Canadian Edge Portfolio picks are up an average of 34.3 percent thus far in 2009. That’s against a 17 percent gain for the broad-based S&P/Toronto Stock Exchange Income Trust Index.

Only six picks are trading higher than they were a year ago: Ag Growth International (TSX: AFN, OTC: AGGZF), Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF), Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF), Colabor Income Fund (TSX: CLB-U, OTC: COLAF), Just Energy Income Fund (TSX: JE-U, OTC: JUSTF) and Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF).

In fact, many are still well in red for the 11 months since the fall of Lehman Brothers, particularly those operating in the energy patch.

The good news is there’s a lot more upside ahead for all trusts and companies whose numbers indicate healthy underlying businesses. For one thing, Canada’s central bank has proclaimed the country’s recession “is ending.” If true, even the cyclical fare hit hardest in recent months have a lot of reason to hope.

Renewed investor confidence lifted the share price of battered transporter TransForce (TSX: TFI, OTC: TFIFF) by more than a third in late July. The stock is now double where it began the year and three times its early March low. And more gains lie ahead after the company reported generally solid second quarter earnings and slashed debt by CAD50 million despite its worst business conditions ever.

On the other hand, TransForce management is maintaining a cautious business outlook for the rest of 2009. And that attitude is shared by executives across a wide range of industries as Canadian business deals with high unemployment, lower demand for a range of products and services and, after last month’s surge to as much as 94 US cents, a more expensive Canadian dollar.

As we’ve been pointing out here and in CE’s weekly companion Maple Leaf Memo, the long-term underpinnings of the Canadian economy are as strong as ever. The banking system has weathered the storm, with Standard & Poor’s affirming in late July that “stress tests reveal banks have sufficient capital to withstand losses.”

The 35 percent increase in Chinese iron ore imports in July is a sure sign that country’s demand for Canadian natural resources is heating up again. So is renewed interest in Canadian coal, uranium and oil.

If second quarter numbers are any indication, however, full recovery is a long way off for industries heavily dependent on consumer demand as well as for the companies that service them.

All four How They Rate trusts cutting dividends last month met that description, and unfortunately more are likely to follow their example. Even energy producers–which have hunkered down for survival–aren’t immune from further damage, as natural gas prices remain stuck around USD4 per million British thermal units.

Truthfully, I’m more optimistic than I’ve been in some time. But now is certainly no time to throw caution to the wind.

Canadian trusts and dividend-paying corporations with strong balance sheets and growing, recession-resistant revenues are still starkly undervalued. The best will benefit richly from the Canadian recovery, including the appreciating Canadian dollar.

And as this month’s Feature article makes clear, they’re in line for a windfall in coming months as they demolish the mythology surrounding 2011 taxation.

If you’re light on Portfolio picks, now’s an ideal time to lock down their high and growing yields. I suggest one of two approaches. First, you can buy a basket of eight to 10 selections in three increments, a third now, a third in four to six weeks, and the last third a month or so after that.

Your selections should be drawn from the group that best fits your own strategy, i.e. risk-averse income seekers should stick with Conservative Holdings.

The other approach is simply to take full positions each month in the High Yield of the Month entries until you have the exposure you want. There are two listed each issue; they represent my top buys for any given month, based on fundamentals and share price.

Equally, however, not every How They Rate entry is attractive as a buy or even a hold. In fact, more than one in five still rate sells. A rising tide may indeed raise their boats initially as well. But a weak business sooner or later spells doom for any stock, and they’re always best sold.

Looking ahead, I see nothing to hold back energy prices from new highs or the Canadian economy from robust growth. Even if the US remains weak, demand for Canadian commodities from Asia will restore large segments of the country’s economy to health.

Despite the gains we’ve seen in 2009 for solid Canadian trusts and companies, there’s room for much more for the rest of the year and into 2010.

The key is remaining selective: Buy the best and sell the rest. That’s the only way to weather whatever is left of this global downturn, while positioning to ride the inevitable recovery, whether it’s already begun or not.

Portfolio Action

There are no changes to the Canadian Edge Portfolio this month. Second quarter numbers for our trusts and high-yielding corporations reporting so far have been strong. The Portfolio section analyzes what we know so far. The rest will be highlighted in Flash Alerts in the coming days and recapped in the September issue.

Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) didn’t earn its distribution during the quarter. But it does appear to be nearing a favorable agreement with Ontario regulators regarding the future of its Stratacon unit, which would trigger a substantial profit rebound. Consumers’ Waterheater Income Fund is a hold until the matter is resolved.

So is Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), which has emerged as more economically sensitive than I anticipated. Hold Yellow Pages Income Fund.

Note US investors cashing out of Sentry Select Canadian Income Fund (888-730-4623) should by now have received the proceeds, which I advise deploying into EnerVest Diversified Income Fund (TSX: EIT-U, OTC: EVDVF) for mutual fund exposure.

High Yield of the Month

The August High Yield of the Month entries are both very healthy businesses with no exposure to 2011 trust taxation.

As reported in the July 7 Flash Alert, Great Lakes Hydro Income Fund (TSX: GLH-U, OTC: GLHIF) is converting to a corporation, following a strategic repositioning that includes absorbing considerable assets from parent Brookfield Asset Management (TSX: BAM/A, NYSE: BAM). The move will not involve a dividend cut.

Meanwhile, Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) anticipates no impact on its distribution from 2011 taxation, as the bulk of its cash flow comes from overseas.

Despite operating in the highly cyclical chemicals business, the trust continues to generate more than enough cash flow to cover distributions and capital costs, thanks to well-protected niches, cost controls and conservative financial policies.

Great Lakes Hydro Income Fund is best for conservative investors up to USD17. Chemtrade Logistics Income Fund is a buy for the more aggressive up to USD8.
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.

Note this month, we’ve dropped the following trusts that have broken under a dollar, have ceased to pay distributions and have rated sells for many months: Huntingdon REIT (TSX: HNT-U, OTC: HURSF) and SFK Pulp Fund (TSX: SFK-U, OTC: SFKUF). If you own them, dump them.

Advantage Oil & Gas (TSX: AAV, NYSE: AAV)–Sell to Hold. The conversion process is over. What’s left is a highly leveraged bet on natural gas, though no dividend.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Hold to Buy @ 4. Second quarter earnings show the trust is capable of generating sufficient cash flows to stay healthy even with the biomass operations shut down. A dividend cut is still possible but well priced in.

Eveready Inc—Sell to Acquired. The company has now been acquired by Clean Harbors (NYSE: CLH) for a combination of CAD3.30 per share in cash and 0.1304 shares. Investors who didn’t sell per my instructions can hold Clean Harbors, but it won’t be tracked in Canadian Edge.

Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF)–Sell to Hold. As expected, the trust’s new arrangement with troubled partner Air Canada (TSX: AC/B, OTC: AIDIF) crimped cash flow, forcing a 40 percent dividend cut. The worst is now out, however, and the new deal is for 20 years, so the lower dividend should hold.

Potash Corp (TSX: POT, NYSE: POT)–Buy @ 120 to Hold. The company is cutting production dramatically in the face of very weak market conditions. This is still a solid business backed by an unmatched reserve, but it may take time to deliver on further profits.

Priszm Income Fund (TSX: QSR-U, OTC: PSZMF)–Hold to Sell. The proposed restructuring plan involved a much-steeper-than-expected dividend cut, a sure sign that business is worse than thought.

Feature Article

Since Finance Minister Jim Flaherty made his Halloween 2006 trust tax announcement, many, if not most, investors have assumed Jan. 1, 2011 would be a day of reckoning for trusts. Massive dividend cuts have been built into share prices literally since mid-November 2006.

Many, if not most, investors have assumed the only possible salvation for trusts is a possible reversal of the trust tax by the Canadian government. Reality, however, is shaping up quite differently.

In fact, more often than not, the trust conversions to corporations we’ve seen to date have triggered windfall profits for their investors. Meanwhile, a growing number of trusts are finding ways to preserve dividends despite new taxes.

I explore what’s happened to trusts converting to corporations ahead of 2011, and what it means for those yet to make their move, particularly our CE Portfolio holdings.

Canadian Currents

Sovereign wealth funds (SWF) have faded into the background of the global landscape, the swell of suspicion they inspired in mid-2007 giving way to the fear caused by the twin financial and economic crises.

Although many have suffered along with most market participants and continue to keep their powder dry, one SWF, China’s, is back in business.

The story of China Investment Corp’s (CIC) purchase of 17 percent of Canada-based Teck Resources (TSX: TCK/B, NYSE: TCK) is notable for many reasons: it’s another manifestation of China’s relative strength; the terms of the deal suggest China understands the sensitivity in the West to state involvement in the private market; and it’s further reminder that China will play a significant role in Canada’s economic future.

CE Associate Editor David Dittman explores these and other issues in CIC’s Shopping Spree.

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—Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF) and Suncor Energy (TSX: SU, NYSE: SU) each increased distributions dramatically last month and, despite weak natural gas prices, all other energy trusts held their payouts level.

All the damage to dividends came from outside the energy patch. The cutters were 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).

The rest of the Dividend Watch List (excluding oil and gas producers) includes: 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 Trust (TSX: ESN-U, OTC: EEYUF), FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF), InnVest REIT (TSX: INN-U, OTC: IVRVF), and Primaris REIT (TSX: PMZ-U, OTC: PMZFF).

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.

Sunsets–The time is rapidly approaching when Congress will have to take up the matter of the 15 percent tax rates on dividends and capital gains, which will sunset in 2010 without legislative action. The Obama administration has made its policy choices clear. Will Congress fall in line?

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 www.adviceforinvestors.com, the website 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 website for a range of information on income and royalty trusts.

The Web site 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 website 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