspend distributions confirms earnings are being stressed a lot more than they were letting on initially.

Extendicare REIT (TSX: EXE-U, OTC: EXETF)–Sell to Hold. US courts have thrown out a pair of potentially devastating lawsuits against the owner and operator of retirement living facilities, in Minnesota and Washington state.

GMP Capital Trust (TSX: GMP-U, OTC: GMCPF)–Hold to Sell. Management has pledged to pay a quarterly dividend after the trust converts to a corporation later this year. But given the stock’s 44 percent boost this year, the current weakness of Canada’s market and the lack of dividend now, there’s little incentive to stick with GMP.

Home Equity Income Trust (HEQ-U, OTC: HEITF)–Hold to Sell. Management now plans a deep dividend cut when it converts to a corporation later this year. With the shares already up more than 10 percent and the company’s health heavily dependent on easy credit, it’s time to cash out.

H&R REIT (TSX: HR-U, OTC: HRREF)–Buy @ 7 to Hold. The Alberta office property market continues to weaken, even as the trust pushes ahead with the enormously expensive Bow project for Encana (TSX: ECA, NYSE: ECA). If financing comes apart or Encana backs out, we’ll see another dividend cut. Meanwhile, the shares have rallied over the past month above my prior buy target.

InStorage REIT (TSX: IS-U, OTC: INREF)–Sell to Acquired. The REIT was officially acquired for CAD4 per share in cash on March 20. Investors should have received the cash in their account by now. There’s no Canadian withholding of the proceeds.

Primaris REIT (TSX: PMZ-U, OTC: PMZFF)–Hold to Sell. The REIT has no major near-term liquidity concerns. But shopping malls are in the cross hairs of this recession, the payout ratio is high and fourth quarter funds from operations per share fell 7.4 percent.

Priszm Income Fund (TSX: QSR-U, OTC: PSZMF)–Sell to Hold. There’s nothing like posting vastly improved earnings in a recession to earn an upgrade from me. Fourth quarter cash flow rose 35.6 percent, the full-year payout ratio is now comfortably below 100 percent and management projects improved liquidity throughout 2009.

Royal Host REIT (TSX: RYL-U, OTC: ROYHF)–Hold to Sell. Fourth quarter earnings only look solid because of asset sales. Bay Street is squarely bearish, and the hospitality business looks weak.

Russell Metals (TSX: RUS, OTC: RUSMF)–Hold to Sell. This is a solid company but last month’s 44 percent dividend cut is a clear sign the recession is taking a big bite out of profits. And with the industry’s dependence on steel and autos, things could get worse still, even with the shares at just 63 percent of book value.

Student Transportation Corp of America (TSX: STB-U, OTC: SUDRF)–Hold to Buy @ 7. Organized as an income participating security, Student Transport’s distribution is roughly half equity dividend and half debt interest. More important, however, it appears to be weathering the recession well, winning a valuable Illinois bus contract and buying back a large swath of its own securities.

Trilogy Energy Trust (TSX: TET-U, OTC: TETFF)–Buy @ 4 to Hold. Since last month, the trust has surged. A takeover is still possible, but the shares are now above net asset value.

Wajax Income Fund (TSX: WJX-U, OTC: WJXFF)–Hold to Buy @ 12. The trust is down more than 35 percent year to date and is already pricing in a deep distribution cut. Insiders are buying heavily.

Note we’re also adding seven Canadian corporations to How They Rate coverage this month, as noted in the Feature Article. See the table for details and my initial advice: Brookfield Asset Management (TSX: BAM/A, NYSE: BAM), Canadian Natural Resources (TSX: CNQ, NYSE: CNQ), Encana (TSX: ECA, NYSE: ECA), Nexen (TSX: NXY, NYSE: NXY), Potash Corp (TSX: POT, NYSE: POT), Research in Motion (TSX: RIM, NSDQ: RIMM) and Suncor Energy (TSX: SU, NYSE: SU).

Feature Article

With 2011 and new taxes approaching, trusts of all stripes are exploring their options. Several have already converted to corporations and, barring a change in the law most of the rest will follow by the end of 2010 at the latest.

For investors, the critical thing to remember is it’s all about the business. Healthy and growing companies are worthy buys no matter how they’re organized for tax purposes, just as no tax advantage ever increases the true value of a faltering business.

I examine the conversions we’ve seen to date, what they’ve meant for investors, and which of the newly minted corporations rate strong buys now. I also analyze the future dividend prospects for CE Portfolio trusts and introduce the “Magnificent Seven” Canadian corporations we’ve added to How They Rate coverage this month.

Canadian Currents

In November 2007, the Canadian dollar hit an all-time high against the US dollar, roughly USD1.10 per loonie. Since then, Canada’s currency has sharply reversed course, sinking to less than USD0.80. Such volatile exchange rate swings have profound implications not only for US investors–as they directly affect the value of Canadian trusts and corporations and their dividends–but for the health of Canadian businesses as well.

CE contributing editor George Kleinman, a 30-year-plus veteran of the futures markets, looks at the prospects for the loonie, and why it has the potential to be a big winner for 2009 and beyond.

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–The pace of distribution cuts tapered off somewhat last month for How They Rate entries. Nonetheless, 11 made noticeable cuts in the face of bear market stress tests. Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV) and Contrans Income Fund (TSX: CSS-U, OTC: CSIUF) eliminated their payouts completely. Meanwhile, Bonavista Energy Trust (TSX: BNP-U, OTC: BNPUF), Citadel Diversified Income Trust (TSX: CTD-U, OTC: CTDXF), Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF), Home Equity Income Fund (TSX: HEQ-U, OTC: HEITF), Lanesborough REIT (TSX: LRT-U, OTC: LRTEF), NAL Oil and Gas (TSX: NAE-U, OTC: NOIGF), Paramount Energy Trust (TSX: PMT-U, PMGYF), Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) and Westshore Terminals Income Fund (TSX: WTE-U, WTSHF) all made partial reductions.

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

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

Quantitative Easing–Central banks are firing up the printing presses, a practice that invariably results in inflation.

Tax Statements–We’re compiling the information you’ll need to back up your qualified dividends.

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