The 33 Canadian Edge Portfolio picks returned an average of 60 percent in the first 11 months of 2009. Now for the really good news: Every one of them has what it takes to add to those robust returns for the rest of the year and well beyond.

It’s pretty clear some areas of the North American economy are getting traction. Energy producers’ third-quarter 2009 results were almost universally worse than a year ago, but they were far better than during the prior quarter. Even North American demand for natural gas appears to have stabilized. Meanwhile, oil use has rebounded mightily in Asia and is starting to rise again in the US as well.

Canadian real estate is another bright spot. Real estate agent franchiser Brookfield Real Estate Services Fund (TSX: BRE-U, OTC: BREUF) reported a 30 percent boost in transactional dollar value of Canadian home sales in the third quarter versus year-earlier levels. Owners of commercial property like RioCan REIT (TSX: REI-U, OTC: RIOCF) recorded lower vacancy rates and rising rents.

Health care, the subject of this month’s Feature, continued to charge ahead. So did Canadian banks, communications, utilities and energy infrastructure companies. Even several food services, natural resources and transportation outfits came in with unexpectedly positive results. And for the first time in many months, managements of a growing number of companies sounded optimistic notes about the future, particularly noteworthy given Canadians’ propensity for understatement.

As in the US, there are still plenty of pockets of weakness, particularly among the highly leveraged. Debt reduction remains a critical priority in industries like energy services, which continues to suffer mightily due to massive latent capacity and producers’ reluctance to ramp up drilling efforts. Consumer-focused firms and businesses that are dependent on US markets–particularly home-building–are also still in retreat, as Dividend Watch List makes clear.

Natural gas is living up to its reputation as a widow-maker for all those who try to predict its price. For most of the fourth quarter thus far, prices have been roughly double the early-September lows, portending well for producers’ next round of earnings numbers.

Higher prices, however, have only revived worries that winter in the Northeast will be as mild as summer and that inventories will continue to overflow. One rumor making the rounds has it that a flood of cheap liquefied natural gas (LNG) from the Middle East will soon pull into US ports, forcing producers to sell at steep losses and driving prices to fresh lows.

None of that, of course, is really news. Neither does the LNG story make much real sense, given that gas prices are still much higher outside of North America. In fact, as my colleague Elliott Gue points out, most actual LNG transport ships are currently on course for Asia.

But investors should certainly not expect any kind of quick fix for troubled companies in this market. Those that have survived this far should do so going forward. And that definitely goes for the remaining natural gas trusts, all of which have become masters at doing more with less. In fact, even the most leveraged producers like Advantage Oil & Gas (TSX: AAV, NYSE: AAV) and Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) were highly profitable in the third quarter with spot natural gas at less than USD3 per million British thermal units (MMBtu).

Heavy debt, however, is still toxic and the economic recovery is likely to remain slow. That means progress for the weak will be both gradual and tough to come by. And that’s a pretty good reason to purge your portfolio of any sell-rated companies in How They Rate.

In stark contrast, companies that posted good third-quarter numbers have again proven their ability to weather the worst beyond the shadow of a doubt. It’s never easy to maintain a strong balance sheet and safe dividend coverage while pursuing a sound strategy for long-term growth. But those that have achieved those goals the past two years are practically a lock to keep doing so in 2010 and beyond, as the market and economic conditions around them improve.

That’s definitely the case for CE Portfolio picks, including those that hail from still-weak industries like natural gas production. And it’s the surest possible sign of robust investor returns ahead. All of them are bona fide merger candidates as well, even the biggest. That’s particularly true of the trusts, as their solid businesses continue to sell far below valuations of non-trusts.

The 2011 Windfall

Ironically, the main factor holding back trusts’ share prices now–prospective conversions to corporations prior to 2011 taxation–is perhaps the biggest reason to be bullish on 2010. Despite its gains since March, the broad-based S&P/Toronto Stock Exchange Income Trust Index is still nearly a third off the highs it hit in mid-2006 and again briefly in mid-2008.

The primary reason is US and Canadian investors alike are still holding back from income trusts for fear that 2011 will be some kind of doomsday. That’s despite the fact that 25 trusts have either already completed or have announced early conversions to corporations. And not only are all of them still going concerns, but they’re up on average nearly 40 percent from pre-announcement prices.

Moreover, nearly half have maintained their pre-conversion dividends despite absorbing higher taxes–by virtue of having strong and growing businesses. And all of them have rallied strongly following their conversions, including Atlantic Power Corp (TSX; ATP, OTC: ATLIF).

“Assessing 2011” updates the conversion status of CE Portfolio holdings. We’ll be presenting similar information for all How They Rate entries in the coming weeks.

Nine CE holdings have either already converted to corporations or won’t need to because they’re real estate investment trusts, which have broadly maintained their exemption. 2011 trust taxes won’t affect their distributions one iota.

Another seven holdings have declared their intention to convert to corporations–and they’ve affirmed they won’t cut their distributions when they do so. Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) at this time intends to remain a trust and to maintain at least its current distribution level (see below).

And a ninth, AltaGas Income Trust (TSX: ALA-U, ATGFF), has announced it will convert and has set a reduced but still generous annualized payout range of CAD1.10 to CAD1.40 a share.

That leaves 15 holdings where post-tax dividend policies have yet to be set. Two are closed-end funds, where distributions will be determined largely by what their holdings wind up paying. Seven are energy producers that have affirmed they’ll eventually convert to corporations at dividend rates that will largely be determined by where energy prices are. And six have declared their intention to convert to corporations but have yet to declare what their distributions will be.

It’s these 15 holdings that hold the greatest potential for a 2011 windfall. All continue to perform well as businesses, as evidenced by strong third quarter results. And they’re all selling for low valuations, mainly because of low expectations for their post-2010 dividends.

One in this group is new Conservative Holding IBI Income Fund (TSX: IBG-U, OTC: IBIBF), highlighted as a December High Yield of the Month. Another is co-High Yield of the Month Provident Energy Trust (TSX: PVE-U, NYSE: PVX), which is transitioning into an owner of high-quality, fee-generating midstream energy assets attached to an oil and gas producer. A third is last month’s Portfolio addition Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF).

Until management does clarify a post-conversion dividend policy, all three are likely to remain at low valuations relative to their strong businesses. But a low bar of expectations won’t be hard to beat. Even if there are cuts, it won’t be long before all are at much higher share prices than they are now, as the uncertainty about 2011 is washed away.

The key is all are strong businesses deserving of much higher share prices, regardless of what their current dividends are.

All three are strong buys if you don’t own them already, IBI Income Fund below USD16, Davis + Henderson Income Fund up to USD16 and Provident Energy Trust up to USD7.

The Rest of the Numbers

In the November 2009 issue I spotlighted earnings results for roughly half the CE Portfolio. Below, I look at the rest.

The key takeaway is all of our holdings strengthened their balance sheets and provided solid dividend coverage, even as they continued to advance their long-term business plans. That’s my primary criterion for continuing to hold onto them in the Portfolio as well as recommend them for new purchases.

For new readers, my advice is to build a portfolio of at least eight to 10 Portfolio securities in one of two ways. First, you can take full positions in two of them at a time by purchasing the High Yield of the Month selections that appear in every issue.

These are essentially my best buys of the month. Purchasing them when featured hasn’t always produced instant profits. But this approach has tended to get investors in at good prices, one of the keys to outperforming the overall portfolio over time.

The other approach is to target eight to 10 stocks and take a one-third position now, one third next month and the final third a month later. This has the advantage of effectively being a “dollar cost averaging” strategy–i.e., by definition you’ll buy more of your position at a lower price and less at higher prices.

And buying incrementally has the additional advantage of fostering patience and limiting emotion, always the enemy of rational investment.

The Portfolio is divided into Conservative and Aggressive Holdings, mainly to emphasize the relative importance of commodity prices on returns. All holdings are priced and pay dividends in Canadian dollars, whose fortunes tend to follow commodity prices over time. That makes even the most conservative of them a potential hedge against inflation and a collapse in the US dollar.

Conservative Holdings, however, have underlying businesses that are not directly affected by commodity prices. Whether oil is at USD100 or USD30, they can continue to generate steady cash flows and pay generous dividends. In fact, they proved this over the past year as only one of their number–Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–trimmed its payout, despite the worst economic and credit conditions in decades and a more than halving of oil and gas prices.

In contrast, Aggressive Holdings’ primary appeal is precisely that cash flows and therefore distributions do depend on energy prices. If energy prices rally as I expect, they’ll throw off huge returns. The tradeoff is, as we saw clearly over the past year, they’re vulnerable to steep declines.

In fact, of the current lineup, only Ag Growth International (TSX: AFN, OTC: AGGZF), Chemtrade Logistics and Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) did not cut distributions over the past year. The rest were forced by falling commodity prices to reduce payouts. Those dividends, however, will ratchet back up again when energy prices do.

Should you concentrate on Conservative or Aggressive Holdings, or some mix of them? The answer depends on what your objectives are and how much risk you can afford to take.

Every investment has its risks and they should be well understood before anyone puts in dollar one. But if your goal is solely to garner high current income with a maximum of safety, the Conservative Holdings are where you should be concentrating.

Conversely, if you’re looking for explosive growth and can tolerate some volatility in dividends, the commodity-focused Aggressive Holdings will be much more to your liking. Most investors will probably want to own some of each group.

Note that Canadian income trusts and stocks are just like any other common stock you might buy. There are no special rules, though you’ll want to be sure up front of what fees and commissions your broker is charging. Be sure to check out Tips on Trusts for a suggested broker if yours doesn’t measure up.

Here’s the breakdown of third-quarter results for the Conservative Holdings we didn’t recap in the November CE.

For analysis of the Aggressive Holdings reporting, see the next section of the article. CML HealthCare Income Fund (TSX: CLC-U, OTC: CMHIF) is highlighted in the Feature.

Artis REIT’s (TSX: AX-U, OTC: ARESF) portfolio of mostly oil patch properties looked extremely vulnerable to recession a year ago. As a result, the owner of commercial property saw its share price slip under USD4 by late 2008 as many investors panicked and bailed.

Business results, however, continued to attest otherwise. In fact, management’s relentless focus on high-quality properties with below-market rents during the boom times has kept occupancy rates high and rents rising over the past year, even while rivals have floundered. Third-quarter 2009 was no exception, as same property net operating income rose 3.6 percent and occupancy actually rose to 96.7 percent from 96.2 percent in the second quarter.

The third-quarter payout ratio based on funds from operations (FFO) came in at just 69.2 percent. The REIT reduced debt to just 47.7 percent of book value from 51.6 percent at the beginning of 2009.

And Artis has already shored up 2010 revenue by renewing in advance some 20 percent of expiring and swapping higher risk property in Calgary for less exposed assets elsewhere.

Artis’ continuing strong results haven’t been lost on the market, and its units are now close to three times their lows. The REIT’s dividend yield, however, is still more than 10 percent, and it sells for little more than book value.

To be sure, Artis, like all holders of commercial properties in western Canada, will face challenges as long as the energy patch is in slowdown mode. But with many of its rents still below market, lease terms and debt maturities staggered and the distribution well covered, its position remains strong.

In fact, the REIT is well-placed to pick up additional cash-generating properties from distressed owners. And management notes “market conditions affecting (Artis’) target market…are showing signs of improvement.”

Meanwhile, low Canadian interest rates are easing financing and refinancing needs. Artis’ geographic concentration does make it somewhat riskier than my other REIT picks, and its unit-price volatility over the past year confirms it. But with solid fundamentals, a high yield and the worst clearly behind its market, Artis REIT is also a compelling value of up USD10 for those who don’t already own it.

Atlantic Power Corp (TSX; ATP, OTC: ATLIF) has completed its conversion from an income participating security (IPS) to a corporation. The entire dividend is now an equity dividend and therefore qualified for tax purposes in the US. Accordingly, its trading symbols have now changed to ATP on the Toronto Stock Exchange and ATLIF on the US over-the-counter (OTC) market.

Management still plans to introduce a New York Stock Exchange (NYSE) listing in early 2010, which will open the stock up to institutional investors for the first time.

One question I continue to get from readers is how a company in the power business like Atlantic can pay a 10 percent-plus dividend, when high-quality US utilities typically pay between 5 and 6 percent. The answer is twofold.

First, Atlantic isn’t a utility. Rather, it’s an investment company that owns interests in 13 operating power plants and the Path 15 power transmission line in California. These projects generate cash flow, which management hedges against volatility in energy prices, interest rates, currency exchange rates and other factors to ensure a level flow. Cash flow rises over time as management adds assets and a large chunk of it–by no means all–is paid out in dividends to investors.

Atlantic’s move to go corporate has, if anything, made its current monthly dividend rate of 9.12 cents Canadian more secure than ever by eliminating a huge chunk of debt from its balance sheet.

But the real security of the payout lies in the high quality of the assets, which generated 22.7 percent more distributable cash flow during the seasonally weak summer quarter. The nine-month payout ratio is now 83 percent and management has increased expected full-year cash flow by 5 percent to CAD95 million to CAD100 million.

The bottom line: Atlantic’s assets generate more than enough cash flow to cover the distribution as well as to pursue new opportunities to boost cash flow even more over time. And that’s the most important thing for investors to keep in mind.

In my view, Atlantic is cheap because it’s up to now been a largely unknown quantity, and that’s changing quickly. The shares have appreciated sharply in the weeks since the October 13 conversion announcement. The NYSE listing should narrow the gap further. Whether an investment company like Atlantic will wind up with a utility-like yield is unknown. But as long as its results are sound, the stock looks headed for at least a low teens price next year. Meanwhile, my buy target for those who don’t yet own Atlantic Power Corp is now USD11.

Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF) has yet to announce a post-2010 dividend policy. But with third-quarter distributable cash flow surging 15.9 percent and covering the distribution itself by a 2-to-1 margin, there should be plenty of room to pay a hefty one.

Meanwhile, the current yield of nearly 11 percent and share price of just 83 percent of book value indicates a very low bar that should be easy to beat.

As in the US, the rural phone business is a steady one that generates lot of cash. The core of Bell’s business is still basic phone service, which continues to lose customers as it has for several years. The third-quarter annualized loss rate of 4.9 percent, however, is a clear sign the unraveling is not happening quickly, leaving the company plenty of time to up-sell to Internet and entertainment services.

Overall web revenue rose 11.1 percent in the third quarter as the company boosted customer rolls by 7.1 percent. And the company continued to advance its broadband and business market efforts with acquisitions and fiber-to-the-home partnerships with provincial governments.

Management has said it plans to give more detail on its 2011 plans in February, when it announces fourth-quarter and full-year 2009 earnings. In the meantime, Dominion Bond Rating Service has confirmed the ratings on its subsidiaries, with the expectation that the “financial profile will remain stable and strong for the remainder of 2009 and 2010 with healthy levels of free cash flow” giving them “the ability to boost distributions to their ultimate parent Bell Aliant or to further reduce their debt as it matures.”

That’s a healthy prognosis no matter what management decides to do with the distribution. Bell remains a buy up to USD28 for those who don’t already own it.

Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF), like High Yield of the Month and new Portfolio addition IBI Income Fund, has been challenged by a pullback in new construction projects in the private sector. Also like IBI, however, it’s held profit margins high through successful cost controls and has kept backlog steady by increasing its share of government and large institution-sponsored projects.

Third-quarter revenue slipped 14.5 percent, primarily on a decline in energy patch projects from year-earlier levels. But income before taxes nonetheless rose 7.1 percent. Moreover, backlog was again boosted above CAD1 billion, a good sign that the summer quarter will prove the low point for this cycle.

That’s a good sign for the monthly distribution of CAD0.15 per share, which has been raised twice since the trust tax was announced on Halloween 2006, most recently by 24 percent with the July 2009 payment. So is the coverage ratio of more than 2-to-1 in the third quarter.

In its third-quarter earnings release, Bird’s management affirmed the current distribution rate through the March 19 payment. Beyond that, however, it’s saying little about its plans. The third quarter 2009 MD&A statement highlights executives’ view that business conditions will remain difficult in 2010, particularly in the industrial market (39 percent of 2008 revenue). That will put increasing pressure on the institutional market (32 percent 2008 revenue) to pick up the slack, and margins could well be lower due to competition. On the other hand, there is no long-term debt and the company does maintain hefty cash reserves. 

Ultimately, we’re just going to have to wait and see what management does. But selling at 49 percent of sales–despite tripling over the past year–it again looks like the bar is set low. And that’s a good reason to buy Bird Construction Income Fund up to USD33 if you haven’t yet.

Canadian Apartment Properties REIT’s (TSX: CAR-U, OTC: CDPYF) third-quarter results testify to the fact that boring is often better when it comes to income investments. In fact, the REIT’s results were little different than they’ve been in quarters when the rest of the economy was booming, as management’s ultra-conservative approach again produced modest growth with very little risk to distributions or the balance sheet.

Operating revenue rose 2.8 percent on a 1.5 percent boost in average monthly rents as the residential property owner continued to go about its business of managing its diversified base of high-quality assets. Occupancy remained extremely stable at 98.3 percent, in part because only 7 percent of the portfolio is in hard-hit Alberta. Renewals of leases, meanwhile, resulted in an average rent increase of 2.2 percent for the first nine months of 2009.

Net operating income rose for the 15th consecutive quarter, and funds from operations per unit was virtually the same as a year ago. And the third-quarter payout ratio came in at just 78.4 percent, again virtually identical to last year’s 76.8 percent.

As for debt, the company continues to borrow at rates 150 to 160 basis points below conventional rates, a testament to good relations with bankers as well as focus on quality. Debt coverage was 1.27-to-1 at the end of the third quarter, down from 1.31-to-1 a year ago. And its policy of buying assets at least 50 percent below replacement costs continues to lock in future growth.

The chief drawback of owning Canadian Apartment REIT is that this strategy doesn’t produce rapid growth, even in the best of times. In an environment like this one, however, that’s a small price to pay for sleep-easy safety and a yield of more than 8 percent. Canadian Apartment Properties REIT is a buy up to USD15 for those who don’t already own it.

Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF) is another trust to affirm it will convert to a corporation while remaining vague on what that ultimate payout will be. The key is still how successful it is growing cash flows from the assets the trust has acquired and built over the past several years, and the new projects it contemplates between now and the end of 2010.

Third-quarter results were promising in no uncertain terms. Wind-power production at its two facilities rose 12 percent above its long-term average, while hydro production from its 10 plants was 5 percent above average.

Meanwhile, the payout ratio came in at 95 percent of distributable cash flow in what’s historically been a seasonally weak quarter. Long-term power purchase agreements continued to generate their built-in rate increases and plant efficiency was again strong.

Innergex’ total focus on green energy, relatively small size (market capitalization CAD294 million) and low price of just 1.55 times book value should make it an attractive takeover candidate. Pending carbon dioxide regulation has increased the urgency for major emitters to come up with offsets. Acquiring renewable energy producers is one way to achieve that in one fell swoop. In fact, we’ve already seen one deal: TransAlta Corp’s (TSX: TA, NYSE: TAC) now completed purchase of the former Canadian Hydro Developers.

Speculating on when mergers may occur and at one price is always an uncertain business. My rule is only to hold takeover targets you won’t mind owning even if there’s no deal. That definitely applies to Innergex, particularly with the bar on post-2010 dividends set this low. Buy Innergex Power Income Fund up to USD12.

Just Energy Income Fund (TSX: JE-U, OTC: JUSTF) has stated its intention to convert to a corporation by the end of 2010. Moreover, in the words of CEO Rebecca MacDonald: “The growth we have noted in the (fiscal 2010) second quarter is another step toward our goal of growing our cash flow by the 2011 trust tax conversion date with the expectation that a converted Just Energy would be able to pay CAD1.24 in dividends replacing the more heavily taxed CAD1.24 distribution.”

Nothing will be official until there’s an actual conversion and dividend policy set. Until that happens, however, that’s about as clear a statement of intent regarding post-conversion dividends as you’ll find.

The key question, then, is can the company follow through. The good news: While the future holds no guarantees, the numbers show the odds of success are very strong indeed.

Gross margin–basically revenue less the cost of the energy sold–surged 43 percent in the fiscal second quarter. That pushed up distributable cash flow by 26 percent.

Customer additions through marketing hit a record 140,000-plus and, counting the acquisition of Universal Energy Group, hit 430,000. Distributable cash after marketing costs, which essentially are Just Energy’s equivalent of capital spending on growth, rose 19 percent. That was largely the result of success in the trust’s green energy programs, with nearly half new additions going green.

All this points to management making good on its promises for post-conversion dividends. In the meantime, Just Energy is still slated to pay a special distribution to unitholders of record between CAD0.10 and CAD0.15 per share to “true up” income and limit taxes with the December 31 payment, with an ex-dividend date of December 15. Buy Just Energy Income Fund up to USD14 if you haven’t yet.

Northern Property REIT (TSX: NPR-U, OTC: NPRUF) derives the majority of its cash flows from properties in western Canada, including a large share in Alberta. The commercial property owner, however, actually reduced its third quarter payout ratio to 65.4 percent from 65.6 percent the year before. Revenue and cash flow were also slightly higher as FFO per unit was basically flat at 57.2 cents Canadian.

That’s an extraordinary performance in view of the extreme weakness in several of Northern’s key markets, including Grande Prairie, Lloydminster and Fort McMurray in northern Alberta. And it came in the face of ramped up capital spending, as the REIT took advantage of higher vacancies at some properties to make needed improvements that will boost future profitability.

One reason is diversification. Even as Alberta weakened, Northern’s eastern Canada markets, particularly St. John’s and Gander in Newfoundland, remain very strong. Markets in Nunavut and the Northwest Territories were also insulated from energy market troubles, affirming the wisdom of investment in those markets while others focused only on the energy patch.

Looking ahead, Northern’s ability to weather even the worst of markets means there’s little risk to holding it, even for the most conservative investors. And the REIT’s exceptionally low cost of funds points the way to future growth when the health of the market returns. The company actually cut its average weighted cost of mortgage debt to 4.89 percent from 5.13 percent since the beginning of 2009. The units are up big this year but there’s more to come. Buy Northern Property REIT up to USD22.

Get Up and Grow

Our twin graphs of oil and natural gas prices shows pretty clearly how difficult it’s been to forecast energy markets in recent years. Starting with the spike following hurricanes Katrina and Rita in 2005, prices have been on a literal roller-coaster ride, plunging in 2006, spiking again in early 2008, nose-diving to new lows by early 2009 and finally surging again in recent months.

To say the ups and downs of energy prices have been tumultuous for investors is surely the understatement of the year.

But the stakes for energy producers have been literally life and death, and more than a few trusts and corporations alike failed to survive.

It certainly wasn’t easy sailing for our Aggressive Holdings either. But in stark contrast to the weaklings, all have stayed profitable and–more important–third-quarter earnings demonstrate all are in great shape to get up and grow as economic conditions improve.

Note that Provident Energy Trust (TSX: PVE-U, NYSE: PVX) is highlighted in High Yield of the Month.

Ag Growth International (TSX: AFN, OTC: AGGZF) has had one major advantage over our other Aggressive picks this year: The commodity its fortunes follow is corn, which remains in very high demand in large part due to government mandates for ethanol use in fuel.

Demand for Ag’s grain handling equipment remained extremely robust in the third quarter. The main reason: A corn crop that the US Dept of Agriculture anticipates will be the second-largest in recorded history for 2009 and a soybean crop expected to set a new record. And after massive increases in production capacity over the past couple years, Ag couldn’t be better positioned to meet it.

Third-quarter earnings surged 56 percent increase on a 12 percent boost in revenue and 25 percent jump in adjusted cash flow. Better, with the company expected to enter 2010 with “low levels of inventory,” sales growth should remain robust next year, and even accelerate as international markets return to health.

Third-quarter earnings covered the monthly distribution of CAD0.17 by more than a 2-to-1 margin. That’s plenty to ensure its future, especially since Ag Growth already converted to a corporation earlier this year–without cutting its distribution a penny.

This one has run somewhat this year. But it remains in the neighborhood of where it was when I originally recommended it. And given its still tremendous growth potential, Ag Growth International is still a value up to my buy target of USD30.

ARC Energy Trust (TSX: AET-U, OTC: AETUF) sold its natural gas at an average price of just USD3.25 per thousand cubic foot in the third quarter. Yet it still managed to cover its distribution by nearly 2-to-1, hold debt to just 1.4 times annualized cash flow and continue to invest in its promising portfolio of new and old projects, including in the prolific Montney shale, which it’s developing on time and within budget.

Production held steady even as the trust managed to cut its operating costs from CAD10.19 to CAD9.68 per barrel of oil equivalent. Net debt was cut 8.8 percent, and the trust demonstrated its ability to access capital at a low cost, even amid dire overall conditions for its industry.

And management announced plans to spend CAD575 million on capital projects in 2010, roughly half of which will be allocated to Montney. Enhanced oil recovery initiatives are also promising for keeping output levels stable and costs low.

Like all energy trusts, ARC remains largely at the mercy of volatile oil and gas prices. The ability to generate these kinds of results in such times is simply exceptional, and the biggest reason the unit price has roughly doubled off its March lows. It’s also a testament to management’s commitment to paying distributions, and portends well for when it converts to a corporation, probably at the end of 2010.

ARC’s post-conversion dividend level will depend heavily on where oil and gas prices lie. But given the strong dividend coverage even at this level of energy prices, the trust’s plans to continue developing long-life reserves even as a corporation and the likelihood of higher energy prices ahead, I’m looking for higher dividends in the years ahead. So apparently is Bay Street, which remains strongly bullish on ARC despite its recent run up. ARC Energy Trust is a buy up to USD20.

Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) is another trust whose management has made it clear it expects to pay the same level of distribution in 2011, when it expects to be reorganized as a corporation. That, however, is basically a testament to management’s conservative approach, which has kept the specialty chemicals producer’s head well above water even in the very worst of times.

Demand for the company’s major product, sulphuric acid, remains anemic globally in the face of the worldwide slowdown in heavy industry, despite noticeable sequential improvement in the third quarter from the second. And it’s not likely to get a whole lot better until growth gets considerably stronger.

Nonetheless, third-quarter FFO per share hit CAD0.38, up from CAD0.36 in the second quarter. That was enough to easily cover the monthly distribution rate of CAD0.10 per share as well as the trust’s capital spending needs.

Some years ago, management stated it couldn’t conceive of conditions so dire that it couldn’t maintain the annualized distribution rate of CAD1.20 per share. In fact, given its extensive foreign operations–which aren’t subject to additional taxes in 2011–it continues to assert that it will preserve that rate after 2010.

In fact, at the company’s third-quarter conference call, CEO Mark Davis stated “the effect of the new tax would not be significant” since “Chemtrade receives a large portion of its earnings from non-Canadian sources or in the form of dividends. Accordingly, in 2011 we believe that the new SIFT tax will apply to less than one-third of the Fund’s income, resulting in an effective tax rate of less than 10 percent.” Davis went on to say “the Fund believes that the income trust structure remains desirable and has no current intention to cease being an income trust even after 2010.”

That leaves the economy as the primary risk to the payout. And given the results this year amid the most dire of conditions, odds look good there too. Up sharply from their March lows, Chemtrade shares still yield nearly 12 percent and sell for just 46 percent of sales. That’s still a solid deal. Buy Chemtrade Logistics Income Fund up to my new target of USD10.

Enerplus Resources Fund (TSX: ERF, NYSE: ERF), like ARC, also appears to have bomb-proofed itself against today’s low energy prices. Despite an extremely steep drop in realized selling prices–the trust sold natural gas on average for less than USD3 per thousand cubic foot–distributable cash flow covered the monthly distribution of CAD0.18 by better than 2-to-1. In fact, dividends and capital spending during the quarter were only 68 percent of distributable cash flow and 73 percent for the first nine months of 2009.

That’s left the trust in the strongest financial shape of any company in the sector. Net debt-to-cash flow, for example, is by far the lowest at just 0.7-to-1. And that’s despite the fact that management continues to pursue new developments throughout North America, including a newly acquired project in the Marcellus Shale region of the US. The company plans to use its excess cash to ramp up this development in the next few quarters, laying the groundwork for future prosperity.

Enerplus was among the first oil and gas trusts to declare its intention to convert to a corporation in late 2010 as well as to state its plans to “balance” the future level of distributions with capital spending for growth.

That’s basically the same strategy it’s had since inception more than two decades ago, and it’s something management should be able to stick to, given the trust’s continued focus on long life reserves.

That leaves energy prices as the primary variable for future dividends, just as it is for every other producer trust.

The good news is realized third-quarter selling prices for both oil and gas were well below current prices, auguring for better cash flows going forward.

That’s no guarantee management will hold the current rate when new taxes kick in. But coupled with last quarter’s solid coverage in the worst circumstances, it bodes well for a generous payout, even as Enerplus’ units continue to sell for barely half the last assessment of the value of its assets in the ground.

If we’ve learned nothing about oil and gas producer trusts over the past several years, it’s that you’ve got to be prepared for the effects of volatile energy prices on dividends. In my view, however, no trust is simultaneously better prepared for another dip in energy (however unlikely) and a more likely rebound. That makes Enerplus Resources Fund my favorite energy producer trust and a buy for even the more conservative up to USD25.

Paramount Energy Trust’s (TSX: PMT-U, OTC: PMGYF) third-quarter payout ratio came in at just 30.7 percent of funds from operations. The trust also managed to reduce its net bank debt by CAD23 million to CAD295.5 million and completed the acquisition of junior oil and gas producer Profound Energy, boosting its productive capacity by 10 percent and reserves by 15 percent, despite the opposition of certain Profound shareholders.

That’s a busy quarter for any trust. But it’s a particularly remarkable one considering 100 percent of Paramount’s output is natural gas. Not only did gas prices average 67 percent less than the year ago quarter, but the trust actually shut in nearly 20 percent of output due to those low prices. The result was average production for the quarter that was just 83 percent of third quarter 2008 levels.

Coupled with an increase in outstanding units, the result was a 23 percent decline in output per unit. And production has taken another hit in the fourth quarter as well, as Alberta regulators have ordered the shut-in of wells located on top of potential oil sands reserves, pending a full review.

Cost controls played no small role in Paramount’s ability to weather these conditions. Aggressive hedging of sales played an even larger one, as the trust’s average realized price for gas of CAD7.51 per thousand cubic feet was only down 14 percent from last year’s selling prices and two-and-a-half times prevailing spot prices. That performance was no accident, as management has locked in prices for a growing percentage of output in recent years to cope with an increasingly uncertain price environment.

My primary reason for recommending Paramount now is as a vehicle for riding a rebound in gas prices. That’s still the main reason for anyone to hold it. But without management’s ability to manage cash flows in this environment to maintain production and distributions while systematically cutting debt, the trust would have been toast long ago. And no one should own it without the understanding that a misstep could be fatal. Paramount Energy Trust remains a buy up to USD5–but only for those willing to live with the considerable risk for the promise of a triple down the road.

Peyto Energy Trust’s (TSX: PEY-U, OTC: PEYUF) fortunes are also closely tied to natural gas prices, with the fuel 84 percent of its total output. The nature of its reserves, however, make it a far less aggressive play on gas than Paramount, namely a 17-year reserve life for proven reserves and the lowest production costs in the industry.

Peyto’s third-quarter earnings clearly reflected the downside of tumbling natural gas prices. Realized selling prices for the fuel were 35 percent below 2008 levels at USD5.74 per thousand cubic feet, as hedging somewhat offset the impact of falling spot prices. Management restricted output in the face of falling prices, pushing down overall output 11 percent. The result was a 44 percent drop in FFO per share, driving the quarterly payout ratio to 93 percent.

There was some real good news in the report, mainly continued progress with the company’s Cardium play and other projects to lift reserves and future output. Cardium has shown success both with traditional vertical drilling and horizontal drilling. Both are specialties of Peyto, which operates the vast majority of its own production.

Management now expects “building new production in 2010 may be even more efficient than that demonstrated in 2009 and should deliver growth in production throughout the year.” It also expects to be able to fund capital spending for this growth without accessing the equity and debt market. The trust also reported progress with its hedging program, locking in higher prices as gas prices have risen in recent weeks.

Historically, payout ratios of 90 percent or higher for oil and gas producer trusts have been the harbinger of dividend cuts, unless brought dramatically lower in a hurry. In Peyto’s case, cost reductions, higher output and some recovery in gas and oil (realized third-quarter selling price USD47 per barrel) should boost fourth-quarter cash flows. But until the payout ratio comes down, the distribution should be considered at some risk despite the trust’s underlying long-term strengths.

Looking ahead to 2011, CEO Darren Gee stated in the third quarter conference call that “it doesn’t appear at this point that there are really enough pros and far too many cons to stay as a trust” and “as it stands now, we’re currently on a schedule pending all the necessary approvals to convert back to a corporation by the end of 2010.”

As for the dividend, Gee not surprisingly asserts “a lot of it depends obviously on natural gas prices.” However, he goes on to say that “assuming that we get what the current forward strip beyond 2010 or for 2010 is offering and assuming our (drilling) results…I don’t see us having a big problem being able to fund both the capital program and the current level of distributions.”

That’s in effect not only an affirmation that Peyto will maintain its distribution in the near term despite its currently high payout ratio. It’s in fact something of an affirmation that management expects to be able to convert to a corporation without cutting its distribution, at least as long as the forward curve for natural gas prices stays more or less in its current range.

Should that prove to be the case, it would almost certainly trigger a windfall gain for Peyto Energy in 2010. But even if gas prices don’t cooperate, the trust is likely to beat the bar of expectations, given that its market value is only a little more than half its net asset value. The bottom line, though Peyto has more than doubled since its March lows, is that there’s still a lot more upside left in this one, which still trades at barely half its mid-2008 peak. Peyto Energy Trust is a solid buy up to USD12 for those who don’t already own it.

Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) has been the top performing oil and gas trust the past several years, both in the market and as a business, for several reasons.

First, it’s the only trust with a truly global business. Only 37 percent of third-quarter output in barrels of oil equivalent was produced and sold in Canada. The rest came from company wells in France (27 percent), the Netherlands (11 percent) and Australia (25). As a result, 38 percent of output was sold into the European market and 25 percent into the Pacific Rim, where natural gas prices in particular have remained much higher and more stable than in North America.

During the third quarter, for example, natural gas prices averaged just USD3.03 per thousand cubic feet. In France, however, they were USD7.26, while in the Netherlands they were USD6.73. Realized oil prices company wide, meanwhile, were USD70 per barrel, as opposed to an average price of less than USD64 in Canada.

Production outside of North America will be further increased by the now completed acquisition from Marathon Oil (NYSE: MRO) of an 18.5 percent interest in the Corrib Field, located off the northwest coast of Ireland. The project will be developed and operated by Super Oil and 45 percent owner Royal Dutch Shell (NYSE: RDS-A) and Statoil Hydro ASA (NYSE: STO), which holds a 36.5 percent ownership interest.

The project is expected to produce up to 60 percent of Ireland’s gas at peak supply and will add approximately 9,000 barrels of oil equivalent per day to Vermilion’s output. That’s a boost of nearly a third from the trust’s current level when the project begins producing gas, projected for the end of 2011.

Coupled with cost controls, Vermilion was able to hold its third-quarter payout ratio down to just 59 percent. And despite an aggressive capital spending program–which management expects to be between CAD285 and CAD330 million in 2010–net debt-to-cash flow was just 1.20-to-1. Cash flow essentially covered distributions and capital expenditures outside of the Corrib project.

The second great advantage of Vermilion is its ability to absorb 2011 taxation, thanks to generally low debt levels and the fact that some 70 percent of current cash flow is realized outside of Canada and is therefore not subject to the tax. The sale of the company’s 42 percent stake in exploration and production company Verenex Energy (TSX: VNX, OTC: VRNXF) to the Libyan government promises to add another CAD133 million to the company’s coffers, further increasing financial flexibility.

Even with those advantages, energy prices will play a big role determining whether management can live up to its stated goal “to maintain current distribution levels” after converting to a corporation at the end of September 2010.

Also, management maintains it has numerous other projects in Canada, Australia and Europe to ramp up production, but the success of the Corrib investment will nonetheless be critical.

Nothing is a sure thing in the world of producing oil and gas. And Vermilion is pricier than its rivals at more than three times book value. But for those in search of a high-percentage energy play that will increase distributions over time, you won’t go wrong with this one. Buy Vermilion Energy Trust up to USD30 if you haven’t already.