Underlying business strength was the key to surviving the bear market and riding the recovery that began in early March 2009. And it’s the key to hurdling the Canadian markets’ biggest challenges for 2010: maintaining strong business results while successfully navigating the rising tide of trust conversions to taxable corporations.

The final numbers for 2009 are a 65 percent total return for the Conservative Holdings and a 66 percent return for the Aggressive Holdings. Those figures are basically in line with the 65.5 percent total return registered by the S&P/Toronto Stock Exchange Income Trust Index (SPRTCM). Returns for US investors were also helped by a roughly 16 percent gain in the Canadian dollar versus the US dollar.

Will our picks repeat their fine 2009 performances in 2010, or is there a day of reckoning pending? The answer lies in the outlook for individual recommendations.

The Leaders

Several picks returned more than 100 percent for the year. Artis REIT (TSX: AX-U, OTC: ARESF) trounced expectations by continuing to post high occupancy rates and rising rents, even while several rivals in Western Canada real estate were going belly-up.

This month, the REIT further demonstrated its strength by reaching agreements to buy 50 percent of a Vancouver office building, an industrial property in Saskatchewan, retail property in British Columbia, and a flexible industrial property in Edmonton, Alberta.

The total cost of the four acquisitions was CAD72 million, mainly financed by CAD50.6 million in proceeds from a successful unit offering. The Kincaid building in Vancouver is 100 percent occupied by Eastman Kodak (NYSE: EK) under a 10-year lease slated to expire in 2019, with a rent step-up in 2014. The other properties are also 100 percent occupied by credit-worthy tenants under long-term leases.

These deals will all immediately add to distributable cash flow. They also include rents 15 percent below market, one of Artis’ trademarks and a key to its success in Alberta’s rough property market. The deals also reduce the overall share of Alberta in the REIT portfolio to 45.7 percent. The result is further protection for a yield that’s still near 10 percent. Buy Artis REIT up to USD11.

Bird Construction Income Fund’s (TSX: BDT-U, OTC: BIRDF) 113.6 percent total return for 2009 was part of a dramatic comeback from the 2008 selloff that took shares from a high in the low 40s at mid-year to a low of less than USD11 in early December. Sellers badly underestimated the company’s ability to tack from a hefty reliance on the floundering energy patch to more secure revenue sources, such as government contracts.

As a result, many were shocked when Bird inked enough new contracts and held enough old business to keep its backlog rising last year. And still more were astounded when it boosted its distribution more than 24 percent in May.

The cancellation of a delayed contract in the oil sands region demonstrates the tough conditions still facing construction in the energy patch, and will shave CAD107 million from backlog in the fourth quarter of 2009.

A pair of new contracts in Ontario announced in early January, however, will add back some CAD70 million, while a third in British Columbia will add CAD41 million. Moreover, all three contracts are with quasi-government entities, ensuring costs will be paid even if the economy should unexpectedly weaken again. Together, they more than offset the lost revenue from the oil sands projects and again demonstrate the company’s flexibility.

Bird has yet to reveal plans for dealing with 2011 taxation. But with a very low payout ratio of just 45 percent, a steady business backed by a near-record backlog and no debt, it definitely has the means for a cut-less conversion. Meanwhile, Bird Construction Income Fund is a buy up to USD33 for those who don’t already own it.

Just Energy Income Fund (TSX: JE-U, OTC: JUSTF) is the third member of our 100 Percent Club after ringing up a 116.4 percent gain in 2009. Its secret was nothing fancy, just simple execution of its business plan of acquiring customers for its electricity and natural gas retail business and locking in profits with conservative hedging policies.

The company’s two biggest coups last year were completing the acquisition of rival energy retail company Universal Energy and successfully expanding its green energy product throughout North America. Both will continue to push profits higher in 2010 and beyond.

Management has stated it expects to be able to maintain its current monthly distribution rate of 10.333 cents Canadian per share after converting to a corporation, probably later this year. As long as it continues to post great business results in an otherwise tough environment, there’s no reason to doubt. Just Energy Income Fund is a buy up to USD14 for those who don’t already own it.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF) also came in with a 100 percent-plus gain, as management’s strategies beat the broad market and a once-yawning discount to net asset value tightened up a bit.

How the fund will fare in 2010 will depend on the health of the broad Canadian stock market. But with management dedicated to shareholder-friendly principles as never before, EnerVest is a solid fund for those who want to buy a bunch of high yielding trusts and corporations from Canada at once. Buy EnerVest Diversified Income Trust up to USD12.

Not surprisingly, the year’s two biggest winners were a pair of former trusts that have converted early to corporations. Ag Growth International (TSX: AFN, OTC: AGGZF) posted a 122 percent gain on the back of surging demand for its grain handling equipment thanks to near-record and record corn and soybean crops in the US, respectively.

The company should continue to enjoy good fortune in 2010, thanks to robust demand and skillful management of production and inventories. Stock repurchases and additional investments in growth should also prove to be a big plus. Ag Growth International is a bit expensive now but would be back in a bargain range again on dips to USD30.

Ironically, my biggest winner in 2009 was from one of Canada’s worst-hit industries, transport. Even while rivals like Contrans (TSX: CSS, no US symbol) were floundering as they converted late to corporations, TransForce (TSX: TFI, OTC: TFIFF) scored a gain of 152.1 percent by doing little more than holding its dividend, controlling its debt and executing the same business plan it’s had for years: profitably acquiring and consolidating the extremely diffuse Canadian trucking industry.

The late November buyout of ATS Andlauer’s Retail Solutions unit–a division with CAD120 million of annual revenue–is a clear sign this company has maintained its underlying strength amid the absolute worst possible conditions. That’s a good sign TransForce will build on last year’s gains in 2010, as it fights its way back toward its mid-2006 highs in the mid-teens.

The yield of a little less than 5 percent isn’t what it was when TransForce was a trust. But it’s by far the highest and most secure in what’s otherwise been an extremely battered business. And when the North American economy does bounce back, this is one company that’s going to profit very richly. Buy TransForce on dips to USD8 or lower if you haven’t already.

Other noteworthy outperformers in 2009 with gains approximating 90 percent include High Yield of the Month Atlantic Power Corp (TSX: ATP, OTC: ATLIF), RioCan REIT (TSX: REI-U, OTC: RIOCF) and Trinidad Drilling (TSX: TDG, OTC: TDGCF). More important, all three showed every sign of staging another blockbuster showing in 2010, in part by taking advantage of industry weakness.

RioCan spent the early part of the year raising capital at what became increasingly favorable rates. It then suffered a couple of light quarters holding high cash balances while waiting for bargains to appear, which happened in the second half of 2009.

Last month, Canada’s largest owner of shopping centers completed the acquisition of four retail properties totaling approximately 1.2 million square feet.

Three of the four properties are anchored by Wal-Mart (NYSE: WMT) stores, occupying 54 percent of leasable area and contributing 34 percent of rental revenue. The other will be anchored by Lowe’s (NYSE: LOW). The cost of the acquisitions was CAD280 million, or CAD166 million for RioCan, which purchased two on a joint venture basis.

Joint ventures and focusing on anchor tenants are two ways RioCan was able to keep its occupancy rates high despite the slowing North American economy, and even as sometime US partner Kimco Realty Corp (NYSE: KIM) was slashing its distribution. The REIT also announced a deal with Cedar Shopping Centers (NYSE: CDR) to expand in the much-harder-hit US market.

Now able to issue equity capital at the lowest cost in many months, RioCan is likely to keep making more deals in coming months, further expanding its base of high earning assets. That means additional gains on top of what we saw this year. Buy RioCan REIT up to USD19.

Trinidad Drilling’s focus on non-conventional and deep drilling rigs has been its saving grace since the energy markets began crashing in late 2008. Now, with North American drilling rigs operating at some of their lowest capacity levels in history, that’s paid off with still-reliable cash flow and a dividend that’s remained steady now for more than a year.

This month, the company announced it will resume the construction of six contracted drilling rigs that had been delayed because of industry conditions. That’s a stark contrast to the likes of rival Precision Drilling (TSX: PD-U, NYSE: PDS), which is shutting down 38 rigs in Canada and the US.

In addition, the rigs are under five-year, take-or-pay contracts that were unchanged with the resumption of construction. That’s a testament to Trinidad’s focus on credit-worthy clients, as well as on key locations where demand for energy services remains robust.

The first rig’s delivery is expected in the first quarter of 2010, with the rest by the end of the year. The estimated CAD60 million cost of completing the work will be covered with cash already raised, with the customer compensating Trinidad for the cost of temporarily mothballing the projects. That should give a lift to the company’s 2010 earnings, even if overall market conditions stay weak.

Trinidad’s low yield will no doubt turn off some yield-seekers. The company’s strengths, low price (1.05 times book value), and ability to realize geometric gains when the energy patch recovers make it a super play on energy prices for more aggressive investors. That’s why the stock remains in the Aggressive Portfolio. Pick up Trinidad Drilling anytime it trades under my buy target of USD8.

The Laggards

Last year’s worst performer, by far, was Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF). I sold the shares from the Portfolio in November, but not before they had dropped 44.3 percent for the year.

In retrospect, the time to sell Consumers’ was in late March 2009. That’s when the Ontario Energy Board’s compliance office issued a ruling that installation of smart sub-metering systems in residential complexes was not authorized under the Electricity Act, except for condominiums.

The ruling not only slammed the brakes on the growth of Consumers’ recently acquired sub-metering business Stratacon. It also threatened revenue from about half of its existing customers in Ontario. Coupled with the additional debt taken on at high rates to fund the purchase during the credit crunch, the hurt was on Consumers’ profits.

At the time, I felt certain the ruling would be overturned once Consumers’ and industry rivals told their side of the story. That was certainly the impression given by Consumers’ management in its official statements. Unfortunately, after months of deliberations, the case is still unsettled, and Stratacon remains largely in limbo.

At the same time, even the company’s core waterheater operation has been subjected to increasing competition. The result was the September distribution cut to a monthly rate of 5.4 cents Canadian from a prior 10.75 cents.

Since I unloaded Consumers’, the shares have dipped and then rallied somewhat as the company managed to arrange a new credit deal at what appears to be a reasonable rate. Management still maintains that it will be able to sustain the same distribution rate after converting to a corporation sometime in 2010; the payout ratio–even in a dismal third quarter–came in at just 65 percent.

That looks pretty good. On the other hand, this company still faces some pretty tough challenges in all of its major business lines. It’s relatively loaded down with debt, posting a debt-to-equity ratio of more than 390 percent. And management has a bad habit of downplaying risk. I still advise avoiding Consumers’ Waterheater Income Fund, despite the 14 percent-plus yield.

The other two notable underperformers were Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) and Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF), both of which were held to returns in the 12 percent range. That would have been a positively solid showing in most years. In this one, however, it demonstrated a total lack of respect from investors.

In the case of Canadian Apartment, underperformance was wholly unjustified as the REIT has continued to post steady results, keyed by high occupancy and steady rent growth. Last month, Dominion Bond Rating Service underscored that business strength by affirming the REIT’s credit rating, citing its very high occupancy rate and focus on high-quality properties.

The REIT has continued to cover its distribution by a safe margin and has held debt to a low level as well. Bearish opinion on Bay Street–two buys, six holds and four sells–appears to be driven by a lack of enthusiasm for its growth. Interestingly, though, the top analysts have been the bulls.

As I’ve written before, this one isn’t going to make anyone rich overnight. But with a very steady dividend and equally reliable business, it’s a solid yield play. Buy Canadian Apartment Properties REIT up to USD15 if you haven’t yet.

In contrast, there’s good reason for investors to be skeptical of Yellow Pages. After all, this is the trust whose management in late 2006 pledged to “outgrow” its prospective 2011 tax bill and maintain its full distribution. Management also maintained all along that it was a different animal altogether from the US directory companies that went bankrupt in the heat of the credit crunch.

Then in May of 2009, it faced the ignominy of having to cut its payout by 31.5 percent to 6.67 cents Canadian a month. That seemed to confirm all the bad things the critics had been charging since Yellow peaked in late 2007 in the mid-teens and began a plunge to a late February 2009 bottom of barely USD4.

The real irony is that Yellow is indeed a far different animal than the US directory companies. Those companies failed to warm to the promise of the Internet until it was too late, and their print directories became dinosaurs. In contrast, Yellow has been systematically building a web presence since it was spun off from BCE (TSX: BCE, NYSE: BCE) and then spun out from Bain Capital in 2002. Today, it owns the top three directory websites in Canada.

The trust has also continued to make a good business from its print directories. That’s in large part because it’s acquired a de facto monopoly across most of Canada. Management has also learned to control costs, and it’s actually been able to reinforce its print business with its web business, a trick US rivals never learned.

If anything, Yellow’s troubles came about because it got too aggressive trying to build its web business by acquiring the Trader advertising directories, which focus on real estate and automobiles. Advertising in both of these areas crashed and burned during the recession, turning Trader from a projected profit center into a major cash drain.

Trader’s demise ended any hopes Yellow management had of out-earning its 2011 tax burden. That more than anything else triggered the decision in May to trim the payout and to utilize the saved cash to cut into the company’s debt load, which it had rolled up to pay for expansion.

Yellow still likely faces some tough sledding in the Trader business. Fourth-quarter earnings results will be particularly important for what they indicate in this business and whether the company is getting its costs under control. I’ll also be looking for signs that Internet growth is continuing and that the print business is still stable, as well as evidence of debt reduction.

At this juncture, however, it looks like Yellow is succeeding in righting its ship. And as long as the payout ratio stays below 60 percent of distributable cash flow, management should be able to make good on its pledge to maintain the current rate after trust taxes kick in.

That’s clearly not what the market expects, pricing Yellow at a yield of more than 14 percent and at just 55 percent of book value. And it leaves the door open for a huge capital gain when Yellow does convert to a corporation later this year.

This one is not for the impatient, and there is a risk business results will disappoint, despite the fact that this company has already weathered some very difficult conditions. On the other hand, you won’t find any 14 percent yielders with so much to back them up. Buy Yellow Pages Income Fund if you haven’t already up to USD8.

Finally, despite solid showings in 2009, Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) and Newalta Corp (TSX: NAL, OTC: NWLTF) are both still down from where I initially recommended them. That raises the question of whether or not it’s time to pull the plug and move onto something else.

My answer for both is to stick in there. Macquarie declared its intention on Sept. 29, 2009, to convert to a corporation sometime in late 2010. In the meantime, however, it’s reducing its distribution from a monthly rate of 8.75 cents a share Canadian to 5.5 cents Canadian, a cut of roughly 39 percent designed to save money to boost the balance sheet.

The lower rate will produce a payout ratio of 70 to 75 percent of distributable cash flow over the next five years and “is expected to be sustainable for the foreseeable future.” That includes the anticipated impact of “an approximately 29 percent tax on the Fund’s taxable income,” as well as “uncertainty regarding the terms of any future contract” for the Cardinal gas cogeneration facility. Cardinal currently contributes half of Macquarie’s distributable cash flow.

Management’s other goal with this move is to position itself to expand Macquarie’s base of infrastructure assets, the fuel for cash flow to provide dividend increases. If it succeeds, investors will get not only a monthly yield that’s still well over 10 percent, but sizeable capital gains besides.

Units are already up roughly 10 percent from the day before the conversion announcement. I look for a lot more. And there’s always the possibility parent Macquarie will make a takeover bid, which would have to be at a substantial premium to the current price of barely book value to pass muster.

If you already own Macquarie Power & Infrastructure Income Fund, plan to stick with it next year and through the conversion; if you don’t, it’s a buy up to USD8.

Newalta is even more of a test of patience. The company traded as high as USD34 a share back in late October 2006 before entering a prolonged downturn and finally striking bottom at just USD2.50 in late March 2009.

Why did I stick with it when so many others didn’t? Despite hard times in virtually every area of its business, Newalta management continued to build its environmental cleanup and recycling franchise at natural resource and heavy industrial sites throughout Canada.

Even this year, with the oil sands business in the doldrums, drilling at all-time lows in the conventional energy patch, and Canada’s industrial base on the ropes, the company plans for CAD60 million of CAD87 anticipated capital expenditures to be on growth; CAD35 million of that, more than half, will go into the heavy oil business.

Reflecting the tough times in all of these industries, Newalta is funding all of its capital expenditures with internal cash flows. Meanwhile, it continues to look for ways to cut costs, notably the recently completed amalgamation of its businesses to better reflect revenue flows.

After an abominable start to the year–in part a reaction to its conversion to a corporation and subsequent 64 percent dividend cut–Newalta turned in solid returns in 2009. That’s mainly because it demonstrated its ability to survive the worst possible conditions. This year, with commodity prices rising and business improving ever so slowly and steadily, it has an opportunity to produce solid results.

That’s at least what half the analysts who track it expect. And given Newalta’s proven staying power in hard times, I see little risk betting on it, particularly with the stock selling for just 70 percent of book value. Buy Newalta Corp up to USD10, a level I look for the share to hit later this year.

What’s Ahead

What can we expect from the rest of the Portfolio in 2010? The most important clues as always will be found in earnings reports. Here are the projected dates for the next round of announcements, which will include both fourth-quarter and full-year 2009 results.

Oil and gas producers will also be reporting on their reserves around the same time. Note dates can change, and we’ll be updating via Flash Alerts and the weekly Maple Leaf Memo as news comes available.

Conservative Holdings

• AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF)–February 26
• Artis REIT (TSX: AX-U, OTC: ARESF)–February 12
• Atlantic Power Corp (TSX: ATP, OTC: ATLIF)–March 31
• Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)–February 3 (confirmed)
• Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)–February 12
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)–February 5
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)–February 26
• CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF)–March 4
• Colabor Group (TSX: GCL, OTC: COLFF)–February 25
• Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)–February 24
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)–February 12
• Innergex Power Income Fund (TSX: IEF-U, OTC: INRGF)–March 16
• Just Energy Income Fund (TSX: JE-U, OTC: JUSTF)–February 5
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)–February 18 (confirmed)
• Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF)–February 19
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)–March 2
• Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)–March 3
• RioCan REIT (TSX: REI-U, OTC: RIOCF)–February 2
• TransForce (TSX: TFI, OTF: TFIFF)–February 25 (confirmed)
• Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)–February 12

Aggressive Holdings

• Ag Growth International (TSX: AG-U, OTC: AGGZF)–March 16
• ARC Energy Trust (TSX: AET-U, OTC: AETUF)–February 11
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–February 19
• Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF)–March 4
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)–February 26
• Newalta (TSX: NAL, OTC: NWLTF)–March 5
• Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)–March 10
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE)–February 18
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)–March 10 (confirmed)
• Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–March 11
• Trinidad Drilling (TSX: TDG, OTC: TDGCF)–February 26
• Vermilion Energy Trust (TSX: VET-U, OTC: VETMF)–February 12

As noted in the intro, the other major fault line on performance will be how the various trusts handle conversions to corporations. As of now, the fear element is running high that conversions will be disastrous, with steep dividend cuts at best and bankruptcies at worse.

Fortunately, that perception remains at sharp odds with reality. And that definitely includes current and former Portfolio members that have converted early, as shown in “Early Converts.”

As the list of 11 former trusts suggests, management teams pursued widely different strategies for their dividends following conversions.

Six didn’t cut their distributions at all when they converted.

Two completely eliminated their payouts, and the other three made somewhat drastic reductions.

GMP Capital (TSX: GMP, OTC: GMPXF) actually resumed paying dividends in July 2009, but at a third of the pre-conversion rate.

The one thing almost all of them do have in common, however, is they’ve rallied–often sharply–from prices held before conversions were announced.

Those that cut dividends did sell off initially, some quite dramatically. And those that didn’t cut dividends rallied sharply and almost immediately. But once the uncertainty about 2011 taxation was removed, all eventually surged to higher prices.

The only company on the list that’s still trading below its pre-conversion price is Trinidad. But it’s clearly the exception that proves the rule. When Trinidad converted in early January 2008, it cited a desire to grow as the primary reason for cutting its distribution by more than half. Investors initially reacted negatively. But within a few weeks, sellers were more than replaced by buyers who were intent on cashing in on rising energy prices with a premier energy services company.

By the time energy prices peaked in mid-2008, Trinidad was up more than 50 percent from its pre-conversion announcement price. With 2011 uncertainty out of the way, investors were free to focus on the company’s business prospects, which in early 2008 looked clearly unstoppable. And by mid-year, with oil at USD150 a barrel and natural gas in the teens, the shares were back in the neighborhood of the highs hit in mid-2006.

Conversely, the crash in Trinidad shares to a low of just USD1.67 per share in early March 2009 had nothing to do with 2011, but rather with the sharp deterioration in energy market conditions that undermined the entire drilling business. Neither did the recovery we’ve seen off the lows and neither will any future performance by Trinidad or the other stocks in the table.

As for trusts yet to convert, the key to immediate performance is beating expectations, particularly on the dividends. And given the steep drop in the cost of capital to converting trusts that preserve dividends, we’re likely to see more management teams lean that way.

The real beauty here, however, is that as far as long-term returns are concerned, it almost doesn’t matter what management does with the payout. Rather, the most important thing is simply continuing to run a strong business.

There are some examples of trusts whose conversions were simply the latest step in a long downward slide. Most were high-yield sirens that lured investors to destruction. But as the table shows, you won’t find their like on any list of Canadian Edge Portfolio picks, past or present.

As long as a converting trust has a strong business behind it, its value will be recognized. And strong businesses are the hallmark of all of our recommendations, even those we wind up selling.