Fallout from the global recession, particularly sliding energy prices: That’s been the primary cause of the unprecedented number of distribution cuts in the Canadian Edge universe over the past 12 months.

The good news is the pace has tapered off dramatically in recent months, as Canada’s economy has stabilized and companies have hunkered down. In fact, increases last month outnumbered cuts by a 2-to1-margin. Nonetheless, we’re still seeing a few casualties, and there will likely be at least a few more even if the global recovery exceeds expectations.

That the hospitality industry has suffered over the past year is no secret to anyone who’s traveled lately. Last month it was unitholders of InnVest REIT (TSX: INN-U, OTC: IVRVF) that felt the bite, as the owner of Canada’s largest hotel portfolio and largest hotel franchisor slashed its payout by roughly a third to a new monthly rate of 4.17 cents Canadian. The new rate is effective with the October 15 payment to unitholders of record September 30.

InnVest also announced a CAD50 million equity offering, with the funds to be used to boost liquidity and control debt. In addition, days earlier, management announced the refinancing of a CAD177 million mortgage secured by 40 limited service hotels and maturing in July 2010. The new loan is at an interest rate of 7.5 percent and matures in three years.

The good news is InnVest no longer has any significant debt coming due until 2011. That takes the pressure off in what’s still a very tough credit market for hospitality companies in general.

On the other hand, 7.5 percent is considerably above the 5.9 percent average rate across the fund’s loan portfolio and will consequently drive up costs. That plus the weakening environment probably made the distribution cut inevitable.

Second quarter revenue per available room, for example, fell 14 percent, as occupancy slid 7 percent and average room rates portfolio-wide contracted 4.2 percent. Overall revenue dived 11.9 percent, and margins dropped 470 basis points.

The hotel business depends on two things: business travel and tourism. Both have been weak across Canada in the wake of the North American recession. They’ve also arguably been hurt by the jump in the Canadian dollar since March, as a worsening exchange rate has made many Americans less willing to venture north for either business or pleasure.

Unfortunately, this is an industry that will almost surely be one of the last to recover from this recession. Businesses continue to tighten their belts. Consumers, meanwhile, are on a tear building up savings and bringing down credit card debt, particularly in the US, where many have a rational fear of losing their jobs. In such times, leisure travel is a rare luxury many just simply can’t afford.

With these moves InnVest appears to have prepared itself to weather this severe downturn intact. The property portfolio remains exceptionally well-diversified geographically and of high quality. That was evidenced by the takeover interest over the past year from rival hotel owner Royal Host REIT (TSX: RYL-U, OTC: ROYHF), which appears to have backed off its efforts for now but may return.

On the other hand, until conditions improve these companies will definitely be swimming upstream. And while solvency may no longer be in question, the current level of distributions certainly is.

Finally there’s the question of what management will do to deal with 2011 taxation. Unlike other real estate owners, neither InnVest nor Royal Host appears to qualify for REIT status when the new taxes kick in. Unless the situation is resolved favorably, that could trigger another round of distribution cuts. Either way, there are more secure ways to garner double-digit yields. Both InnVest REIT and Royal Host REIT remain sells.

Unfortunately, over the next 12 to 18 months we’re increasingly likely to see a rising number of distribution cuts across the Canadian trust universe for precisely that reason: as managements adjust distributions to absorb the new taxes set to kick in with 2011.

As I pointed out in August, eight of the 18 trusts to convert to corporations to date have done so without cutting distributions. And even those that have made cuts have generally exceeded expectations. In other words, management didn’t cut disbursements nearly as much as investors had expected and their unit prices reflected.

Beating expectations is always the key to building wealth in the stock market. Over the long term, that means tapping into underlying businesses that are healthy and growing. In this case, it means owning trusts that will either not cut dividends at all when they convert to corporations in coming months, or else will cut less than expected.

Put another way, most trusts won’t be able to avoid distribution cuts entirely during this transition–and that includes those of the highest quality. But when the trust tax was announced on Halloween 2006, markets reacted immediately to the projected damage. And with many investors still fearing some kind of apocalyptic mass liquidation, the bar of expectations for converting trusts almost couldn’t be lower. It won’t take much to beat those expectations, handing investors a windfall even with trusts that do cut dividends.

For those of us who have been around income investing for a while, this is pretty much new territory. On the other hand, this is a unique situation, where all the bad news has been out for nearly three years. That probably more than anything else explains why the 18 trusts converting to corporations so far have rallied on the order of 30 to 40 percent since announcing their moves.

And it’s why we can expect a similar windfall as trust after trust in the coming months ends the uncertainty about how they’ll absorb the new taxes.

Last month three trusts made their 2011 adjustments by cutting distributions, Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF), Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) and Pengrowth Energy Trust (TSX: PGF-U, NYSE: PGH).

Of the trio, October High Yield of the Month Macquarie Power & Infrastructure topped expectations the most. Next was Pengrowth, which announced a “Value Creation Strategy” that included a reduction in its distribution to a new monthly rate of CAD0.07 per unit from the old rate of CAD0.10 it had paid since March.

The oil and gas producer’s cut was its fourth since the trust tax was announced in October 2006. Given the extremely volatile nature of its business–mainly its dependence on oil and gas prices–another reduction certainly can’t be ruled out. Barring a further steep drop in oil and gas, however, this one is almost certainly the last and will be more than enough to absorb any new 2011 taxes.

The cornerstone of this new strategy is to devote a higher percentage of cash flow on “operated, low cost, low risk, repeatable drilling opportunities in the Western Canadian Sedimentary Basin.” These are the type of properties trusts have traditionally drilled from to realize maximum cash flows from which to pay high distributions. The focus is a clear indication of what the new management wants Pengrowth to be going forward: a high-dividend-paying corporation.

Aside from the distribution cut to increase internal cash financing capability, the strategy shifts capital expenditures from higher-risk ventures to lower-risk ones such as the Horn River Shale in northeast British Columbia and the Lindbergh enhanced oil recovery project. The trust also plans to reduce debt sharply over the next 18 months and cover future distributions and capital expenditures entirely with cash flow, avoiding the need to issue new equity or debt except to finance acquisitions.

Pengrowth has had a solid record creating wealth at the drill bit in recent years. That should ease the shift to higher-percentage drilling, further boosting efficiencies and therefore cash flow. This week, the trust acquired an additional 28,842 acres of undeveloped lands in the Horn River play, giving it 73,147 net acres in the region.

The distributions Pengrowth will pay going forward and even its ability to absorb 2011 taxation will depend heavily on what happens with energy prices. For the first time since I’ve been covering this trust, however, I’m feeling good about its chances. The new strategy is conservative and provides the best possible chance for generating high income in the long run, particularly as energy prices rebound with the global economy.

The trust still trades at roughly 70 percent of the value of its assets in the ground and barely book value. That low price coupled with its immense reserves and raw land holdings opens the possibility of a takeover. And Pengrowth is also no longer organized as a limited partnership in the US, so the tax treatment for US investors are now the same as every other trust, i.e. as a qualified dividend.

I still prefer the oil and gas trusts in the Aggressive Portfolio. But at its current price and with the new strategy, I now rate Pengrowth Energy Trust a buy up to USD10. Those who’ve owned for a long time should hang in there as well.

Consumers’ Waterheater has easily been the most disappointing Portfolio pick this year. To be fair, most of its troubles have been well beyond management’s control. Recapping, last year the trust acquired the sub-metering business of Stratacon in an attempt to boost growth enough to absorb 2011 taxes. It was able to finance the deal at competitive rates despite the ongoing credit crunch, thanks to a strong balance sheet.

Then came the quizzical decision from Ontario regulators prohibiting the installation of sub-meters in apartment complexes without the permission of tenants. Buildings where sub-meters were already installed were required to get the permission of tenants to keep them. That decision was later modified in a way that allowed Consumers’ to continue growing its business, but at greater cost and time.

As a result, rather than boost cash flows present and future sub-metering has been a cash drain thus far. And given the new operations restrictions and debt taken on to buy the properties, it may remain so well into 2010.

Meanwhile, the open bill access and collection services agreement with Enbridge’s (TSX: ENB, NYSE: ENB) Direct Energy unit–underpinning the core water heater rental business–is still under negotiation. A deal is all but done, but until terms are set there’s uncertainty about cash flow from this business.

Slashing the distribution from the prior rate of 10.75 cents Canadian per share per month to a new rate of 5.4 cents breaks a string of seven consecutive annual increases, dating back to the trust’s inception. It also seems to have created a psychological breakdown for the stock, despite the fact that such a deep dividend cut was absolutely priced in well beforehand. Many investors, it seems, have taken the dividend cut as a point to give up.

My view is Consumers’ is now a very cheap stock with the bar of expectations set extremely low, given the essentially stable nature of its core business. The CAD32 million saved by the distribution cut will cover all projected costs and revenue shortfalls triggered by recent events and then some. In fact, management projects “to be able to maintain” the new level of distributions after 2011, when it will almost surely convert to a dividend-paying corporation.

That’s a major vote of confidence for the yield of more than 15 percent. And it’s certainly more than enough reason to hang on to the units now, particularly with Dominion Bond Ratings Service affirming the trust’s financial strength at A in late September after the moves were announced.

On the other hand, I’m not yet ready to upgrade Consumers’ back to a buy again. I recall similarly bullish and reassuring statements made about the higher dividend rate following the acquisition of Stratacon. Management at the time was giving its best forecast, but as the event of the past several months show economic events can always derail even the best-laid plans.

I believe this dividend cut will be the last, that business will stabilize, and that Consumers’ will smoothly convert from trust to corporation. At that point we should see a mighty recovery in the share price.

That potential and the still-generous distribution are definitely worth hanging on for. They key to the whole equation, however, is business strength. And I want to see some stabilizing numbers before I get bullish again.

The advice remains to let positions ride. But let’s not buy more Consumers’ until there are hard numbers backing up management’s words. We’ll get our next indication of how things are going later in the month. Until then, hold Consumers’ Waterheater Income Fund.

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, which should always be considered at risk since dividends depend on energy prices. Boralex Power Income Fund’s (TSX: BPT-U, OTC: BLXJF) prospects are highlighted in the October Portfolio Update.

• 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 (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

Movie-going is reputed to be one activity consumers will stick to even during severe economic downturns. Most of us have never experienced anything like what we’re going through right now in terms of job losses, wealth destruction and behavior changes, but, folks are still flocking to the cinema.

The critical variable for operators such as Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF) is the films: If Hollywood churns out solid material, people will come. Super heroes, animated 3-D and Harry Potter seem to be a bankable rotation for now, and Cineplex is benefitting.

Canadian box office was up more than 8 percent from year-ago figures on the attraction of Ice Age: Dawn of the Dinosaurs, GI Joe: The Rise of the Cobra and the sixth entry in the epic tale of a shaggy-haired wizard. Based on these results, Scotia Capital (Bank of Nova Scotia, TSX: BNS, NYSE: BNS) has raised its third quarter revenue growth forecast to 8 percent from 4 percent, which, if it happens, would translate into 4.6 percent year-over-year earnings growth. The Bay Street bank maintained its “Sector Outperform” rating and CAD19 target.

The second entry in the Twilight saga, New Moon, and the highly anticipated sequel (the original took in USD217 in North America) The Chipmunks: The Squeakuel are the hopes for the fourth quarter.

Cineplex Galaxy has boosted its distribution twice since Finance Minister Jim Flaherty introduced the Tax Fairness Plan on Halloween 2006, and the company, after weathering this downturn in fine form, looks set to cover its current distribution in and after 2011, although we’ve heard nothing from management about its plans.

Alberta’s Sovereign Wealth

Does Alberta have its own entry in the “return of state capitalism” parade?

Alberta Investment Management Corporation (AimCo) bears the hallmarks of a sovereign wealth fund (SWF): it has a lot of public money to put to work; it is a creation of the state run on commercial principles by outside managers; it is a means to diversify economic exposure as well as to generate wealth for future generations.

This week AimCo reported assets under management of CAD69 billion. Were it ranked among SWFs, it would appear just outside the top 10, in the neighborhood with the Libyan Investment Authority and the Qatar Investment Authority.

The rapid growth of SWFs, driven primarily by Asia, has inspired a lot of debate in recent years. In addition to the amount of money they control (estimated as high as USD3 trillion buy likely somewhere near USD2 trillion after disastrous 2008-09 losses) and the rate at which this amount is growing, SWFs’ collective lack of transparency had many observers concerned about the possible introduction of motives other than profit into the market.

However, the record demonstrates that SWFs are in the main responsible investors seeking only to maximize their returns, without designs on taking control of foreign companies. Many have taken steps to make their activities more open to scrutiny, and an international group sponsored by the International Monetary Fund has published the Santiago Principles, a set of best practices for sovereign investors and recipient nations.

Between March 2007 and April 2008 SWFs provided USD45 billion to needy Western financial institutions weakened by the subprime crisis; these investments have generated mixed results. The equities rally post-March 9 has allowed some to exit positions with handsome profits, while others might never recover their losses.

Now SWFs are seen by many–hedge funds, for example–as potential white knights. Their long-term horizons and significant asset bases make them ideal stabilizing forces during volatile periods. They don’t have to react to short-term market movements.

But they still hold their cards close to the vest. The fact that AimCo’s annual report is available for review on the Internet make it one the exceptions to the rule of SWF secrecy, and CEO Leo de Bever is also a talkative guy.

AimCo invested CAD290 million in Precision Drilling Trust (TSX: PD-U, NYSE: PDS) to help solve its debt problems and provided CAD220 million to Viterra to help Canada’s largest grand handler acquire an Australian rival.

The difficulty for AimCo now, as it chooses to react to the recent market past by picking up good assets at low valuations, is that the opportunities it sees are concentrated in commodities and agriculture. Part of its mandate is to diversify Alberta’s economy, and resources and farming are two pillars of provincial commerce. de Bever has also identified public infrastructure as of the best investment opportunities right now.

Loonie Levels

The Canadian dollar soared past USD0.94 this week to a one-year high as rising commodity prices, a sinking US dollar and a surprising rate hike by the Reserve Bank of Australia drew attention to currencies backed by resources.

The London Independent reported this week that Gulf Arab states were in secret talks with Russia, China, Japan and France to discuss moving away from pricing oil in US dollars. Most of the nations named have denied the report, but markets reacted anyway, pushing the greenback down and oil up above USD71 a barrel. Oil exporters, especially Russia, Iran and Venezuela, discuss moving away from pricing oil in US dollars from time to time, but it should be noted that Saudi Arabia, the largest OPEC producer, owns a large stock of US assets.

A move away from dollar pricing could weaken the US dollar if it reduced the use of the dollar in oil transactions and savings.

And Australia became the first G-20 nation to increase borrowing costs in more than a year when Reserve Bank Governor Glenn Stevens announced a 25-basis point increase in the central bank’s benchmark interest rate to 3.25 percent.

Australia is experiencing an increase in hiring, retail sales and house prices, and surging business and consumer confidence support the central bank’s conclusion that the “basis for such a low interest rate setting has now passed.” Stevens also noted that it was now prudent to “begin gradually lessening the stimulus provided by monetary policy.”

Like Canada’s, Australia’s economy is heavily focused on natural resources. The Land Down Under also benefits from proximity to China and other emerging Asian economies. The Australian dollar has rallied over the last several months on speculation its central bank would act before its global monetary peers, but only one analyst of 20 surveyed by Bloomberg predicted a rate hike this soon.

The market read the move as a sign the global recovery is taking root. If Australia is now viewing their market and the Asian market as growth returning to trend, that’s positive for commodities. And that, by default, would be positive for Canada.