Thus far, autumn is treating the Canadian Edge Portfolio of trusts and high-dividend stocks much better than it did last year. Our 33 recommendations tacked on additional gains last month and are now up nearly 50 percent for 2009 in US dollar terms.

Fat yields are still the chief attraction. Our companies’ underlying businesses are healthy and growing, and that’s shining through again in the third quarter earnings numbers now being released. That’s what’s kept their cash flowing to pay dividends despite North America’s worst recession and credit crunch in decades.

High yields have ensured market outperformance as well.

The graph “It’s Better Up North” compares head-to-head the performance of the S&P/Toronto Stock Exchange Income Trust Index (SPRTCM) with the S&P 500 since the close on Halloween 2006, just hours before Finance Minister Jim Flaherty announced the 2011 trust tax.

Flaherty’s move triggered an estimated CAD5 billion one-day loss in the trust market on Nov. 1, 2006.

But even starting a day before that, the SPRTCM has beaten the S&P by nearly 20 percentage points. And when the race begins Jan. 1, 2009, SPRTCM’s lead widens to more than 30 points.

Ironically, the Canadian edge is even greater after taking into consideration the gains former trusts have realized after formally converting into corporations. For example, Aggressive Holding Ag Growth International (TSX: AFN, OTC: AGGZF) is up roughly 20 percent since converting to a corporation in early June. Yet as a corporation it’s no longer part of the trust index and can no longer contribute to its gains.

In the September 2009 issue I highlighted the 18 How They Rate trusts that had either already converted to corporations ahead of 2011 taxation or had announced definitive moves to do so. Since then five more have joined their ranks, including Conservative Holdings Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) and Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF).

The average return for the 23 early converters from pre-announcement prices: 32 percent. Dividends remained the same for 11 converting trusts. But even of the 12 that did make cuts, nine boast substantially higher share prices now than before making their moves. And the other three are under water solely because oil prices are half their mid-2008 levels, while natural gas has fallen by nearly two-thirds.

I can’t think of any clearer proof that conversions are positive for unitholders of well-run trusts. In fact, over the next year we’re all due a conversion bonus, as three years of uncertainty are washed away and a bright future is revealed. What’s had me puzzled is why more investors, particularly Canadians, haven’t recognized this and therefore pushed trusts’ prices above today’s still-abysmal valuations.

Penn West Energy Trust (TSX: PWT-U, NYSE: PWE), for example, still trades for barely half the value of its oil and gas in the ground. Enerplus Resources Fund (NYSE: ERF) and Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF) are almost as cheap, as are the rest of the energy producers in the CE Portfolio.

Meanwhile, Conservative Holdings that have proven themselves recession-proof, such as Colabor Group (TSX: GCL, COLAF) and Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) still yield more than 10 percent. That’s the despite the fact that neither’s dividend is at risk either before or after 2011. Colabor has already converted to a corporation at the same dividend rate though the frequency is now quarterly (the next payment is due Jan. 10, 2010).

Two weeks ago, I got a pretty good answer why Canadian buyers have stayed scarce, as I moderated two panels of advisors at InterShow’s inaugural Toronto World Money Show. It’s not that these guys weren’t good and didn’t have great ideas. But their sentiment on income trusts was decidedly of the “show me” variety. The upshot: Until a trust makes its move for 2011, it’s probably not going to attract many buyers.

To date, five CE Portfolio holdings have converted from trusts to corporations. Three more have announced plans to do so in the immediate future and set their post-conversion dividends. Another six have said they plan to convert and have set future dividend rates, though as yet there’s no official conversion date.

Leaving out the four REITs and the two closed-end mutual funds–none of which face a tax change in 2011–that leaves 14 recommendations yet to declare a post-conversion dividend policy, including new addition Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF). That’s a lot of uncertainty likely to resolve itself on the upside in coming months. In fact, it’s probable that even the already converted are still lingering under a cloud of uncertainty that will only blow away when 2011 gets closer.

My job here isn’t to read minds, either of the US or Canadian variety. Rather, it’s to identify healthy, growing businesses that will continue paying big dividends and building wealth to 2011 and beyond. The good news is doing that is the key to getting our conversion bonus. And that means, if anything, the year ahead will be more profitable than the year behind.

One more thing: If you have questions about anything related to Canadian Edge, 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

With 2009 nearing an end, it’s time for some Canadian Edge Portfolio housecleaning. Happily, this year virtually all of the picks have performed up to snuff. The obvious exception has been Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF), which in fact has now underperformed the average recommendation by nearly 100 percentage points in 2009.

Consumers’ hasn’t rated a buy for some months. Rather, I’ve held onto it with the expectation that third quarter earnings would show stabilization of the waterheater rental business and a path to profits for the sub-metering operations acquired last year.

As it turned out, the overall numbers did level a bit. Unfortunately, they raised new questions as well about the ability of Consumers’ share price to rebound meaningfully in the next 12 to 18 months. As a result, I’ve elected to sell Consumers’ Waterheater Income Fund and replace it with a trust that’s almost as cheap and high-yielding but has more upside potential and lower risk: High Yield of the Month Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF).

For more on Consumers as well as earnings reports for roughly half the CE Portfolio, see the Portfolio Update.

High Yield of the Month

November High Yield of the Month and new Conservative Portfolio addition Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF) has yet to announce its dividend policy for 2011 and beyond. Management has stated it intends to convert to a dividend-paying corporation. And given its demonstrated recession-proof franchise and considerable store of non-cash expenses to shelter income from taxes, it’s a very strong bet to surprise on the upside, particularly with its current yield over 12 percent.

So is the other High Yield of the Month AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF), which offered a low-ball projection for its post-conversion distribution earlier this year but continues to announce solid results and expansion of its mainly fee-based assets. It too yields about 12 percent.

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 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.

Imvescor Restaurant Group (TSX: IRG, OTC: IRGIF)–Sell to Hold. If you didn’t sell Imvescor–formerly PDM Royalties–on my recommendation, you should have by now have received one share of Imvescor for every PDM unit you once held. The company is not currently paying a dividend but is “expected” to do so as part of a cash management strategy to be announced in mid-December.

Advantage Oil & Gas (TSX: AAV, NYSE: AAV)–Hold to Buy @ 7. This one isn’t suited for anyone who doesn’t want to speculate on natural gas prices. But with gas more positive and the shares selling for barely half the net asset value of its reserves, Advantage looks interesting as a potential takeover target.

Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF)–SELL to Hold. The trust has at last reached a deal with the US Dept of Justice that may allow it to operate normally. Trouble is, the recession is still hurting business, and the company has admitted guilt, so it could still face exposure from other lawsuits.

I like the business plan here and always have, especially the fact that 80 percent of income is generated outside of Canada and therefore isn’t subject to the 2011 tax. But I want to see more clarity before jumping back in.

Baytex Energy Trust (TSX: BTE-U, NYSE: BTE)–Hold to Buy @ 27. This well-run oil trust looks increasingly like takeover bait.

Canadian Hydro Developers (TSX: KHD, OTC: CHDVF)–Hold to SELL. The friendly takeover by TransAlta Corp (TSX: TA, NYSE: TAC) for CAD5.25 per share in cash leaves only potential upside from a rising Canadian dollar before closing.

Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)–SELL to Hold. Third quarter earnings showed a great deal more stabilization than I expected, thanks to cost-cutting and some improvement in the pulp market.

Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF)–Hold to SELL. This one is more about opportunity cost, as there are still numerous questions about the underlying business and the units’ ability to recover lost ground. It could be a takeover, but there’s little attraction here without one.

Harvest Energy Trust (TSX: HTE-U, NYSE: HTE)–Hold to SELL. The takeover offer of CAD10 per share in cash from the Korean National Oil Company seemed very low. But management’s willingness to accept it probably means heavy debt and shrinking refinery margins were taking their toll. In any case, this looks like a done deal, so the only potential upside is from a rising Canadian dollar before the close, a bet much better trusts also offer.

Keystone North America (TSX: KNA, OTC: KNAIF)–Buy @ 5 to SELL. The company has attracted an all-cash takeover offer of CAD8 per share, a 34 percent premium to the pre-deal price. The share price is nearly there now, and the company will not pay a dividend until the close, slated for early 2010.

That leaves little upside barring an unlikely shareholder rebellion and potential appreciation in the Canadian dollar. Take the profit and move on.

Potash Corp of Saskatchewan (TSX: POT, NYSE: POT)–Hold to Buy @ 100. The third quarter earnings weren’t spectacular but showed signs of stability. The dividend’s not high but the recovery potential is.

Feature Article

In mid-2007, Abu Dhabi Energy Company, the national oil company also known as TAQA, offered a premium of nearly 50 percent to buy out the former PrimeWest Energy Trust. Last month, Korean National Oil Company offered a similar premium to market price to buy out investors in troubled Harvest Energy Trust (TSX: HTE-U, NYSE: HTE).

Coupled with the purchase of 17.2 percent of mining giant Teck Resources (TSX: TCK-B, NYSE: TCK) by sovereign wealth firm China Investment Corp, the move is again raising the prospect of another takeover wave for Canada’s resource wealth, as well as income trusts.

More than three-dozen deals for trusts were struck in mid-2007. And with 2011 taxation fast approaching, there’s the prospect for even more over the next 12 months. My long-standing rule is never to buy a takeover prospect unless you’d want to own the company if no deal occurs. With that in mind, I identify the best targets to buy now.

Canadian Currents

Only one country shares Canada’s breakaway prospects for growth from the global natural resource boom within a stable political environment. That’s fellow Anglophone Australia, home to many of the world’s biggest resource companies and also a major investor in Canada.

CE Associate Editor David Dittman highlights the big picture play here, as well as the top players such as BHP Billiton (Australia: BHP, NYSE: BHP) and Rio Tinto Plc (NYSE: RTP). Rio operates the Iron Ore Company of Canada facility that contributes all the cash flow of buy-rated Labrador Iron Ore Royalty Trust (TSX: LIF-U, OTC: LBRYF).

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–Four How They Rate companies trimmed distributions last month. Cuts at Cathedral Energy Services Trust (TSX: CET-U, OTC: CEUNF) and Contrans Income Fund (TSX: CSS-U, OTC: CSIUF) are part of recently announced conversions to corporations ahead of 2011.

Contrans management currently “believes that a payout of 30 percent of the free cash flow of the new public corporation” would be appropriate. Cathedral has set no such parameters, though it will “review the proposed dividends for 2010 as part of its annual operating and capital budget process.”

Keystone North America (TSX: KNA, OTC: KNAIF) is suspending its distribution as part of a takeover offer from Service Corporation International (NYSE: SCI) of CAD8 per share all cash.

Finally, Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXHF) has at last succumbed to the pressures facing all oilfield service companies this year, trimming its payout by a little more than half. It remains an exceptionally solid trust, however.

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), 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.

Broker Watch–All brokers are definitely not equal when it comes to investing outside the US. In fact, some have actually become hostile. Here again are our favorites and a word of warning about others.

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