Four Canadian trusts cut distributions last month: Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF), Noranda Income Fund (TSX: NIF-U, OTC: NNDIF), PDM Royalties Income Fund (TSX: PDM-U, OTC: PDMRF) and Priszm Income Fund (TSX: QSR-U, OTC: PSZMF).

Each owed its fate to lower demand from North American consumers, which has constricted cash flow at its business.

Jazz Air had to date been largely immune to the economic meltdown, despite the impact of volatile jet fuel prices, tight credit and declining passenger traffic on its industry. The primary reason: A sweetheart deal with Air Canada (TSX: AC/B, OTC: AIDIF), itself 75 percent owned by Jazz Air’s former parent ACE Aviation Holdings (TSX: ACE/B, OTC: ACEBF). The deal, slated to expire in 2015, essentially passed on all of Jazz Air’s “uncontrollable costs” and guaranteed the capacity from which the trust’s cash flowed.

In recent months, however, the terms became untenable for Air Canada, which, like many North American airlines, was sliding toward bankruptcy. As a result, Jazz Air was forced to come to the table to reach a new bargain that would certainly be less favorable, meaning lower cash flows and a likely dividend cut.

In late July a deal was struck. The bad news is the trust was forced to accept lower capacity purchase revenue for its fleet from Air Canada, with the latter’s commitment cut to 125 planes from a prior 133. And its “markup rate” for controllable costs has been cut as a percentage from 16.72 to 12.5 percent.

The result is a sharp drop in expected cash flows, which, in turn, forced management to cut dividends by roughly 40 percent to a new monthly rate of CAD0.05 from the prior rate of CAD0.0838.

On the plus side, Air Canada’s ability to avoid bankruptcy has been greatly enhanced, dramatically lessening the risk that Jazz Air will see its main business partner go bust and leave it with no cash flow.

The term of the agreement is now extended to 2020. The 125 planes is a “minimum” that can be ramped up when business conditions improve for Air Canada. And the reduced number may allow Jazz Air to speed up the “renewal” of its fleet, possibly with improved plane models.

All that should be positive for Jazz Air going forward. The best news, however, comes from a somewhat unexpected quarter. Mainly, Jazz Air management now states it won’t be cutting dividends again when it converts to a corporation in late 2010 or early 2011, but rather will be able to absorb new taxes under the new plan.

Considering the trust still pays a yield of more than 17 percent after the cut, that’s very bullish. So is the fact that it trades at just 53 percent of book value and 26 percent of sales. Until Air Canada shows real signs of being back on its feet, Jazz Air will be at risk to further setbacks.

Until the airline industry stabilizes, Jazz Air Income Fund is a hold.

Noranda’s woes have intensified over the past year as demand and prices for processed zinc and its byproducts have dropped in the face of the global economic weakness.

All of the trust’s cash flow comes from a royalty on the output of a single facility in eastern Canada, operated by a unit of global mining giant Xstrata (London: XTA, OTC: XSRAF). As part of a strategy to deal with world economic weakness, Xstrata has shut in 20 percent of the plant’s capacity, triggering a further decline in Noranda’s revenue and cash flow.

The trust’s second quarter revenue tumbled 50 percent, exceeding a 30 percent drop in production costs and a slight dip in selling, general and administrative costs. A concentrated debt reduction program did cut interest expense for the quarter to CAD2.4 million from CAD3.5 million. But six-month consolidated earnings nonetheless swung to a loss of CAD3.4 million, versus income of CAD9.9 million a year ago.

Distributions to “ordinary” shareholders have been suspended since February, when the plant began operating at 80 percent of capacity. After these results, however, management has elected to stop paying to “priority” unitholders as well, mainly those who own trust units.

A restoration of the plant to full capacity would restore Noranda’s ability to pay full distributions again. Unfortunately, that’s not going to happen until Xstrata is satisfied that global demand for zinc and its byproducts is back on track. And there’s also no assurance Noranda will restore the full CAD0.04 a share last paid on July 27, which itself is less than half the CAD0.085 last paid February 25.

On the plus side, the cash saved by suspending the distribution will shore up finances. As of June 30, Noranda had drawn just CAD41 million of CAD95 million in available credit and the soonest debt maturity is not until December 2010, when CAD153.5 million in notes come due. In addition, interest coverage of 5.8-to-1 is nearly twice what’s needed to meet the required 3-to-1 ratio under debt covenants. And leverage and current ratios are also at comfortable margins.

On the negative side, management stated, “If the fund is required to continue to operate at less than full capacity and the weak market conditions continue, it may be in breach of the leverage ratio covenant as of Dec. 31, 2009.” The fund is now in discussions to address such a contingency and management is optimistic it will avoid a breach, which in a worst-case could trigger a restructuring and shareholder wipeout.

Noranda’s third quarter results–slated for release in November–should offer a definitive clue as to how successful its efforts are. Until we get that information, however, everyone is better off out of the shares, their 8 percent drop since July 1 notwithstanding. Sell Noranda Income Fund.

PDM Royalties’ (58 percent dividend cut) and Priszm’s demise (80 percent cut) points up growing weakness in the Canadian restaurant business.

PDM’s steep payout reduction came as something of a surprise to the market, evidenced by the sharp drop in its unit price since the announcement in mid-July.

PDM had been covering its payout rather handily, with its first quarter payout ratio of 69 percent well below many of its restaurant royalty peers. Rather, the reduction comes as part of an “amalgamation” or merger with privately held Imvescor, which currently operates PDM’s restaurants under a royalty agreement.

PDM owns the trademarks and licenses for popular Canadian restaurant brands Pizza Delight, Mikes, Scores and Baton Rouge. Under the current deal, it licenses them to Imvescor in exchange for a royalty equal to 4 percent of system sales for Pizza Delight and Mikes, and 6 percent for Scores and Baton Rouge. Those royalties, in turn, pay the trust’s distribution.

The amalgamation will require the approval of PDM unitholders, as well as the Nova Scotia Supreme Court. Assuming management gets it, the deal will close on or about Oct. 10, 2009. If completed, PDM holders will get one share of the new company for every trust unit they already own, effectively converting the trust into a taxpaying corporation ahead of the 2011 trust tax.

Management of Imvescor and PDM state that cash saved from the distribution reduction will “reduce indebtedness and support operational and growth requirements as well as finance the cost of the transaction.”

PDM has never been a Canadian Edge Portfolio holding or even a recommendation. Nonetheless, I can’t help but be somewhat angry for unitholders about the terms of this deal, which at first glance appears to benefit PDM’s management and Imvescor’s owners at the expense of everyone else.

At this point we don’t have the benefit of seeing PDM’s second quarter results. But based on the first quarter numbers, the trust appeared to be earning enough not only to sustain its distribution now, but to maintain it even after 2011 when it would be forced to absorb corporate taxes.

A sharp deterioration in results in the second quarter would of course cast the deal in a wholly different light. Barring that, however, I strongly advise PDM holders to reject this offer, which could well be defeated given that it requires two-thirds approval. In the meantime, the 16 percent yield even after the proposed dividend cut is enough reason to hold PDM Royalties Income, though not to buy.

As for Priszm, its problems are considerably more business-based. In fact, a distribution cut had long been anticipated, given negative cash flows in the first quarter due to shrinking margins.

The magnitude of the 80 percent cut, however, was something of a surprise, and triggered a near-halving of the already depressed share price over a two-day period in late July.

The restaurant royalty trust did report some promising developments with its second quarter earnings (ended June 14). Some 13 restaurants were moved from discontinued to continuing operations. Management reported CAD8.7 million in cash along with positive cash flow and slightly lower costs. And the brand names of KFC, Taco Bell and Pizza Hut restaurants–which contribute all of Priszm’s income–appear to be holding their own.

Unfortunately, sales dropped 2.5 percent, while costs as a percentage of revenue rose to 90.8 percent from 88.9 percent a year earlier. The result was a 25 percent drop in distributable cash flow, even with a sizeable cut in maintenance capital expenditures.

On the plus side, such a sharp cut in distributions should ensure Priszm has the financial strength to weather the rest of this recession. Management should be able to mitigate at least some of the impact of the higher interest rate paid on its credit facility. Cash flow from operations should now easily cover capital expenditures without resorting to adding new debt.

The trust’s only significant debt maturity is CAD75.6 million in long-term loans due in 2011. However, because of the credit crisis and weaker business performance during the recession, lenders have required Priszm to abide by a covenant to increase its cash position every quarter to the end of 2010.

Barring a major business collapse–which would require a big negative reversal from generally solid second quarter numbers–that shouldn’t be a problem. It does place strict limits, however, on distributions, unit buybacks and potential expansion.

That, in turn, severely limits the appeal of owning Priszm Income Fund; sell.

Here’s the rest of the Dividend Watch List. See How They Rate for buy/hold/sell advice. Note I don’t include energy producer trusts. Again, investors should consider these as high-cash-flow bets on energy prices that ebb and flow with what happens to oil and gas. Note also that this list could well be expanded in coming days, should incoming second quarter numbers fail to measure up.

• 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)
• Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF)
• 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)
• Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF)
• Primaris REIT (TSX: PMZ-U, OTC: PMZFF)
• Primary Energy Recycling Corp (TSX: PRI-U, OTC: PYGYF)
• Royal Host REIT (TSX: RYL-U, OTC: ROYHF)
• Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF)

Bay Street Beat

North American waste management heavy hitter IESI-BFC Ltd (TSX: BIN, NYSE: BIN) is a perfect 10-for-10 on Bay Street this week: Of the analysts who cover the stock, all have it rated a buy.

The company, which was BFI Canada Income Fund before it converted and became BFI Canada Ltd in September 2008, continues to post solid results. IESI-BFC, which operates across five provinces up north BFI Canada and in the south and northeast US as IESI, is well positioned to grow as the economy stabilizes.

The stock price is still less than half it was at its all-time high in 2005. It has rebounded from a post-Lehman Brothers low below CAD8 to trade in the mid-teens, but Bay Street’s bullishness suggests much more upside. Second-quarter numbers are further evidence of the company’s operational strength.

IESI-BFC’s results were in line with analyst expectations on key metrics. Earnings per share of USD0.18 was down from USD0.25 a year ago, but met Street estimates. Revenue fell 9 percent year-over-year to USD253.7 million, still within analysts’ forecast range, while volumes dropped 1.1 percent in Canada and 4.4 percent in the US, numbers that were actually better than anticipated.

It its conference call to discuss the second quarter, management noted that trends in Canada “remain stable.” Volume improved significantly on a quarter-over-quarter basis, and overall revenue growth was positive in Canadian dollar terms.

Management also seemed hopeful that things may be turning around in the US northeast. Margins in this territory improved by 80 basis points year-over-year, primarily on lower fuel costs. Management pointed to signs of stabilization in volumes and recycled commodities prices, which could boost third quarter results.

In the US south, results remain soft: Margins contracted quarter-over-quarter on a combination of increased residential volume and higher legal and administrative fees.

The stock still trades at a discount to the solid waste sector, but this should narrow as management’s ability to execute gets more notice.

IESI-BFC has a strong balance sheet that should help it grow through acquisitions, which will be key to lifting the stock price. IESI-BFC Ltd is a buy up to USD14.

Sunsets

The Obama administration released highly anticipated details about its proposed tax cuts and revenue raisers on May 11 via the Treasury Dept’s General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals, also known as the “Green Book.”

As for tax rates, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) lowered the individual marginal tax rates “temporarily” for a 10-year period. The current rates of 10, 15, 25, 28, 33, and 35 percent will sunset after 2010. The administration wants to extend the 10, 15, 25, and 28 percent rates for another 10 years, and reinstate the pre-EGTRRA top rates of 36 and 39.6 percent for individuals with incomes over $200,000 and married couples filing jointly with incomes over $250,000.

In 2003 and again in 2006, Congress lowered the maximum tax rates on qualified capital gains and dividends. Both these rates are currently at historic lows, thanks to provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003.

For 2009, the maximum capital gains and dividends tax rate is 15 percent (0 percent for taxpayers in the 10 or 15 percent brackets).

These lower rates are scheduled to sunset after 2010. The administration wants to impose a 20 percent rate on qualified capital gains and dividends for individuals who then fall within the new 36 or 39.6 percent brackets. The 0 and 15 percent rates would be made permanent.

Although the basic rate for net capital gains would go up for taxpayers in the two highest income tax brackets, the news isn’t all bad. The administration recommends continuing the favorable capital gains rates for qualified dividends in all income brackets. Before the change in 2003, dividend income was taxed at ordinary income tax rates and, unless legislation is enacted, that rate structure for dividends is scheduled to return in 2011.

Interestingly, the Obama administration shares a concern for the multiple layers of tax on corporate earnings and dividends. Dividends, rather than reverting back to being taxed at the maximum rate, would be taxed at a 20 percent rate like long-term gains.

The current capital gains rate now tops out at 15 percent and has disappeared entirely for anyone in the 10 percent and 15 percent income tax brackets. If the law isn’t extended, capital gains taxes will return to pre-2003 rates, which in most cases were 20 percent.

With a current maximum rate of 15 percent, taxes on dividends are now at their lowest rate since World War II. In the past, dividends have been taxed as ordinary income, and that’s how they’ll be taxed again if the current law is allowed to sunset at the end of 2010.

The administration has defined how it would like to proceed when current capital gains and dividend tax rates expire at the end of 2010. Resolution of these issues will soon be on Congress’ agenda.