Everyone knows about Major League Baseball; the New York Yankees are among the top five sports franchises in the world. Year-in and year-out, the Bronx Bombers compete for World Series titles. They’ve established a standard that’s easy to measure and from which they rarely wildly deviate. They’re consistent winners.

Below the surface, beyond the House that Ruth Built (can this really be called that?)–in the bushes, if you will–toil aspirants to the Big Leagues, who play in leagues labeled, in descending order from the majors, AAA, AA, A and “rookie league.” For the very young prospects there’s extended spring training and baseball academies all over the world.

Down here–riding buses, eating fast food, sleeping in motels–getting to the majors is all about sustained performance as you move up the difficulty level. Those who top out at AAA or can only just linger as a 25th man or second lefty in the bullpen are often labeled “AAAA” players–not quite good enough for The Show, a little better than most AAAers.

The Canadian Edge How They Rate coverage universe includes more than 150 prospects. Thirty-two of those trusts and high-yielding corporations are represented in the Portfolio, 20 Conservative Holdings and 12 Aggressive Holdings. We also recommend two Fund Alternatives that provide one-stop exposure to Canada and its generous dividends.

Among that roughly 80 percent of the CE universe that hasn’t found a way into or has been banished from the Portfolio lurk a couple companies that merit a little extra scrutiny–primarily because of what their cases reveal about what separates the Portfolio-worthy from the mere contenders.

These companies are at the doorstep of the CE Portfolio for a reason. Their strengths having gotten them close enough to smell or have tasted the coffee, let’s take a look at what’s held them back and whether current circumstances justify a little risk capital.

The best-case scenario is that they’ll overcome the short-term or structural challenges that keep them from exploiting their full potential and become long-term income producers. In other words, we’re not looking for the next Joe Charboneau.   

So Is Dustin Pedroia

The Boston Red Sox second baseman, Dustin Pedroia, has been on what seems a takeoff path from the start: Rookie of the Year, Most Valuable Player, key contributor to a World Series champion. He hasn’t struggled much since reaching Fenway Park in 2006. The next season he was the American League’s top newcomer and led off the Fall Classic with a homerun.

The thing about Pedroia is he’s listed at 5’7”–small, even by second-baseman standards. But he’s managed to overcome his lack of obvious stature with quick hands, patience at the plate, and dedication to fielding his position well–in 2008 he won his first Gold Glove as the best defensive second baseman. Grit and competitiveness drive him to be reliable at bat and in the field.

Though there’s really no way to measure these qualities in a ballplayer, we can–through the CE Safety Rating System–distinguish among and prioritize according to our respective risk tolerance and objective potential investment.

“Small,” as it concerns Avenir Diversified Income Trust (TSX: AVF-U, OTC: AVNDF) and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF), is one consideration that keeps them out of the top ranks of CE oil and gas producers. But it’s just one consideration. Both companies constantly struggle to keep operating and finding, developing and acquiring (FD&A) costs down, but these issues can be managed.

Right now for Avenir the major sticking point–the resolution of which would give it another point under the Safety Rating System and likely earn it a fresh “buy” rating–is that management hasn’t provided a concrete plan for the company’s conversion from an income trust into a corporation.

Avenir was downgraded from a buy up to 5 to a hold a year ago, in the April 2009 issue. At the time, it was in the middle of rationalizing its asset base and had sold a significant piece at a loss. Roger Conrad, writing up Avenir in the April 2009 Dividend Watch List, expressed concern “about the small size of the energy production arm and negative distributable cash flow in the fourth quarter (of 2008) due to restructuring.”

The company still has outstanding receivables from the bio-diesel business it exited in late 2008 and early 2009. Avenir has negotiated a CAD5.5 million securitized note in lieu of one balance but stated that payment is uncertain. Funds from operations for 2009 were up 7 percent, and the annual payout ratio declined 24 percent to 127 percent; FFO for the fourth quarter rose 139 percent, and the payout ratio for the period was down to 56 percent.

Efforts to focus assets have resulted in a natural gas and oil production mix of 53 and 47 percent, respectively; this business accounted for 48 percent of overall revenue, while strong growth in the liquefied petroleum gas marketing segment pushed its share to 48 percent as well. Real estate now contributes just 4 percent to the top line.

According to the CE Safety Rating System, “The final number is intended to be a relative gauge of safety across the trust universe, rather than a point of comparison between various trusts and other investments. Generally speaking, however, trusts with CE Safety Ratings of 5 and 6 are safe enough for income investors of all stripes. You can hold trusts with ratings of 0 and 1, but only as part of a diversified portfolio that includes stocks, preferreds, bonds and funds outside the trust universe.”

Avenir, with a 3, right now is fair-to-middling on the Safety Rating System scale; as soon as it issues a conversion plan, it will pick up a fourth point. Management has guided that a 75 to 80 percent payout ratio “currently remains comfortable. It also has tax pools sufficient to shelter payment of taxes “into 2012.”

The most attractive thing about it right now, from a purely visceral perspective, is the gaudy 12 percent yield. But CE is not about yield-chasing, nor do we engage in short-term speculative trades to benefit from any upside resulting from press releases. We want verification from management that it intends to continue as a high-yielding entity and validation in the numbers that it has the wherewithal to execute.

For the foregoing reasons, Avenir Diversified Income Trust–for now–is a hold.

Zargon Energy Trust is a buy up to 20. It’s a “3” under the System.

Full-year FFO was down 19 percent, though the fourth-quarter figure rose 8 percent. The 2009 payout ratio was 59 percent, while for the fourth quarter it was 56 percent. Overall production expenses were up 19 percent from 2008 to 2009 on the acquisition of higher-cost gas properties; oil production costs actually came down year over year.

Zargon’s shortcomings–mainly its size–are balanced by a low payout ratio and a strong balance sheet that features the lowest debt-to-cash flow ratio in the industry. Management has said it’s shooting for a 35 percent post-conversion payout ratio, which leaves a lot of room for interpretation. Here’s the thing keeping Zargon from a “4” rating and serious consideration for Portfolio inclusion:

Zargon is currently reviewing and assessing this recent legislation and is considering its potential impact on the organization while Zargon’s management develops its strategic plan beyond December 2010, which is the effective date of the new SIFT tax rules. Zargon’s current plans are to convert from its trust structure to a corporation at the end of 2010 or early in 2011. Zargon’s management continues to believe that a partial cash flow distributing model is an effective model to produce conventional oil and gas assets in our relatively mature sedimentary basins, and as such plans to distribute regular dividends under the corporate structure.

One way to read it is as an ambiguous statement; another is to see it in terms of Zargon’s conservative management team, which won’t make a decision until it has to. Zargon is scraping its buy target of USD20 as of this writing; the pattern that’s emerged from previous conversion announcements is that the units will dip then rally strongly. It’s likely–for both Avenir and Zargon–that you’ll be able to pick them up cheaper just after their respective conversion and post-Jan. 1, 2011, dividend policies are concrete.