Over the past several months I’ve focused the High Yield of the Month column almost exclusively on trusts and corporations operating in recession-resistant industries. My reasoning has been two-fold.

First, economic uncertainty has been a constant risk to commodity prices and in fact to any company operating in a cyclical business. Second, trusts in recession-resistant businesses with no real dividend risk have been selling at historically high yields and low valuations.

Why recommend anything else when you can get 10 percent-plus yields with absolute safety and every promise of big-time capital gains when overall economic and market conditions improve?

One of this month’s selections certainly fits that enviable mold with room to spare: Great Lakes Hydro Income Fund (TSX: GLH-U, OTC: GLHIF). However, my other pick, Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF), takes us a little further out on the risk spectrum for the first time in a while, reflecting the likelihood the economy is bottoming as investors’ underrating of its strong prospects.

What the pair do have in common are strong prospects that have already produced solid gains this year and promise a lot more the rest of the year and into 2010.

Optimally, investors will want to own both. But for the most conservative yield-seekers, Great Lakes Hydro is the higher-percentage bet.

As reported in the July 7 Flash Alert, the trust has announced a strategic repositioning consisting of two major steps. The first is the purchase of 15 hydroelectric facilities from a unit of 51 percent owner Brookfield Asset Management (TSX: BAM/A, NYSE: BAM).

The deal effectively combines Great Lakes’ assets with substantially all of Brookfield’s renewable generation assets not currently in its portfolio. The new company, which will be renamed Brookfield Renewable Power Fund when the transaction is completed, will own 42 hydroelectric facilities throughout a diversified base of watersheds in the US and Canada.

It will also own two wind farms, one already operating and one under development. That adds up to a combined capacity of 1,700 megawatts and long-term average annual generation of 6,500 gigawatt hours (a gigawatt equals 1,000 megawatts).

The purchase is expected to be immediately accretive to Great Lakes’ cash flow by roughly CAD100 million annually.

It will boost the asset base to more than CAD3 billion, improve the projected average annual payout ratio to 80 percent over the life of the assets and add CAD35 million in annual operating cash flow for growth.

The newly acquired plants operate under long-term contracts to creditworthy utilities and government entities and enjoy built-in rate increases as well.

The purchase comes with a hefty price tag of CAD945 million, roughly halfway between the value of CAD905 million to CAD1 billion calculated by an independent committee. The terms of the deal, however, strictly limit the financial burden to the trust.

First, some CAD380 million will be covered by the issue of 25.6 million trust units issued to parent Brookfield to maintain its 50.01 percent ownership stake. A private placement with restrictions on selling, including certain existing unitholders, will contribute another CAD195 million.

Another CD180 million has been raised via a bought-deal transaction, and the remaining CAD200 million is through a senior unsecured note to be held by Brookfield. That adds up to no immediate cash outlay other than what’s been raised through financing, maximizing resources for further expansion.

These opportunities should be considerable. For one thing, Brookfield has unmatched reach across Canada and its existing hydro and wind base yields numerous opportunities for “tuck-in” projects to grow output.

The wind farm under construction in southwestern Ontario, for example, promises to add 50 megawatts to output with construction to begin in the second half of 2009. And all output will be sold at premium prices under a 20 year agreement to the Ontario Power Authority.

For another, the popularity of carbon-neutral power production will only grow in coming years, as restrictions on greenhouse gas emissions kick in across North America. Transalta Corp’s (TSX: TA, NYSE: TAC) ongoing hostile bid for Canadian Hydro Developers (TSX: KHD, NSDQ: CHDV) may or may not result in a merger. But it’s a sure sign that power producers relying on fossil fuels (70 percent of North American output) are increasingly anxious to lock up companies producing from renewable fuels.

One reason is to secure needed carbon dioxide (CO₂) emissions credits, the value of which will only rise in coming years.

And while Brookfield isn’t likely to sell Great Lakes on anything less than a very high premium offer, any takeover deal in the Canadian power sector will only increase the market value of the overall enterprise.

The other major piece of Great Lakes’ repositioning is the announcement that it will convert to a corporation sometime before 2011, without reducing its distribution. Instead, management asserts it will be able to absorb any taxation by virtue of expanded profits, made possible in part by this asset purchase.

Obviously, sustaining distributions depends heavily on the long-term health of the business. But as Great Lakes’ second quarter tallies demonstrate, that’s not even at risk in the worst of economic environments.

Second quarter revenue and operating income surged 16 and 7 percent, respectively, despite a 9 percent decline in hydro output due to water conditions that were lower in Ontario and British Columbia than historical averages. That was made possible largely thanks to solid performance at the wind plants and cost controls.

As for financial strength, Great Lakes remains the best in its class. The fund has CAD30 million in committed credit facilities, of which CAD28.8 million is available.

verall, cash, credit facilities and the hydrology reserve add up to liquidity of nearly CAD80 million. Average yield and term-to-maturity for long-term debt of CAD932 million are 5.86 percent and 7.9 years, respectively.

This adds up to a low-risk package with a high and growing yield and real upside from North America’s renewable energy investment boom. Great Lakes Hydro Income Fund is a buy up to USD17.

For those willing to take on a bit more risk for a higher reward, Chemtrade’s monthly yield is more than twice as high as Great Lakes’. The reason: The trust’s revenue and cash flow are infinitely more cyclical.

Second quarter distributable cash flow, for example, came in at only 36 cents a share, half 2008 levels. And that was a powerful improvement from first quarter tallies, when the outage of a key facility pushed cash flows from operating activities into the red.

The shortfall from last year was due to two things. First, demand and prices of sulphur products were at record levels last year. Second, the severe global recession triggered a sharp reduction in demand and prices for most of Chemtrade’s products below historic norms, particularly for all-important sulphuric acid and sulphur.

The Sulphur Products and Performance Chemicals division saw a 39 percent drop in revenue and a 36 percent slide in operating cash flow from year-earlier levels. Meanwhile, reduced demand for sodium chlorate used by industry sent revenue from that segment down 8.3 percent from 2008 levels and International sales–from outside North America–slid 74.7 percent, reflecting a steep drop in demand from developing nations.

Ironically, those scary figures, which were an improvement on first quarter numbers, point up one of Chemtrade’s enduring strengths: Thanks to extremely conservative financial management, its monthly distribution remains well covered by distributable cash flow.

After taking out maintenance capital expenditures, the second quarter payout was still just 83 percent. In fact, the trust actually managed to cover its first quarter payout with cash flow as well, despite the costly outage of its Beaumont facility in Texas.

Earlier this year, with the economic crisis at its worst, management asserted that it couldn’t conceive of a circumstance when its cash flows wouldn’t cover its distribution.

That commitment has been put to the test in recent months, and it will almost certainly continue to be until this recession yields to a recovery.

But second quarter numbers prove Chemtrade has weathered the worst so far and are the best possible indication that it will be able to maintain the current payout rate for the rest of the year, even past 2011, as management also pledges.

Drawing more than 80 percent of income outside of Canada exposes the trust to foreign exchange risk when its home currency’s value rises. Chemtrade, however, holds a large portion of its debt in foreign currency, so it gains from lower interest costs and debt values when the Canadian dollar rises.

Each one-cent rise in the Canadian dollar does impact distributable cash flow by CAD100,000 on an unhedged basis. But foreign exchange contracts are currently in place at a rate of USD0.85 per Canadian dollar for 2009. And higher sales as the economy recovers will more than offset any currency risk.

Also, Vale Inco is the trust’s largest supplier of sulphur products and a major source of marketing income. That company’s Sudbury, Ontario, facility currently lacks a labor agreement and workers went on strike July 13. The trust is currently using alternative suppliers but a prolonged strike could wind up impacting supply costs and selling prices, hence trust revenue.

Finally, 65 percent of sodium chlorate sales are to Canfor Corp (TSX: CFP, OTC: CFPZF), which is itself suffering from the weak economic environment. And there’s CAD178.1 million in term bank debt due August 2011 that will have to ultimately be refinanced, though the company has drawn only CAD1 million on its line of credit leaving it with CAD65 million of headroom.

Ultimately, dealing with these challenges depends on the market for the trust’s products to stabilize. According to management, that appears to be happening.

Meanwhile, even if demand remains sluggish in the second half, management still expects cost controls to lift cash flow, including lower prices for inputs and raw materials that have also fallen due to the recession.

And the selling arrangement with Vale Inco calls for the latter to bear much of the risk of price decreases, something parent Vale is well equipped to do given its great size and backing by the government of Brazil.

As I’ve consistently advised Canadian Edge readers, nothing pays a yield of more than 15 percent without carrying some risk. Chemtrade has weathered this horrific environment thus far with room to spare.

An accelerated downturn for the global economy or some other unforeseen circumstance, however, could still force a payout reduction.

That’s why no one should buy in without a clear-headed idea of the risks; it’s why the trust is in the Aggressive Holdings. But if you can live with the risks, this is one recommendation that could easily double or even triple from current levels in addition to paying an exceptionally generous dividend. Chemtrade Logistics Income Fund remains a strong buy up to USD8.

For more information on Great Lakes Hydro and Chemtrade Logistics, visit How They Rate. Click on the “.UN” symbol to go to the website of our Canadian partner MPL Communications for press releases, charts and other data.

These are substantial companies, so any broker should be able to buy them, either with their Toronto or OTC (US over-the-counter) symbols. Ask which way is cheapest. Click on the trusts’ names to go directly to their websites.

On Taxes

Both trusts’ dividends are considered qualified for tax purposes in the US. Tax information to use as backup for filing them as qualified–whether or not there are errors on your 1099–is listed on the Canadian Edge website; mouse over “Resources,” then click “Income Trust Tax Guide.”

As is customary for virtually all foreign-based companies, the host government–in this case Canada–withholds 15 percent of distributions paid to US investors at the border. This tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can be carried forward to future years.

Great Lakes’ decision to convert to a corporation without cutting its distribution basically removes any prospective 2011 risk. Chemtrade Logistics, meanwhile, garners only about 20 percent of its revenue inside Canada. As a result, it faces little prospective new taxation in 2011. Management is at this point undecided on whether it may convert to a corporation. But even if it does, it expects no impact on distributions.

The bottom line is 2011 taxation is no longer an issue for distributions of either company. Instead, payouts going forward depend wholly on the health of their underlying businesses. And at this point, both look healthy despite weak economic conditions.