For investors, it’s become clear that all three–the SPRTCM, oil prices and the Canadian dollar–are moving in lock-step. And calling the tune are the market’s ever-shifting hopes and fears for the global economy.

Since the fall of Lehman Brothers in mid-September 2008, this interconnection has been a decided negative for our favorite Canadian trusts and high-yielding corporations. Producer trusts especially have been crushed by the weight of falling cash flows in distributions. But even trusts and corporations with basically recession-proof businesses have been hit in the share market, as falling oil prices have slammed the Canadian dollar, and therefore the US dollar value of all things Canadian.

Ironically, this is the relationship that portends an even more powerful virtuous cycle in the not-too-distant future. When energy prices began to fall in mid-2008, supplies were tight and producers were scrambling to spend money on new projects to meet what was expected to be mushrooming demand over the next three to five years.

The collapse of the global economy in the wake of the credit crisis triggered a quantum contraction in demand for oil and gas, particularly from heavy industry. That took the edge off the supply squeeze and sent prices plummeting. But it also triggered a massive wave of cancellations and postponements of new energy projects that has yet to abate.

As a result, a return to pre-crisis demand levels will reignite the supply squeeze. Moreover, producers are likely to be deeply skeptical the next time energy prices rise, and that much more hesitant to ramp up output. Increases in the US may be further delayed by producer concerns about new regulations and taxes from the Obama administration. And the result is likely to be even higher energy prices than we saw last summer.

The big question, of course, is when that will happen. In my view, it won’t before the global economy bounces back. We could see a rebound in oil prices from a general drop in the US dollar and other currencies versus commodities, resulting from the flood of federal money entering the system to combat the recession. But only a return to growth can restore normal demand and bring supply back to the fore.

It’s fairly common knowledge that stocks always bottom before the economy in a bear market/recession. But the low point is never confirmed until much later. Until then, every surge is suspect to being a “bear market rally” or “bull trap,” luring in overly optimistic buyers and then collapsing to new lows.

Bull markets always climb a “wall of worry,” and the going is steepest of all for new bulls. The current market certainly meets that description. In fact, you’d have to look very hard to find anything approaching optimism in the financial press. Wednesday’s Wall Street Journal, for example, featured the headline “Global Slump Seen Deepening,” with an accompanying graph of economic growth plunging off the grid.

As we’ve pointed out in CE’s weekly companion Maple Leaf Memo, Canada expects to post an 8.5 percent annualized decline in its first quarter 2009 GDP. That’s that steepest contraction since 1961, far worse than even the 1990s, when the country’s energy patch was mired in a deep depression.

With all fourth quarter earnings reports in and many trusts and corporations posting guidance, we have a pretty good picture of where this recession is hitting the country. Companies involved in energy have suffered the steepest declines since summer 2008. But arguably even worse hit are businesses that rely heavily on major American industries such as housing or the auto sector.

Canadians’ innate conservatism has saved them from the worst of the leverage crisis. There was never a subprime crisis and, also unlike the US, regulation always held banks accountable. As a result, the country’s major financial institutions still have strong capital ratios, haven’t flagged in their lending, and in fact are poised to start acquiring good assets selling for distressed prices in the US.

That, in turn, has kept Canadian businesses in general flush with cash. Nonetheless, there are still some that overextended and are paying the price.

Two Takeaways

This month’s How They Rate highlights earnings results for trusts and high-dividend-paying corporations not reviewed in March. The distribution cuts for both March and April are reviewed in the Dividend Watch List.

Viewed as a whole, there are two important takeaways. First, if a business was suffering in the recession/credit crunch before the fall of Lehman Brothers on Sept. 15, 2008, it almost always did even worse during the fourth quarter that followed. Most cut distributions at least once, and some even eliminated them in the face of increased pressures on sales and credit.

The old rule about always selling a dividend cutter certainly proved out again as the crisis worsened. Today 16 trusts and high-yielding corporations in the How They Rate universe are selling for less than USD1 per share, and 19 have either suspended distributions or abandoned them entirely.

Such is the stuff of bear markets. The other takeaway from fourth quarter numbers, however, is equally compelling: Businesses that were surviving and thriving during this recession/bear market up to Lehman’s demise also did well in the fourth quarter of 2008. In fact, the numbers produced no surprise meltdowns or dividend cuts. And most of their managements have issued positive guidance for 2009 as well.

Of course, even trusts and corporations exhibiting no real business weakness have still taken on water in the stock market since mid-2008. But here, too, a curious thing is happening: Shares of trusts and corporations with strong business numbers seem to forming a bottom.

They’re still getting clocked on bad days. But the damage is far less than just a few months ago. Meanwhile, when the dust clears, they’re basically standing in the same place. In fact, some are wending their way higher and are actually back where they were when Lehman Brothers fell and chaos cut the global stock market loose from its moorings.

One great example is Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF). From the outset of the market meltdown, this owner of power plants and power lines exhibited strength, actually completing the purchase of a power plant and boosting its distribution during one of the worst weeks in stock market history.

This week it gave investors something more to cheer about: a 7 percent jump in operating cash flow, pushing the payout ratio for its 14 percent-plus yield down to just 36 percent of distributable cash flow for the fourth quarter and 59 percent for the full year. Operationally, the Federal Energy Regulatory Commission (FERC) staff and intervenors in the case approved a rate settlement for Atlantic’s Path 15 power line in California, granting it a 13.5 percent return on equity and new revenue for 2009 and 2010 in line with management expectations. FERC is expected to approve the deal by early summer.

Management also reported that it has now retired 558,620 income participating securities (IPS), or roughly 14 percent of the total buyout proposed in a July 25, 2008 filing. And it again affirmed its current cash flow stream is capable of sustaining the current distribution into 2015.

From the outset of this crisis, management has maintained that its portfolio of projects was sound, its access to capital was unfettered, and that its customer base of regulated utilities was about as recession-proof as it gets. These results back up those words with deeds.

For months now Atlantic Power’s shares have ranged all over the map. In fact, since last September there have been more than a dozen days where the price fluctuated 10 percent or more. As of now, however, Atlantic shares are right back where they were the day Lehman Brothers died.

In early September 2008, I noted how Canadian Edge Portfolio picks had held their own since the bear market began in mid-2007, mainly because their businesses had remained solid throughout the turmoil around them. The Wall Street fire sale that followed scorched even the strongest. Now value seekers are apparently returning, and prices are rebounding again.

Again, even if the bear market has bottomed, we won’t know for certain for several, possibly many, months. Until then, everyone should be prepared even for the likes of Atlantic Power to dip lower. But high-quality businesses are holding their ground in this market. And coupled with the big dividends they pay, that’s plenty of reason to hold onto the best–and leave the guesswork of whether this is a turn or bear market rally to those who want to trade.

Three Kings

Atlantic Power’s not our only holding to start asserting itself. In the December CE, I added a trio of trusts backed by businesses that were holding up well in the recession but whose share prices had been battered in the bear market: Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), CML Healthcare Income Fund (TSX: CLC-U, CMHIF) and Innergex Power Income Fund (TSX: IEF-U, OTC: INRGF).

Of the three, the best performer by far has been Bird. The main reason is we were fortunate to add it close to a bottom in early December. At the time, the infrastructure building trust had just released strong third quarter earnings. But Bay Street was intensely worried about the impact of the credit crunch and deepening recession on project backlog and earnings. As a result, the shares had plunged from a summer 2008 high in the mid-40s to a low of barely USD10 on Dec. 5.

As we pointed on the December issue, however, there was no hard evidence of any weakness at Bird. In fact, despite the postponement of one high-profile project, order backlog overall was at an all-time high. In fact, the Canadian government was poised to add to it with a slew of new infrastructure projects.

It didn’t take long for the buyers to start coming back to Bird, and we’ve since reaped a return of more than 70 percent. But the surest indication that the best is yet to come with this recommendation appeared March 23, with the announcement of the trust’s fourth quarter earnings.

As noted in the March 26 Flash Alert, fourth quarter revenue surged 11.4 percent. Meanwhile, the trust was more profitable than ever, boosting earnings 28.4 percent and demonstrating that the acquisition of Rideau Construction was successfully absorbed. And Bird succeeded in virtually eliminating debt while doubling its working capital–a key element for winning contracts–to CAD83.5 million as of the end of 2008.

Management’s statements indicate it expects a tougher year in 2009, mainly because of an expected slowdown in construction work in the energy patch. In fact, the high-profile suspension of a project for oil sands giant Suncor Energy (TSX: SU, NYSE: SU) actually triggered a drop in the shares in late February, before they regained their lost ground in March. That deal, however, had only CAD20 million of work left, making the impact of Suncor’s decision minimal to the bottom line.

Meanwhile, overall order backlog increased by 14 percent last year to a record CAD1.1 billion. And the company is ideally positioned to boost that total in coming months as the Canada’s federal and provincial governments roll out new projects. That should go a long way toward offsetting any private sector weakness. Meanwhile, any rebound in the energy patch is bound to set off a new explosion in construction work for Bird in the region.

Despite their recent run, Bird shares are still selling for less than half their mid-summer 2008 highs. The price-to-earnings ratio based on trailing 52-week profits is only 5 and the shares sell for roughly 30 percent of sales. Finally, every analyst covering the company on Bay Street is bullish on its prospects. Buy Bird Construction Income Fund up to USD22.

CML Healthcare’s solid fourth quarter results were reviewed in the March issue. I did, however, neglect to mention one interesting detail that came from the provider of testing services’ conference call in early March. Mainly, it’s a bona fide high-yielding bet on the Obama administration’s plans for the US health care system.

Over the past couple years CML has steadily built a presence in the US through acquisitions, the latest and most ambitious being Maryland-based American Radiology Services. That puts it in prime position to capture business from the estimated 40 million to 45 million Americans the president is attempting to add to health insurance rolls. Unlike some aspects of the health care business, laboratory testing services will benefit from the increased traffic alone. And CML management has years of experience dealing successfully with Canadian health authorities to win adequate rate increases, unlike its US rivals.

As for the rest or 2009, there’s little indication any of the trust’s operations are suffering from recession pressures and neither are there credit pressures. That adds up to an attractive package in a generally recession-resistant industry. Buy CML Healthcare Income Fund if you haven’t already up to USD13.

As for Innergex, it too turned in banner fourth quarter and full year 2008 results, thanks to a 43.4 percent increase in the output of its fleet of hydroelectric and wind power plants. Revenue surged 38.7 percent and cash flow soared 35.8 percent. Adjusted net income per share, the account from which dividends are paid, rose 37.5 percent, covering both distributions and capital spending in what’s normally a seasonally weak quarter.

The power trust’s core strength is its fleet of well-run, largely new power plants (average projected life is 25 years), backed by long-term (15.4 year average life) sales contracts to ultra-reliable accounts receivable such as utilities and governments. But management has further bullet-proofed results by structuring its debt equally conservatively. Basically, there are no significant maturities until 2013. The credit line of CAD10 million is basically unused, and the trust has another CAD23.7 million in the bank.

In other words, rather than worry about how the trust will make ends meet in the worst recession for Canada since 1961, management can focus on new growth opportunities. And there’s certainly no shortage in the trust’s area of core competency, renewable energy. In fact, in managements own words, it will “consider any investment or acquisition opportunities that might become available on the market in 2009.”

Power trusts continue to prove themselves as ultra-reliable cash earners and dividend payers. And since we added its shares to the CE Portfolio, Innergex has been a prime example of the sector’s strength. Amazingly, it still trades a yield of a little over 11 percent and just 1.24 times book value. Buy Innergex Power Income Fund up to USD12 if you haven’t yet.

Watching the Economy

In general, Conservative Holdings are far more recession-resistant than the commodity-price-dependent Aggressive Holdings. Their primary appeal is high, safe and growing yields backed by strong businesses that can weather any manner of conditions. And thus far at least they’re proving up to the test of some of the worst conditions in memory.

Given the magnitude of the economy’s woes, however, there were several Conservative picks that particularly caught my attention coming into fourth quarter earnings season. Basically, I was confident they’d still be holding their own but determined to catch any signs of weakness that could warn of trouble down the road.

Last issue, I reviewed one of these picks, Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), a trust that specializes in advertising companies, goods and services in traditional print directories and through a budding Internet business. This is a business that’s literally crashed and burned in the US, and many are still convinced such as fate is inevitable for Yellow. Yet quarter after quarter, the business continues to post strong results, and the fourth quarter was no exception as growth actually accelerated from the full-year rate.

This month the only real business news about Yellow was the extension and expansion of its credit lines on very positive terms. But after getting pounded almost continuously since early 2006, Yellow shares have actually stabilized since December. Moreover, insiders have begun to pick up shares, and Bay Street has apparently begun shifting in a more positive direction.

I wouldn’t even hazard a guess as to when Yellow will return even to a modest valuation like its book value, though that would trigger a near double in the share price. And it’s certainly possible the recession will finally slow its growth in the first quarter. But at least some people are apparently realizing that Yellow, despite its bricks-and-mortar name, is no RH Donnelly. As long as the trust keeps putting up those good numbers, we will see that recovery. Buy Yellow Pages Income Fund up to USD8 if you haven’t yet.

Last month, we saw results from Artis REIT (TSX: AX-U, OTC: ARESF). Unlike the other three CE Portfolio REITs, Artis had some real potential exposure to Canada’s recession, due to its high concentration in energy and commodity producing areas, particularly Alberta.

Artis, however, continued to pass all tests. Distributable income per share growth did slow to just 2 percent, due to a slowed pace of acquisitions. But fourth quarter revenue growth still rose 22 percent increase, on the addition of CAD116.6 million in new properties over the past year. Funds from operations (FFO) per share rose 7.7 percent as occupancy rates held at 96.5 percent, 97.4 percent including committed space.

The trend of tightened credit markets constricting new development will continue to limit growth in 2009. Growth in same property net operating income–the best measure of profit margins on already owned properties or excluding acquisitions–was still solid at 6.9 percent in the fourth quarter. One big reason: 45.8 percent growth in fourth quarter rents on expiring leases.

Given the meltdown in the energy patch, rents in the Alberta market, which accounts for half of revenue, are likely to come down in 2009. The good news is rents portfolio wide remain more than 20 percent below current market rates. Coupled with the young age of the properties, that makes them less likely to see higher vacancies and gives them a cushion on renewal rents as well. Moreover, half of properties are leased to “national” tenants and 8 percent to governments. And half of 2009 expiring leases already have commitments, at an average rate 22 percent above current rents.

For some western Canada REITs, debt taken on to fund rapid growth has emerged as an Achilles heel during this crisis. In contrast, Artis’ ratio of total mortgages, loans and bank indebtedness to the book value of its properties stands at just 51.6 percent, versus a 70 percent limit in its charter. Only half of its CAD60 million credit line is drawn, and just 5.4 percent of mortgage debt expires this year, all after June.

The upshot: Artis is weathering the recession thus far, even as it’s priced at just 58 percent of book value. And its 17 percent-plus yield is protected by a payout ratio of just 75 percent. Buy Artis REIT up to USD10.

Of all my Conservative Holdings, TransForce (TSX: TFI, OTC: TFIFF) is by far the most sensitive to economic ups and downs. The business’ exposure to the current recession showed up once again in graphic relief last month, as TransForce rival Contrans Income Fund (TSX: CSS-U, OTC: CSIUF) “indefinitely suspended” paying all distributions, citing increasingly tough operating conditions.

That may ultimately happen to TransForce, depending on how much the downturn worsens. But thus far, at least, the company–which converted from income trust to corporation earlier this year–appears to be coping with the tough environment, thanks to a combination of cost cutting and expansion in targeted niches of the industry.

To be sure, as Contrans’ results showed, the deepening recession on both sides of the border is slowing cross-border transport. Meanwhile, tight credit conditions and slowing sales are squeezing major industries that traditionally patron the industry. And the company’s ability to raise capital has been limited to new borrowing by the drop in its share price.

Nonetheless, as I reported in a Flash Alert last month, TransForce reported a 10 percent boost in 2008 revenue, 21 percent growth in cash flow and a jump in annual earnings to CAD0.92 a share from CAD0.52 a year ago. Those robust results continued in the fourth quarter as well, as the company also grew revenue and cash flow by 10 and 21 percent, respectively. Earnings per share, meanwhile, swung into the black at CAD0.17 a share, up from a year ago loss of CAD0.36. Adjusted for one-time items, fourth quarter profits per share were down slightly at CAD0.26 per share, versus CAD0.29 last year.

Three of the company’s four operating units–Less than Truckload, Specialty Truckload and Package/Courier–reported stronger fourth quarter results, as management successfully expanded services and integrated recent acquisitions. The other, Truckload, saw sales slip 6 percent. But the real surprise is they didn’t slump further, a testament to the company’s high-quality service, cost containment and solid marketing.

Again, there’s no guarantee things won’t worsen further in 2009, and until the economy does cycle out this one will bear close watching. As of now, however, there’s nothing to indicate that this company isn’t continuing its long-term strategy of building a dominant transport franchise in Canada, consolidating a long-fragmented sector. And there’s little to worry about on the debt side, either, with TransForce well within debt covenants and forecast to generate CAD100 million in free cash flow in 2009, despite the tough economic conditions. It’s also in the process of buying back 7.5 percent of outstanding shares.

There’s only one reason I’ve recommended and held TransForce so long: Management has stuck to its goal of building the leading transport company in Canada. As long as it’s progressing toward that goal, I’ll be sticking with it. Meanwhile, the stock yields more than 10 percent and sells for just 63 percent of book value at its current level. Hold TransForce.

Turning to the Aggressive Holdings, Ag Growth Income Fund (TSX: AFN-U, OTC: AGGRF), a maker of grain handling equipment, looked like it could go either way in the fourth quarter. On the one hand, operations looked stronger than ever, as management has solved the supply bottlenecks that had plagued it in early 2008. On the other, grain prices had fallen sharply, and there was the chance that farmers would cancel orders due to the credit crunch.

As it turned out, however, Ag Growth posted one of its best quarters yet. Sales soared 81.6 percent, accelerating from the full year growth rate of 52.9 percent. Cash flow before the impact of foreign exchange movements surged more than four-fold, another sharp acceleration from an already impressive annual growth rate of 44.9 percent.

Ag’s results did reflect new efficiencies in its operations. But the key driver of growth was that grain storage practices in North American agriculture that remained robust as ever, despite the drop in grain prices. Moreover, order backlogs are well above levels of prior years and management reported few credit problems for its customers.

As for financial strength, the trust is using free cash flow to buy back up to 10 percent of its shares, a sure sign of its strong cash position. Credit lines of CAD10 million and USD2 million are undrawn. Total long-term debt is just CAD52.8 million at low effective rates, and there are no significant maturities this year.

It’s always possible agriculture will slow as the rest of the US economy has. But from the view on the ground, management says conditions are “very strong” in the portable grain handling and aeration equipment business, which comprises roughly 65 percent of sales. The stationary grain handling business is expected to be flat, while demand for the trust’s storage equipment continues to “exceed production capacity.” That’s a healthy outlook that provides plenty of room for robust top- and bottom-line growth, and support aplenty for Ag’s 8.4 percent distribution. Buy Ag Growth Income Fund up to USD22.

Energy’s Nadir

Almost all of my energy producer and service trusts reported earnings in time for the March issue. All of those trusts sustained some hit to cash flow from falling energy prices, and their counterparts who reported afterward did as well.

Two reviewed elsewhere in this issue are Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV)–highlighted in the Feature Article and Dividend Watch List–and High Yield of the Month Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF).

Provident Energy Trust (TSX: PVE-U, NYSE: PVX) shares got a lift from the announcement of its fourth quarter earnings and 2008 reserve data. Months of pounding in the marketplace had apparently established a very low bar for the results, and the trust had no problem hurdling it.

Baseline funds from continuing operations–the account from which distributions are paid–fell from CAD0.72 to just CAD0.32 in the fourth quarter, as the trust felt the bite of falling commodity prices. But midstream operations’ profits were basically flat, as efficiencies offset much weaker natural gas liquids spreads. Production costs rose and output fell due to an outage at a pipeline. But all in all, the numbers indicated that the company is making the most of a bad market, and therefore laying the groundwork for a strong recovery when energy prices return to the upside.

The trust’s distribution has been cut twice since November. But the current level looks reasonably protected by a payout ratio of 56.3 percent on fourth quarter cash flow and baseline realized selling prices of USD47 for oil and USD6.63 per thousand cubic feet for natural gas. Moreover, management says midstream margins have improved greatly in the first quarter of 2009.

Finally, management has made great strides cutting debt. Fourth quarter interest expense was slashed 38 percent thanks to a 45 percent reduction in bank debt. More than half the CAD1.125 billion bank line is undrawn and management looks set for more cuts in the future. Proved reserve life was steady versus year earlier levels at 6.1 years, proved plus probable increased to 10 years.

As with all producer trusts, no one should buy or hold Provident with the expectation that recovery will be quick or even painless. But the bar here is survival and the trust thus far at least is making it work.

There’s the additional matter of the suit against the trust’s former US unit BreitBurn Energy Partners (NSDQ: BBEP) still hanging over things. But selling at just 50 percent of book value and 50 percent less than the net asset value of its production assets alone–not counting the midstream assets–the shares are already pricing in far more than any reasonable liability in the case. And the 15 percent distribution now looks well covered. Provident Energy Trust is a buy for aggressive investors up to USD6.

Finally, energy services provider Newalta Corp (TSX: NAL, OTC: NWLTF) has seen its shares slide sharply since announcing its now-completed conversion to a corporation. The selling is almost surely due to the exodus of many high-yield investors from the shares. But their replacement with more growth-oriented investors has been slow to germinate, in large part due to the perceived weakness of the company’s major markets–i.e. heavy industry, mining and energy.

To be sure, there has been an impact. Fourth quarter revenue growth slowed to 6 percent, while cash flow rose only 2 percent, compared to double-digit growth for both for the full year. Fourth quarter net earnings, meanwhile, dropped 62 percent as revenue from recycling energy industry waste fell 14 percent. The good news is that was due entirely to a drop in the value of recycled waste products. Actual activity increased, as waste processing volumes rose, auguring strong growth when energy prices do recover.

As has been the case in recent quarters, Newalta’s Eastern division was the bright spot for operations. The division processes waste from Canada’s industrial base in the eastern half of the country. Fourth quarter revenue rose 43 percent, while margin rose 57 percent as the company successfully integrated acquisitions and expanded its reach, particularly in Atlantic Canada and Quebec.

That growth could slow in 2009 due to declining activity in industrial Canada, which is suffering from the weakness of the US economy. And energy patch operations are also likely to take a hit due to the dramatic curtailment of drilling. Oil sands cleanup remains a huge issue, but low energy prices have slowed activity there as well.

The upshot: Newalta will have to do once again what it’s done so well the past several years: continually streamline operations and look for new niche opportunities to grow new businesses to make up for the slump in its older businesses. Ironically, that will continue to build what’s now a Canada-leading franchise for heavy waste cleanup and recycling.  That’s a business that will only grow in scale and scope in coming years, as environmental concerns become ever-more important.

Again, there’s always the potential for faltering in such a weak environment. But it’s here that converting to a corporation this year and cutting distributions will show up as prudent moves as far as keeping the company on track with its long-run strategy.

As I’ve written repeatedly in the past, Newalta’s strong business performance has been at sharp odds with the weakness in its share price, which is off more than 90 percent from where it was just a few years ago. The trust now trades at just 23 percent of book value and 19 percent of sales and–despite converting to a corporation–still yields upward of 7 percent. The payout ratio is low at just 36 percent of expected 2009 profits, and there’s no meaningful amount of debt due until 2011.

It’s probably going to take a boost in energy prices to ignite any interest in Newalta shares. But if you’ve hung on this long, this is no time to bail. And if you’re looking for a strong company selling for a ridiculously low price and willing to hang on for a recovery, Newalta is a buy up to USD5.