Canada’s economy in January grew at its fastest pace in three years, a much stronger than expected 0.6 percent, the fifth consecutive monthly increase.

Housing, manufacturing, construction and wholesale trade were all key drivers, prompting economists to forecast annualized growth of up to 6 percent for the entire first quarter of 2010. Unemployment, meanwhile, fell again in February to 8.2 percent, from 8.3 percent the month before.

Canada’s robust numbers stand in stark contrast to the as-yet lackluster growth in the US, where the recovery remains heavily dependent on government spending. So does a year-over-year increase in Canadian housing prices of 7.5 percent, which continues to underpin a healthy banking system. Canadian banks universally turned in top-flight earnings in the fourth quarter and forecast strong growth for 2010 as well.

The Canadian dollar has been a major beneficiary of the country’s relative strength. Since the beginning of the year, the loonie has surged from a value of 95 US cents to near parity. With the Bank of Canada likely to end its quantitative easing sooner rather than later, those gains will mount, boosting the US dollar value of Canadian investments and distributions.

Even in local currency terms, the Canadian market has outperformed the S&P 500 this year; including the Canadian dollar’s rise it’s doubled the blue chip US index’ gains.

Best of all have been the returns posted by trusts announcing basically pain-free conversions to corporations, eliminating uncertainty as they become an entirely new breed of high-yield investment.

Last month, FutureMed Healthcare Income Fund (TSX: FMD-U, OTC: FMDHF) announced it will cut its distribution by 27 percent when it converts to a corporation on Jan. 1, 2011. But Portfolio picks Bird Construction Income Fund (TSX: BDT-U, OTE: BIRDF), Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) and Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF) all stated they’ll hold their current dividends when they start paying taxes.

So did A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF), Enbridge Income Fund (TSX: ENF-U, OTC: EBGUF), Northland Power Income Fund (TSX: NPI-U, OTC: NPIFF) and North West Company Fund (TSX: NWF-U, OTC: NWTUF).

Meanwhile, Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF) resumed its special distribution of CAD025 per unit, complementing its regular rate of CAD0.50 per. And despite weak business conditions and investor speculation to the contrary, Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF) CEO Joseph Randell says he sees “no compelling reason to convert” until late 2010 and that the current distribution is “sustainable” even if Jazz switched to a corporation later this year.

That’s a 9-to-1 edge for no-cut conversions last month. More than a few trusts still must announce their plans for 2011–including several Portfolio picks–and some will likely cut distributions. For one thing, prospective taxes vary, and some companies won’t be able to cover them without sacrificing long-term growth and even viability.

It’s clear, however, that as far as management decision-making is concerned, the tide has shifted in favor of preserving as much distribution as is feasible. That means more companies will beat expectations for post-conversion dividends, setting the stage for windfall gains.

As I pointed out in last month’s Feature, what we’ll have then is an entirely new class of high yielding equities, paying monthly and quarterly dividends averaging 8 to 12 percent based on current prices and backed by healthy and growing businesses. Management of this new class has already proven its ability to weather the toughest of market conditions and its willingness to pay dividends that exceed anything on the US side of the border.

US investors in retirement accounts will get an added bonus as conversions to corporations eliminate the 15 percent Canadian withholding tax. As corporations, these companies will again resume dividend growth. And those yields are hedged against inflation as well, as they’re paid in the oil-price-following Canadian currency. Energy-producer dividends will rise even faster, as oil and gas prices pick up steam.

Sound too good to be true? In some cases it will be. That’s why Canadian Edge continues to play the role of skeptic, focusing each quarter on the business numbers to weed out the weak. The good news is Portfolio companies are steady and poised for more solid numbers in 2010 and beyond. But rest assured, we’ll be discarding any that falter. And the next opportunity to separate the bad and ugly from the good is coming up fast: First-quarter reporting season begins later this month.

Below is the Executive Summary of the April issue. If you have questions about anything related to Canadian Edge, please drop us a line by clicking the “Contact Us” link at the top of the page.

Portfolio Action

Once again, there are no changes to the Canadian Edge Portfolio. All recommended companies have reported solid fourth-quarter and full-year 2009 earnings that support current distribution streams. They also point the way to strong results in 2010, for which we’ll get our initial indication of performance when first quarter numbers are released starting later this month.

This month, I review earnings for the following Conservative Holdings:

• Atlantic Power Corp (TSX: ATP, OTC: ATLIF)
• Artis REIT (TSX: AX-U, OTC: ARESF)
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF).

I also review the following Aggressive Holdings:

• Ag Growth International (TSX: AFN, OTC: AGGRF)
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)
• Provident Energy Trust (TSX: PVE-U, NYSE: PVX).

Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) and Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) are reviewed in High Yield of the Month.

Our focus remains on wealth building, with the distribution front and center. Even the strongest company’s stock will take a hit when the market does. And many CE selections have declined in the face of profit-taking as well in recent weeks. The good news is this kind of setback is always reversed, so long as a company’s underlying business is sound. That’s why I always recommend rolling with this kind of volatility, so long as the numbers continue to support us.

Finally, Innergex Power Income Fund has now completed its merger into Innergex Renewable Power. Unitholders should now hold 1.46 shares of the new company for every unit of the trust they held.

High Yield of the Month

April’s High Yield Of The Month entries are two trusts that announced cut-less conversions last month: Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) and Paramount Energy Trust (TSX: PMT-UY, OTC: PMGYF). That’s where their similarities end, however.

Conservative Holding Bird is an extremely steady construction company with a list of blue-chip private and public sector clients across Canada. Its cash flow proved itself resistant to recession over the past couple years, and its payout is well protected, even as there’s basically no debt on its balance sheet. Buy up to USD33.

Aggressive Holding Paramount, in contrast, is heavily leveraged over the long term to natural gas prices, though it’s managed to factor out this risk in 2010 by aggressively hedging on the forward price curve. Its yield is lofty at 12.4 percent and could go a lot higher if gas prices rebound. Buy up to USD5.

Those seeking safety are better off with Bird Construction Income Fund.

How They Rate

How They Rate has automatically updated US dollar unit/share prices, dividend payment rates in US dollars, yields, most recent dividend dates, dividend frequency and debt-to-capital ratios. Information on trust conversions is included in a separate table, accessible in the Income Trust Tax Guide. We’ll be updating this information regularly as new conversions are announced. Information on US taxation of How They Rate companies will now be included in the table on a regular basis.

CE Safety Ratings are based on six operating and financial criteria. Companies meeting all six criteria are rated my highest rating of “6.” “0” is the lowest rating, indicating companies that meet no safety criteria. Safety criteria are described in the text below the How They Rate table and are as follows:

• One point if the payout ratio meets “very safe” criteria for the sector.
• One point if the payout ratio is not “at risk” based on the criteria for its sector.
• One point if the debt-to-assets ratio meets “very safe” criteria for the sector.
• One point if the company is already organized as a corporation, a qualifying REIT (no change to tax status in 2011) or has clarified its dividend policy for when it converts to a corporation.
• One point if the company’s primary business is recession resistant. Qualifying varies from company to company, though virtually all Electric Power and Energy Infrastructure companies qualify, while no Energy Services companies do.
• One point if the company’s profitability is not directly affected by changes in commodity prices.

I list trusts, funds 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.

Advice Changes

Here are advice changes. See How They Rate for other changes in buy targets.

Dynasty Strategic Yield (TSX: SYNSTYDICN)–SELL. The former DiversiTrust Income Fund has now been merged into a much larger open-end fund at a ratio of 0.835 shares per unit of the former closed-end fund.

Former unitholders are slated to receive a cash distribution of 8.5 cents Canadian, payable April 12 from the fund’s manager Goodman & Company. The fund should be a first-rate performer, as the closed-end fund was, and should continue to be held by Canadians. It holds a mix of Canadian corporate bonds, cash and high-yielding equities.

US investors, however, may have trouble holding the fund due to Securities and Exchange Commission regulations and should sell their shares on the Toronto Stock Exchange when possible. To contact Goodman, call 866-977-0477 or write to Goodman & Co Investment Counsel Ltd, 29^th Floor, 1 Adelaide Street East, Toronto, Ontario M5C 2V9. For more information on Dynamic, visit www.dynamic.ca.

Innergex Renewable Energy (TSX: INE, OTC: INGXF)–Buy @ 10. The merger between the former Innergex Power Income Fund and Innergex Renewable Energy is now complete. Former unitholders should now have 1.46 shares of INE for every unit they once held of the now merged IEF-U. Former fundholders should also have received a dividend of 7.946 cents Canadian in cash, the pro-rata amount of the original trust distribution.

Henceforth, Innergex will pay a monthly distribution at an annual rate of CAD0.58 per share, a rate equivalent to 85 cents a share for unitholders based on the merger’s exchange ratio.

Ratings Changes

There are more CE Safety Rating changes than usual this month, owing to the number of conversion announcements and earnings reports. Most months will see far fewer changes.

Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)–4 to 5. Management has declared its intent to convert to a corporation and hold its distribution steady. That earns it a point, as well as mention as a High Yield of the Month for April.

Bonterra Oil & Gas (TSX: BNE, OTC: BNEFF)–2 to 3. The primarily oil producer boosted its distribution 16.7 percent, brought down its payout ratio and reported solid reserve numbers as well. Distributions will rise and fall with oil prices, so this is as high as its rating is likely to go.

Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF)–0 to 1. The oil services trust is converting to a corporation, but don’t count on any dividends to be paid soon, if ever.

FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)–2 to 3. A drop in the payout ratio based on fourth-quarter results earns the trust a one-point boost.

Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)–1 to 2. This trust is still heavily leveraged to natural gas prices, but it has clarified it will hold its distribution steady after converting to a corporation later this year. That earns it an additional point in the CE Safety Rating System.

Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)–1 to 2. A big drop in the payout ratio earns this primarily natural gas producer an additional point in the Rating System.

Westshore Terminals Income Fund (TSX: WTE-U, OTC: WTSHF)–2 to 3. A 5 percent distribution increase and new contract for metallurgical coal handling signal more reliable dividends.

Feature

Oil and gas producer trusts have enjoyed a mighty run since early March. But the industry, by and large, remains extremely cheap, with many trusts selling well below the value of their assets in the ground.

Oil producers are enjoying rising cash flow and passing more of it along via higher distributions. Natural gas-weighted producers, however, are still struggling with low spot prices and are preserving cash flow by hedging far out on the forward price curve. Alberta is again changing its royalty structure, this time for the better to encourage production. And it’s crunch time for trusts converting to corporations that must decide now what kind of company and investment they’ll be in coming years.

In short, oil and gas is a sector rife with opportunity as well as risk. Here’s our plan for navigating it.

Canadian Currents

A couple names in the How They Rate Oil and Gas coverage universe merit a little extra scrutiny; one sports a tantalizing yield but rates a hold, the other has a solidly conservative operating profile, and both have records of long-term success.

Here’s the low-down on why they don’t quite fit the Portfolio bill–and what may change to alter the perception they don’t belong.

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—FutureMed Healthcare Income Fund (TSX: FMD-U, OTC: FMDHF) will reduce its distribution by roughly 27 percent when it converts to a corporation on Jan. 1, 2011. That’s the amount management expects to incur in taxes and, while larger than I expected, it still leaves plenty of room for growth while preserving a sizeable yield.

More impressive, however, is the decision by nine distribution paying trusts to hold their payouts steady in the face of the new taxes. I review Portfolio picks Bird Construction Income Fund (TSX: BDT-U, OTE: BIRDF), Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF) and Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF) elsewhere in the issue as noted above. I highlight the following in the Dividend Watch List:

• A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF)
• Enbridge Income Fund (TSX: ENF-U, OTC: EBGUF)
• Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF)
• Labrador Iron Ore Royalty Income Fund (TSX: LIF-U, OTC: LBRYF)
• Northland Power Income Fund (TSX: NPI-U, OTC: NPIFF)
• North West Company Fund (TSX: NWF-U, OTC: NWTUF).

Bay Street Beat–How the Canadian analyst community views trusts, including our favorite trusts.

The Last Word on Withholding and IRAs–Here it is: The straight dope, uncolored by hope, driven only by what the actual words in the legislation, accompanying explanations and basic ideas about government grabbing its share.

More Information

The following is a regular repeat from prior issues.

Whether you’re a veteran reader or a newcomer, I encourage you to take a moment to navigate the Canadian Edge website, which includes a wealth of information not included with the downloadable monthly “pdf” version. One of the most useful features is our live quote feed in How They Rate for US dollar prices, distributions and percentage yields of trusts and high-yielding corporations. Note that our quote service sometimes includes special annual distributions along with the regular monthly payments.

Clicking on the Toronto symbol (suffix “.UN”) will take you to the website of our Canadian partner, Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8), which includes price charts and access to press releases.

If you click on the US symbol you go immediately to a chronological listing of every Canadian Edge and Maple Leaf Memo article in which that trust has been featured. You can also use that page to access articles on other trusts by typing in the relevant exchange and symbol in the “Search Query” box at the top of the page.

For questions and comments, drop us a line at canadianedge@kci-com.com. Check out the Toronto Stock Exchange Web site 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 our 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.

How They Rate can now be accessed several places on the home page. The Income Trust Tax Guide has backup to file distributions as qualified dividends. Eye on Trusts and How They Rate are accessible via the shaded box in the middle column.

Roger S. Conrad
Editor, Canadian Edge