All rallies eventually run out of gas. And more often than not, the higher they fly, the faster they flame out. This one faces considerable near-term challenges, mainly the fact that the chief catalyst is rising oil prices, which could reverse quickly on a renewed slide in the global economy.

On the other hand, oil and especially natural gas prices are still nowhere close to their highs of last summer. Gas priced at barely USD4 per million British thermal units is clearly unsustainably low, as it is well under reserve replacement and even production costs. And the unprecedented energy supply destruction of the past nine months guarantees a tight global market when economic conditions return to normal.

As for individual Canadian trusts and high-yielding corporations, the broad-based S&P/Toronto Stock Exchange Composite Index is up more than 40 percent from its March 9 low. But it’s also still down more than 40 percent from the highs of last summer.

Individual oil and gas producer trusts sell at discounts of 50 percent and more to net asset value. Trusts in other sectors fresh off posting strong first quarter earnings are still yielding more than 10 percent and trade at or below book value.

The bottom line: The universe of Canadian trusts and high-yielding corporations is still on the bargain counter. Despite some herculean market moves, the bar of expectations is still very low, even for businesses that, quarter after quarter, are proving more than a match for still-abysmal overall conditions.

We may indeed be on the cusp of a summer market swoon, should investors refocus on what’s wrong with the economy. And there’s the risk that individual companies and trusts may disappoint us as well, as underlying businesses succumb to economic pressure. Trust moves to deal with 2011 taxation are another area of uncertainty, though most will be resolved happily like Ag Growth Income Fund’s (TSX: AFN-U, OTC: AGGRF) dividend-preserving corporate conversion.

Our task, however, remains the same: buying the best businesses we can find north of the border and holding on unless they weaken. The recovery since early March has only been possible because our favorites have continued to post strong business numbers, even as rivals faltered.

The good news is CE recommendations proved up to the mark in the first quarter of 2009. The bad news is there’s no rest for the weary. They’re going to have to be put through their paces every time new numbers come out. And those that falter will have to be unloaded, regardless of prior gains or losses.

As long as this recession lasts, risk will remain elevated. I currently have two Portfolio picks rated “hold” because of potential vulnerability revealed in first quarter numbers: Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) and Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF). As I discuss in the Portfolio section, both have given us some reason for encouragement since. But I won’t hesitate to unload either on further stumbles, despite their losses thus far.

The rally, however, confirms once again that sticking with quality is ultimately rewarded. I’ve never been particularly good at crystal-ball gazing. But I’m more confident than ever that there’s an even more powerful rally coming for high-quality Canadian trusts and dividend-paying corporations. All we have to do is make sure we’re in the best and have the patience to keep collecting those dividends.

Even inflation is on our side. The Canadian dollar will rise with oil prices, pushing up the value of trust distributions and share prices along with it. And no return to inflation is possible without black gold leading the way.

Portfolio Action

Energy Savings Income Fund has changed its name to Just Energy Income Fund (TSX: JE-U, OTC: JUSTF). It remains a buy up to USD12.

There’s only one change to the CE Portfolio this month. I’m selling Select 50 S-1 Income Trust (TSX: SON-U, OTC: SFYIF) from the Fund Alternatives and replacing it with old friend EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF).

Select 50 has surged by more than 40 percent this year but manager Sentry Select Capital is converting it to an open-end fund, an arrangement with unknown implications for US investors. EnerVest is up more than 60 percent this year but has now restructured and is well-positioned for solid income and growth going forward. Note I always prefer a portfolio of choice individual trusts to buying mutual funds, where investors lack control.

Earnings for the six oil and gas producer trusts that hadn’t posted numbers as of last issue are highlighted in the Feature. This section has numbers for the other 10 reporting in between issues.

High Yield of the Month

The June 2009 High Yield of the Month entries are again both on the conservative side. Artis REIT (TSX: AX-U, OTC: ARESF) is the highest octane of my real estate investment trusts, due to its focus on the fast-growing energy patch. Unlike its regional rivals, however, it hasn’t faltered in the face of the steep slowdown triggered by falling energy prices. That puts Artis in prime shape for the recovery that appears to already be taking shape, even as it continues to dish out a yield of nearly 13 percent.

Innergex Power Income Fund (TSX: IEF-U, OTC: INRGF) pays roughly 10 percent and is a premier play on the growing value of carbon-neutral electricity, with its growing fleet of wind and hydro power plants. 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.

Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)–Hold to Sell. The remaining dividend is increasingly at risk to a weak market for end products, the lack of supply from the faltering timber industry and increasingly wild US dollar/Canadian dollar exchange rate swings.

EverReady Corp (TSX: EIS, OTC: EVRDF)–Hold to Sell. Shares now appear to be fully priced to takeover offer by Clean Harbors (NYSE: CLH) of CAD2.64 per share in cash plus 0.1304 shares of stock. Getting out now will spare US investors pain from possible complications with the transaction.

FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)–Hold to Sell. Shares are priced for a large dividend cut with a yield of 27 percent, but business may stay weak for a while.

Mullen Group Ltd (TSX: MTL, OTC: MLLGF)–Buy @ 10 to Hold. Shares of the newly converted corporation have surged well beyond my buy target. Business rebound must catch up.

New Flyer Industries IDS (TSX: NFI-U, OTC: NFYIF)–Hold to Buy @ 10. Solid first quarter results on still strong stream of new business have answered questions raised by a surprise order cancellation earlier this year.

Roger Sugar Income Fund (TSX: RSI-U, OTC: RSGUF)–Buy @ 4 to Hold. The rebound in the Canadian dollar will further pressure the already stressed dividend.

Select 50 S-1 Income Trust (TSX: SON-U, OTC: SFYIF)–Buy @ 8 to Sell. The fund is going open-end and no longer trades at a discount to net asset value after this year’s more than 40 percent gain.

Sentry Select Dividend Income Trust (TSX: SDT-U, OTC: SSDUF)–Hold to Sell. The sister fund to Select 50 is also going open-end after a solid gain this year.

Wajax Income Fund (TSX: WJX-U, OTC: WJXFF)–Buy @ 12 to Hold. Management assured investors that first quarter earnings were in line with its expectations. But profits fell enough to send the payout ratio back into the danger zone, even after the reduction in April.

Westshore Terminals Income Fund (TSX: WTE-U, OTC: WTSHF)–Hold to Buy @ 11. Main customer Teck Resources (TSX: TCK/A, NYSE: TCK) now appears to be on much better financial footing and Asian demand for metallurgical coal appears to be picking up.

Feature Article

Since hitting new lows in early March, oil and gas producer trusts have staged a remarkable comeback. All eight in the Canadian Edge Aggressive Holdings have at least doubled off their lows. Oil’s move from under USD40 a barrel to nearly USD70 is the rally’s primary catalyst.

American investors also benefitted from the 20 percent-plus jump in the Canadian dollar versus the US currency, which was itself triggered by oil’s rise. Any surge of such magnitude has to pause eventually, and we may be nearing one. Oil and especially natural gas prices, however, are still only a fraction of their levels before the fall of Lehman Brothers paralyzed the global economy last fall.

Meanwhile, oil and gas trusts are trading at sharp discounts to the value of their assets in the ground. The upshot is there’s plenty more upside potential in these long-battered trusts, and particularly for CE favorites.

Canadian Currents

The Big Five Canadian banks are suffering from higher loan losses in the recession. But by and large, first quarter results paint the picture of an industry coping well in tough times, while positioning for strong growth beyond them. That’s also a good sign for the Canadian economy on the whole, though risks remain to trap the unwary.

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–Only two Canadian trusts trimmed distributions last month, energy producers ARC Energy Trust (TSX: AET-U, OTC: AETUF) and Avenir Diversified Income Trust (TSX: AVF-U, OTC: AVNDF).

 This month, I look at both as well as 16 trusts that no longer pay distributions including Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV), sold from the Portfolio last month.

This month’s Dividend Watch List (excluding oil and gas producers): Big Rock Brewery Income Fund (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 (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 and companies, see How They Rate.

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

Slow DRIP–Only one CE Portfolio recommendation, Aggressive Holding Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) makes its dividend reinvestment plan (DRIP) available to US investors. It’s all about the filing burden: Trusts that want to open up to US investors must satisfy Securities and Exchange Commission registration requirements, which can be relatively, and prohibitively, costly. 

Alberta and OPEC–Alberta Premier Ed Stelmach has accepted an invitation from the Organization of Petroleum Exporting Countries to participate in “dialogues of mutual interest.” The immediate ramifications aren’t so stunning–Alberta doesn’t control a provincial oil company, and it must answer to Ottawa. But there are a couple intriguing possibilities.

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 website 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