One: That’s the very welcome number of distribution cuts in the Canadian Edge universe last month.

Of course, we had seen a record 77 reductions since the fall of Lehman Brothers last September, and that pace was bound to slow. But it’s also undeniable that a growing number of managements have decided to hold distributions level, even as their first quarter earnings are being tallied. The exception, Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), is covered in the Portfolio Article.

That’s a stark contrast from fourth quarter earnings reporting season, when many took the axe to distributions in advance of announcing numbers. And coupled with signs the Canadian economy’s decline is leveling off, it’s very hopeful indeed for future payouts.

Ultimately, paying a dividend depends on maintaining a healthy and preferably growing business. That’s a lot more difficult to do when overall economic conditions are shaky. The upshot is that until the economy definitely bottoms, distributions for many trusts are going to be at risk. And we’re going to have to be extremely vigilant to spot signs of weakness, even at trusts that have held up to the stress tests thus far.

In sectors where profits depend heavily on commodity prices, it’s next to impossible to avoid distribution cuts during prolonged downturns. For example, as I pointed out last month, 47 of the 77 cuts since Lehman Brothers declared bankruptcy were at energy producers and energy services companies.

More than half the dividend-paying trusts and corporations I track in these sectors have cut their payouts more than once since September. In fact, only three haven’t cut payouts to date since the summer 2008 energy price peak: Crescent Point Energy Trust (TSX: CPG-U, OTC: CPGCF), Aggressive Portfolio pick Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF).

My view is every energy producer and services company/trust, including this trio, should always be considered at risk to dividend cuts if energy prices fall far enough. By the same token, however, they’re always primed for huge dividend increases if energy rises enough.

The good news is the energy patch is dirt cheap after suffering through one of the worst collapses ever in any market. A further nosedive in oil prices could yet trigger another round of distribution cuts. Barring that, however, dividend-paying trusts and corporations should be able to hold their own.

Meanwhile, a recovery in oil and natural gas to at least reserve replacement costs–USD70 to USD80 a barrel and USD7 to USD8 per million British thermal units, respectively–will trigger a massive rebound in cash flows, distributions and share prices.

That’s the ballgame here. My view remains that sharply higher energy prices are inevitable when the global economy truly does bottom and returns to growth. Until then, however, energy prices are likely to remain range-bound and always vulnerable to another decline. That means energy producer and service trusts are still at near-term risk to giving up at least a good chunk of the gains we’ve seen since March 9.

Many producer trusts are selling at steep discounts to their reserves in the ground. Despite recent dividend cuts, they still pay out huge amounts of cash. Management at most trusts appears committed to a high dividend payout model, both up to and after 2011. In fact, a rebound in energy prices would give them the ability to easily absorb the trust tax.

No one, however, should own any of the energy producer trusts unless they want to bet on energy. That’s what cash flows and distributions follow, and it’s ultimately what sets your return.

Outside the energy patch, almost every sector has seen some impact from the recession. The worst hit have been those tied in with the US automobile and housing industries, particularly anything to do with metals and forestry products.

The silver lining at this point is the most vulnerable have already taken their dividend-cut medicine to preserve cash. With very few exceptions, trusts paying no distributions and currently trading below USD1 a share should be considered at risk to Chapter 11. I’ve in fact continued to rate the majority of these as sells. But most of those still paying dividends appear to be in good shape to maintain them.

Here’s a roundup of some of the possible exceptions. A late reporter of fourth quarter numbers, Avenir Diversified Income Fund (TSX: AVF-U, OTC: AVNDF) hasn’t yet announced its first quarter results. But its 167 percent payout ratio for all of 2008 and the small size of its oil and gas production operation make it a serious candidate for a cut.

The good news is the possibility of one is already priced in, with the trust’s current yield at over 30 percent and shares trading at just 55 percent of book value. The two Bay Street firms tracking its prospects are bullish, and there’s been some insider buying. Real estate operations also appear to be healthy, with the portfolio “fully leased” in management’s words.

That’s enough to continue rating Avenir Diversified Income Fund a hold, but only with the caveat that a dividend cut of as much as 75 percent could be in the offing.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF) got a nasty jolt last month when AbitibiBowater (TSX: ABH, NYSE: ABWTQ) filed Chapter 11. The giant forest products firm had been a key source of wood waste needed to run the trust’s Dolbeau and Senneterre plants, and it was the key customer for the steam and power output from the Dolbeau plant.

At this point, Boralex management has stated it “has not been able to determine the impact of (the bankruptcy) on the operation of the Dolbeau plant, nor on the dispute between the two organizations.” Bowater and the company had been engaged in a long-standing dispute about the terms of the Dolbeau contract. Senneterre continues to operate. Dolbeau, however, was shut as of April 1 and is expected to stay off line until at least the third quarter of 2009.

Boralex’ first quarter earnings were impacted by the problems at the wood waste operations, as well as a sharp drop-off in water flows to its river-fed hydroelectric power plants. The wood waste plants saw revenue dip 4 percent from year-earlier levels, while cash flow tumbled 16 percent, despite generally remaining in operation. Those results are likely to show an even bigger hit going forward, as wood waste supplies remain tight for Senneterre and Dolbeau is shuttered.

Hydro remains by far the most important contributor to cash flow at 58.6 percent in the first quarter. Output here suffered from a 23 percent drop in output at the US facilities from year-earlier levels, some 6 percent below the historical average. Overall output was off 18.1 percent from year-earlier levels.

The good news is Boralex’ hydro shortfalls have historically been followed by surpluses. And management has been willing to use the fund’s adequate cash reserves to make up the difference for dividends. The bad news is if it’s determined the wood waste assets are permanently impaired, there may be little choice but to trim the payout again.

My view is a yield of nearly 20 percent and price of 74 percent of book value reflect that risk already. But until there’s something more definitive on the wood waste operation, Boralex Power Income Fund is a hold.

FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), as expected, took a big hit to its first quarter earnings from the slowing economy. Advertising revenue skidded 13.1 percent, with the largest category, display ad sales, sliding 13.6 percent.

The trust also saw a 22.6 percent drop in commercial printing revenue, owing to the cancellation of the National Post Winnipeg contract. Flyer distribution sales dropped 9 percent, and circulation revenue for the trust’s three papers fell 2 percent, as higher subscription rates only partly offset more cancellations and non-renewals.

Compared to the woes of some of North America’s biggest newspapers, FP’s problems aren’t nearly as severe. The focus on mostly small to medium-sized towns, for example, means limited competition, and relatively flat subscription revenue is a good sign it’s holding its readership, as is data showing steady market share. One reason is high editorial quality, marked by a large number of staff awards for a small organization. Another is management’s proactive moves to cultivate online readership.

Nonetheless, to pay a distribution, the numbers have to add up. And increasingly, that’s not the case for FP, despite aggressive organization-wide cost reductions. The first quarter payout ratio of 186 percent of distributable cash flow, for example, continues a trend of paying out more than taking in.

To date, management has said little about the distribution, other than a general statement with the earnings release that it expected “cash flow from operations together with cash balances on hand to fund operating requirements, capital expenditures and anticipated distributions, assuming advertising revenues do not materially deteriorate beyond management’s current expectations.” That’s a bold statement given current conditions. But it also leaves an out for a cut, possibly a big one, in coming months.

FP’s current yield of nearly 30 percent and price of 49 percent of book value is pricing in a lot of bad news already. And I’m not quite ready to throw FP into the same category as US newspapers, which have their obvious troubles.

But until this economy really bottoms, FP Newspapers Income Fund is going to be swimming upstream and rates a hold.

Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF) enjoys a lucrative cost sharing arrangement with parent Air Canada (TSX: AC-B, OTC: AIDIF), so it didn’t profit directly from the steep drop in fuel prices since last summer. Worse, neither apparently has the parent, which continues to teeter on the brink of Chapter 11 as it battles with its powerful unions to cut costs. One reason is falling traffic. Jazz itself reported a 13.6 percent decline in traffic for April and a load factor of 68.1 percent of seating capacity, down from 74.9 percent a year ago.

Jazz’ first quarter results aren’t due out until May 15. But given this news, they’re not likely to be very cheery. Then there’s the problem of refinancing a CAD115 million credit facility that matures in February 2010. Unless rate spreads come down sharply, it will make far more sense for management to slash the distribution and use the saved cash to pay off what’s due, rather than try to refinance at high rates that would likely force a dividend cut anyway.

It’s true that Jazz’ yield of nearly 36 percent and price of 42 percent of book value already reflect a fairly large distribution cut. But given this trust’s exposure to both the weak economy and higher fuel prices that are likely to accompany any recovery, Jazz Air Income Fund is a sell.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) more than halved its March distribution due to a steep plunge in demand for zinc and sulphuric acid produced from the facility that is its only source of cash flow. First quarter earnings numbers, however, are a pretty stark reminder that some severe risks remain.

For one thing, these products are used almost exclusively by heavy industry in North America, which remains flat on its back in this recession. Only a real recovery will spark demand back to levels that will restore the trust’s past profitability.

In response, the operator of the facility–mining giant Xstrata (London: XTA, OTC: XSRAF)–is sharply curtailing output until conditions improve. Sulphuric acid production was slashed by 20 percent in April, and similar reductions are in store this month. In addition, Xstrata has now restructured to allocate costs at all of its refineries, putting an additional burden of proof on dividends paid to Noranda investors.

Management has been working overtime to cut costs to offset some of the impact of lower prices and output. The fund was successful in slashing interest expense for the quarter by nearly 35 percent year-over-year by paying down credit balances. Hedging of commodity and currency risk has further safeguarded cash flows.

The plant remains at high efficiency, and the US and Canadian stimulus packages should boost demand for North American steel in the second half of 2009, which should in turn aid demand for the Noranda facility’s output. All that bodes well for Noranda when the global economy bottoms.

But first quarter results and management’s decision to pull in its horns a bit are pretty clear signs it will take time. Meanwhile, a further dividend cut and drop in price are sizeable risks. Sell Noranda Income Fund.

In contrast, I’m maintaining a buy on another trust that’s also been hit hard by the damage to heavy industry, Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF). Labrador’s only source of income is an iron ore processing facility operated by a unit of mining giant Rio Tinto (NYSE: RTP).

First quarter results were generally solid, owing to last year’s contracts for its output of iron ore pellets and concentrates. The payout ratio came in at 156 percent of cash flow, a seasonally high level due mainly to the annual closure of the St. Lawrence Seaway. But higher prices and greater sales of concentrates offset the drop in demand for iron ore pellets.

That, unfortunately, won’t be the case in coming quarters, as iron ore prices are globally negotiated to levels more commensurate with recessionary demand. As a result, Labrador’s royalty cash flow isn’t likely to cover a CAD0.50 per unit quarterly distribution.

The key difference with Noranda’s situation, however, is Labrador’s can turn quickly with an uptick in China’s fortunes, whereas the former needs a break from far more crippled US industry. And a turn in China may be happening already. This one isn’t for the faint of heart and, again, a dividend cut looks likely. But for risk takers, Labrador Iron Ore Royalty Income Fund is still a buy up to USD25.

Here’s the complete Watch List. See How They Rate for buy/hold/sell advice.

• Avenir Diversified Income Fund (TSX: AVF-U, OTC: AVNDF)
• Big Rock Brewery Income Trust (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)
• 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)
• Royal Host REIT (TSX: RYL-U, OTC: ROYHF)
• Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF)

Bay Street Beat

There’s something of a pack mentality that describes analysts on Bay Street as well as Wall Street. Occasionally one will break from the group, notably former Oppenheimer & Co banking analyst Meredith Whitney, who’s parlayed the fame she gained by forecasting the demise of Citigroup (NYSE: C) and other major US financial institutions into Meredith Whitney LLC.

Generally speaking, however, analysts don’t like to go out on limbs. The utility of tracking Street opinion comes from understanding where the group is going. Where one leads, others are almost sure to follow. Because their work comes with the imprimatur of august institutions, money will follow, too.

For some time now, the CE view on Yellow Pages Income Fund has differed from the prevailing view on Bay Street. Analysts have been forecasting a distribution cut for many months now, even before the credit crunch/economic downturn took hold. Well, that cut finally came with Yellow’s first quarter earnings announcement–not, however, for reasons identified in the past couple years by the institutions but because Yellow’s vertical media group was hurt by falling revenue at its AutoTrader franchise. Car sales at all levels have simply cratered during this recession. The future of the business–its growing Internet presence–is intact.

But the long-awaited cut is here. And now analysts are likely to jump aboard Yellow’s train. BMO Nesbitt Burns’ Tim Casey issued a report shortly after Yellow’s Thursday announcement, describing the company’s performance as solid and noting “the distribution cut provides added financial flexibility.”

 “Given the relative underperformance of the stock and the positive financial implications of the distribution cut,” wrote Mr. Casey, “we are raising our rating to market perform from underperform.” Yellow Pages Income Fund is likely to find more buyers on Bay Street.

The Bay Street view on recent Portfolio addition CML Healthcare Income Fund (TSX: CLC-U, CMHIF) continues to be unanimous: The four analysts who cover it all rate it a buy, meaning it has a perfect 5.000 average in Bloomberg’s compilation of analyst sentiment.

New Portfolio member Colabor Income Fund (TSX: CLB-U, OTC: COLAF) also has unanimous “buy” support, as does Bay Street Beat favorite Cineplex Galaxy Income Fund (TSX: CGX-U, CPXGF).

Colabor is already operating under the burden of the entity-level tax on trusts because it opted to follow through on an acquisition that was in the works but not completed at the time of Finance Minister Jim Flaherty’s October 31, 2006 Tax Fairness Plan announcement. The deal put Colabor outside the plan’s “normal” growth guidelines and made it subject to immediate taxation. That it’s survived and thrived is a good sign that there’s life for Canadian income trusts/high-yielding corporations.

Cineplex continues to execute amid this recession, confirming the fact that movie attendance is more about the quality of films produced in Hollywood than consumer pocket-book issues. The industry continues to churn out blockbusters and establish valuable franchises, and going to the movies is still relatively cheap compared to other forms of entertainment.

Even before Statistics Canada reported May 6 that Canadian building permits rebounded 10 times as fast as expected in March, Portfolio holding Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) was viewed in strongly positive light by Bay Street, with five “buy” recommendations against one “hold” and zero “sells.” We’re looking for Bird to report continued bottom-line and backlog growth when it reports first quarter earnings later this month.

A Loonie Play

The Canadian dollar has regained the momentum it established before the Swine Flu scare amid signs of increasing risk appetite. The threat, legitimate or media-driven, of a pandemic drove investors to safe havens for a short time, but over the longer term the Canadian currency is poised to bounce significantly off recent lows.

Part of the loonie’s winning streak can be traced to the BoC’s stance on quantitative easing–that it won’t immediately create money out of thin air reduced the threat of an inflationary spiral.

As our colleague George Kleinman noted in the April Canadian Currents:

There has never been a case of successful quantitative easing in economic history. It has always–repeat: always–led to higher inflation sometime in the future. The only question is when it will start and how bad it will get. Higher inflation is bullish for commodities and therefore bullish for the Canadian dollar.

Longer term the Canadian dollar should appreciate, perhaps dramatically. The question is the timing…

Since trading at its all-time high of USD1.10 (one Canadian dollar got you 1.10 in US dollars; now it only gets you USD0.81) in November 2007, the loonie has continually registered a pattern of lower highs…

This is a bearish pattern, a classic downtrend, and until a new higher high is registered, the trend remains down for the Canadian dollar. There’s no reason to rush in.

This pattern will change with a move above 82.50 on the weekly chart, the first higher high. It would then be confirmed with an eventual move above 85 even, a second higher high. What we’re ultimately looking for is a stair-step pattern of higher lows and higher highs…

The loonie closed at 83.11, above George’s critical 82.50 level, on April 15, and has now surged past 85.

Any US investor long Canadian equities–including income and royalty trusts and high-yielding corporations–is, de facto, long the loonie. You can play the currency and collect regular distributions via the Canadian Edge Portfolio.

Another way to grab some upside and establish a hedge against US inflation is through a direct bet on the loonie, often referred to as a “commodity” currency.

The Canadian federal government managed to avoid budget deficits for a decade until the recession forced significant stimulus spending, and the Bank of Canada has thus far avoided potentially inflationary “quantitative easing” measures.

Once the global economy returns to normal growth, demand for Canada’s essential resources–energy commodities as well as potash–will rise. And that will support the loonie.

Well off its lows but still offering significant upside, CurrencyShares Canadian Dollar Trust (NYSE: FXC) is a buy up to USD85.