Canada appears headed for its fourth national election in five years.

This week, the Liberal Party joined the New Democrats in saying it will support a future no-confidence vote on Prime Minister Stephen Harper’s ruling Conservatives. A similar move by Bloc Quebecois would bring down the government and force elections, possibly before the end of the year.

The Liberals’ stated support of extending income trusts’ tax advantages past Jan. 1, 2011, the date the Conservatives would have them expire, has long given US investors skin in this game. And with the prospective tax increases priced in since November 2006, eliminating them would no doubt hand us a windfall.

On the other hand, an opposition victory would have other implications as well. On the plus side, stepped-up government spending on infrastructure projects would be a boon to Conservative Holding Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF). Green energy would also get a leg up, a big plus for Portfolio favorite Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF), formerly Great Lakes Hydro Income Fund.

On the negative side, higher government spending to spur the Canadian economy could hurt the Canadian dollar and thereby hit the US dollar value of share prices and dividends in the near term. But that would also help businesses that straddle the border manage currency fluctuations more effectively, including Ag Growth International (TSX: AFN, OTC: AGGZF), Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF), CML Healthcare Income Fund (TSX: CLC-U, OTC: CMLIF) and Just Energy Income Fund (TSX: JE-U, OTC: JUSTF).

The biggest worry about a prospective Liberal-led government is the potential for more restrictive regulation, particularly on the energy patch, as well as higher taxes.

We’ll be tracking election possibilities closely in CE’s weekly companion, Maple Leaf Memo. (Sign up to receive MLM, including a weekly roundup of How They Rate news and notes and quarterly earnings summaries for Portfolio companies, via e-mail at www.CanadianEdge.com. It’s complementary for subscribers. Weekly issues are also posted on the website.)

No matter what happens in Canadian politics, however, investor returns will still depend mainly on the health of underlying businesses. The good news: The future still looks bright for well-run Canadian trusts and high-yielding corporations.

As I pointed out in an August 24 Flash Alert, the main takeaway from second quarter earnings numbers is disciplined, low-debt companies and trusts are still generally doing well. Cyclical and debt-heavy rivals, meanwhile, are still sliding.

The second and more surprising takeaway is most energy trusts have established financial policies sufficiently conservative to withstand the historic plunge in natural gas prices.

This good news has been reflected to some extent by the surge in Portfolio holdings in recent months. That recovery has now extended even to particularly battered fare like Aggressive Holding Newalta (TSX: NAL, OTC: NWLTF), which has now more than tripled since early March.

The broad-based S&P/Toronto Stock Exchange Income Trust Index, however, is still more than a third off its 2008 high. Conservative Holdings on average are yielding nearly 11 percent, despite cash flow coverage that’s more solid than ever. Meanwhile, the oil and gas producers in the Aggressive Holdings sell for less than 70 cents per dollar of assets in the ground.

Clearly, these are very low valuations for well-run businesses. I’ll grant that there’s still a chance some will falter if economic conditions relapse. That’s why we’ve got to continue watching the numbers.

Barring that, however, these unmatched values mean tremendous upside. And again, that’s so no matter who the ruling party is in Ottawa.

As I pointed out last month, a number of trusts have announced plans to convert to corporations ahead of 2011. And a growing number of them are doing so without cutting dividends.

That’s hugely bullish for trusts and still vastly unappreciated by investors.

The only negative is it looks like we’re going to have to wait a while for the vast majority to make their move. In fact, many trusts’ managements seem to be waiting to see how the politics will play out, or at least to get an idea of how fast business conditions will improve.

Happily, as the market has shown us with prior trust-to-corporation conversions, we’ll see strong investor returns no matter what’s decided, so long as the underlying business stay healthy. That’s why my focus and yours should remain squarely on the numbers as we move into the latter months of 2009.

One final note: We’ve made a few changes to the Canadian Edge website over the past month, with the intention of making the information on the site easier to access. All of the features are still there, but if you’re having trouble finding them please drop us a line by going to www.CanadianEdge.com and clicking on the “Contact Us” item at the top of the page.

Portfolio Action

The only changes to the Portfolio this month are names. Great Lakes Hydro Income Fund is now Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF). As announced last issue, the fund is planning to convert from a trust to a corporation without changing its dividend, though the date for the transition has yet to be set.

Meanwhile, Colabor Income Fund has now converted to a corporation, also without cutting its distribution, and now trades as Colabor Group (TSX: GCL, OTC: COLFF).

All second quarter numbers for our trusts and high-yielding corporations are now in, and all were on track. Those not analyzed in the August issue are highlighted in Portfolio Update.

The only two holds are Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) and Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF).

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 Yields of the Month

The High Yield of the Month selections for September have enjoyed a great deal of success in the energy business, though from different angles. Both sport high yields that are well covered by cash flows, even in this environment.

The more conservative Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF) earns the bulk of its cash flow from fee-based transportation, storage and processing assets. Keyera has announced it will convert to a corporation in January 2011 and “is positioned to maintain current distribution levels.” Keyera Facilities Income Fund is a buy for even the most risk averse up to USD20.

Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF) is an oil and gas producer that’s expanded output rapidly in recent years by a combination of well-placed drilling and strategic acquisitions. Daylight Resources Trust is a solid conservative bet on oil and gas prices up to USD11.

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 How They Rate (cms 29943) for other changes in buy targets. Price and yield information is updated every 15 minutes in both 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.

This month, I’ve added Liquor Stores Income Fund (TSX: LIQ-U, OTC: LQSIF) to coverage under Business Trusts as a buy up to USD14.

The trust reported a 46.3 percent boost in distributable cash flow from its portfolio of stores in western Canada. That adds up to solid coverage (second quarter payout ratio 68 percent) of a yield of more than 12 percent, and in a business that’s once again proving to be recession-resistant.

Also, we’re picking up coverage under Transports of Canadian National Railway (TSX: CNR, NYSE: CNI). Rails are steady companies and stand to gain from the increased emphasis in the energy patch on exporting to Asia. Buy up to USD48.

Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM)–Sell to Hold. The bank’s steady second quarter and stated expansion plans indicate the worst is over, despite its mistakes last year.

Cathedral Energy Services Income Trust (TSX: CET-U, OTC: CEUNF)–Buy @ 5 to Hold. The trust last month announced plans to convert to a corporation and is moving immediately to a quarterly distribution at half the rate.

That’s not bad on the face, as it indicates management’s desire to be a dividend-paying corporation. But the cut does point to continuing difficult conditions in the energy services sector.

FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)–Sell to Hold. Second quarter earnings at this trust did take a hit from falling advertising revenue. But cost-cutting and steady subscriptions helped cash flow coverage of distributions exceed expectations.

The way ahead is still cloudy, but the company appears at least stable and yielding nearly 20 percent it’s pricing in a lot of bad news that may not occur.

New Flyer Industries (TSX: NFI-U, OTC: NFYIF)–Buy @ 10 to Hold. Weakness in its backlog isn’t an immediate threat to the dividend, but it is a sign that times could get tougher for bus manufacturing.

Feature Article

Oil prices continue to hold their gains for this year, shaking off lingering fears for the global economy. In stark contrast, natural gas has now crashed well under USD3 per million British thermal units, a level not touched since the depths of the previous recession in early 2002.

As a result, activity in Canada’s energy patch has largely shut down, with energy services companies reporting a 70 percent plus drop in active rigs from year ago levels. And still, spare North American natural gas storage is almost non-existent, forcing producers in some areas to cap wells or else burn off the gas.

The collapse in gas has been the final nail in the coffin for some producers, including it appears now converting trust True Energy (TSX: TUI-U, OTC: TUIJF). The best-run, however, are demonstrably managing their way through the crisis, thanks to extremely conservative financial and dividend policies, disciplined hedging strategies, geologic acumen, low-cost reserves and experience.

Ten of them are using their relative strength to make low-cost acquisitions, positioning themselves for growth when gas prices turn up.

I delve into the state of Canada’s energy patch and highlight the winners.

Canadian Currents

The ability of Canada’s banking system to weather the global recession and credit crunch was first highlighted here in late 2008. And it’s been a major plus for Canadian trusts and high-yielding corporations, who unlike many of their US and other foreign rivals have continued to enjoy nearly unfettered access to capital.

Highlighted here, Canadian banks’ second quarter earnings are just the latest evidence of their strength. Note payout ratios and other information for banks are shown in How They Rate under Financial Services.

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–Three Canadian trusts and one closed-end mutual fund of trusts in How They Rate coverage trimmed distributions last month: Cathedral Energy Services Income Trust (TSX: CET-U, OTC: CEUNF), Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF), EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF) and Wajax Income Fund (TSX: WJX-U, OTC: WJXFF).

The rest of the Dividend Watch List (excluding oil and gas producers) includes: 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).

DWL reviews the cutters. All are tracked in How They Rate.

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

New Additions–We’re adding two new entries to How They Rate coverage. Liquor Stores Income Fund (TSX: LIQ-U, OTC: LQSIF) is now tracked under Business Trusts, while Canadian National Railway (TSX: CNR, NYSE: CNI) is tracked under Transports. Here’s the lowdown on each.

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.”