High-quality trusts have fared even better. Aggressive Holding Ag Growth Income Fund (TSX: AFN-U, OTC: AGGRF) jumped nearly 50 percent after announcing it will convert early to a corporation without cutting its distribution a penny.

That’s an example I expect more trusts to follow. But Ag is hardly the only Canadian Edge pick to score big gains off the March 9 lows. Enerplus Resources (TSX: ERF-U, NYSE: ERF), for example, is up 65 percent since then. Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) has doubled in US dollar terms.

After a two-year meltdown of global markets–including Canada’s–this reversal of fortune is welcome indeed. The question is whether the rally has staying power or is simply one of the inevitable bounces that occur on the way to lower lows.

Since this bear began in mid-2007, my standing advice has been to stick with businesses that hold up to the economic stress tests. This got a lot harder in the fourth quarter of 2008 and particularly the first quarter of 2009, as the credit crunch took a major bite out of the real economy.

Canada has fared better than most countries, in large part because its banking system has remained intact. But even it has now recorded two consecutive quarters of negative growth.

The good news is, by and large, CE Portfolio picks reporting first quarter earnings have come in with solid numbers, just as they did in the fourth quarter of 2008. Macroeconomic conditions may or may not improve for some months, anywhere in North America. But our recommendations are hanging in there as businesses.

Most are well below their levels of last year. But strong business performance is still the single surest guarantee they’ll recover their stock market losses. And it’s the single biggest reason to keep holding now, whether the current rally accelerates or falters.

The fact that there are strong earnings on the ground is also a reason to suspect macro conditions aren’t as bad as those operating at 30,000 feet are telling us. Several weeks ago, a Wall Street Journal article laid out three possibilities for the US and global economy this year: a “V” shaped recovery, in which growth quickly accelerates;  a “U” shaped recovery, where it takes somewhat longer; and an “L,” or many years before a real recovery takes hold.

Up until the last couple weeks, the Wall Street consensus has been somewhere between “U” and “L.” That’s when we started to see some encouraging signs from the busted US banks as well as better overall economic data. And since then investors have increasingly acted as though the worst is behind us, with many even daring to hope for a “V.”

For much of this bear market, Canada has acted like a high-beta bet on the US, with bigger gains on the rare good days and larger losses on the all-too-common bad ones. That’s mainly because of the country’s heavy reliance on commodity exports, particularly oil, for which the US is still a key market. And with the Canadian dollar also pegged to oil, losses and gains have been further magnified for US investors.

Up to March 9, this cycle has triggered crushing losses, even in the strongest trusts. But since then, it’s worked in our favor with a vengeance. What’s been considered good for the US has been judged doubly positive for Canada.

The risk now, of course, is the cycle will reverse again, should economic news worsen again here. I certainly can’t rule that out in the near term. But there are also very real reasons why Canada overall should hold up, even if the US has a relapse.

One is that China is an increasingly important trading partner, and its growth appears to be reaccelerating. Another is Canada’s banks are far healthier than their US counterparts and are in fact lending, as the flurry of new credit agreements inked by How They Rate entries shows.

Finally, despite the ties of some sectors to the US economy, Canada’s economy overall is still relatively healthy. Growth looks positively stable relative to the US. So does the Canadian property market, which was never undermined by subprime mortgages. And despite stimulus spending, Canada’s federal budget remains a stone’s throw from balance.

Even these strengths may not prevent a broad retreat in Canadian markets if the most pessimistic economic voices prove on the mark. And even if we have seen the ultimate low for this bear market, history shows recoveries can take some time.

The point remains, however, that we’re buying the business. Our favorites aren’t immune to economic ups and downs, particularly the oil and gas trusts. But through two years-plus of these stress tests, they’re still holding together and are in good shape to grow when the economy perks up.

As long as that’s the case, we’ll see recovery. All we have to do is be patient and vigilant for signs of weakness that could still appear.

Portfolio Action

I’m making two changes to the Portfolio.

To the Conservative Holdings, I’m adding Colabor Income Fund (TSX: CLB-U, OTC: COLAF), a food distributor operating mainly in Quebec and the Atlantic provinces. The trust has been paying the trust tax for more than a year and continues to pay its full dividend, even while growing cash flow at a torrid clip.

I’m also selling Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV), which is converting from trust to corporation while eliminating its distribution. As I pointed out last month, it has great reserves. But management is now saying the conversion will be a taxable event, and there’s no dividend.

Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) is now a hold after reporting disappointing first quarter earnings, as is Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF) after announcing a 31.6 percent distribution cut. All other buys and holds remain the same.

High Yields of the Month

This month’s High Yield of the Month entries are both on the conservative side.

In addition to Colabor Income Fund, I’m also reviewing Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF). Both trusts reported very strong first quarter earnings, even in the most difficult of environments. Both continued to put the pieces into place for strong future growth, particularly as the global economy picks up the pieces. Both yield well over 10 percent, paid monthly. And both are in great shape to keep paying distributions at their current rate or better well past 2011.

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. See the How They Rate Table for other changes in buy targets. Price and yield information is updated every 15 minutes in both the How They Rate and Portfolio tables. Use this service as a reality check when errors occur with US quotes-based services.

Note that it sometimes takes several days for a dividend cut to be updated in the live feed. All dividend cuts in our coverage universe are analyzed in detail in Dividend Watch List.

Column four of the table shows dividend frequency. Note that dividend dates shown are approximate and can vary within two to three days of listed date. 

This column also shows how each trust and corporation can reduce its tax burden in 2011. “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)–Hold to Sell. This one may be worth revisiting once the conversion to a corporation is complete. But with no dividend and the conversion a taxable event, we’re better off out for now, particularly after last month’s partial rebound.

Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF)–Hold to Buy @ 3. I didn’t like management’s gutting of its dividend last year, but this deal to buy part of a US utility is solid.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Buy @ 5 to Hold. First quarter earnings were solid despite very weak hydro flows. But the bankruptcy of AbitibiBowater (TSX: ABH, NYSE: ABWTQ) could be big trouble for the biomass plants and possibly the dividend.

Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF)–Buy @ 10 to Hold. First quarter earnings were disappointing, as is the Ontario government’s policy on submetering residences. Both challenges should be resolved, but the trust isn’t a buy until they are.

Dundee REIT (TSX: D-U, OTC: DRETF)–Buy @ 20 to Hold. Western Canada real estate appears to be weakening, and a dividend cut looks likely.

Eveready Corp (TSX: EIS, OTC: EVRDF)–Sell to Hold. A generous takeover offer by Clean Harbors (NYSE: CLH) is bailing out investors a CAD2.64 per share in cash plus .1304 shares of stock.

Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF)–Hold to Sell. A dividend cut looks increasingly unavoidable, though a large one is arguably already priced in.

Precision Drilling (TSX: PD-U, NYSE: PDS)–Sell to Buy @ 5. First quarter earnings were much better than expected in this weak environment, and Alberta’s financial assistance demonstrates it’s a national champion.

Research in Motion (TSX: RIM, OTC: RIMM)–Hold to Buy @ 90. BlackBerry sales have beaten out iPhone sales, and first quarter earnings were robust.

The Key Royalties Income Fund (TSX: KEG-U, OTC: KRIUF)–Hold to Buy @ 7. First quarter sales were up 9.9 percent despite weaker same store sales, particularly in the US. This business is keeping its customers.

TransAlta Corp (TSX: TA, NYSE: TAC)–Buy @ 22 to Hold. Ottawa’s emerging policy on coal-fired power could be trouble.

TransForce (TSX: TFI, OTC: TFIFF)–Hold to Buy @ 5. The company is being hit by weak economy but is still holding to its strategy of acquisition-led growth and is financially solid.

True Energy Trust (TSX: TUI-U, OTC: TUIJF)–Hold to Sell. Credit problems may be getting worse even as natural gas prices stay depressed. It’s cheap, but may not survive.

Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–Buy @ 8 to Hold. A decline in auto sales hurt Yellow’s vertical media business, though distributable cash flow per share was flat. The distribution cut, however, and strategic shift are cause for investor caution.

Feature Article

A V-shaped economic recovery is still a long shot. But there are some real reasons to be optimistic for a Canadian recovery in coming months that will further propel our picks’ share prices and shore up distributions. I look at the signs of hope, as well as reasons for caution. I also highlight the most attractive sectors and those that should still be avoided.

Canadian Currents

Described by one highly respected observer of Canadian economics, finance and politics as a “game changer,” Canadian National Railway’s (TSX: CNR, NYSE: CNI) proposal to move oil sands via rail is certainly food for thought.

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 heady pace of distribution cuts of Canadian trusts and high-yielding corporations screeched to a crawl last month: Only one How They Rate entry cut distributions, Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), which is reviewed in the Portfolio Article.

Nonetheless, there are still several at risk.

The current list (excluding oil and gas producers): 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), Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF), FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), InnVest REIT (TSX: INN-U, OTC: IVRVF), Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF), Noranda Income Fund (TSX: NIF-U, OTC: NNDIF), Primaris REIT (TSX: PMZ-U, OTC: PMZFF) and Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF).

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

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

Long the Loonie–Last month George Kleinman, editor of Futures Market Forecaster and a CE contributing editor, presented his forecast for the Canadian dollar. A couple of key criteria George established have been met. Here’s a simple way to play a global economic rebound. And guess what: If you’re a US-based investor long Canadian equities, you’re also already long the loonie.

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 S. Conrad
Editor, Canadian Edge