A Gulf of Mexico oil spill that could be the biggest environmental disaster in history, a growing crisis of confidence in government debt that threatens to engulf Europe, higher taxes and the threat of a double-dip recession: these are the four horsemen that are increasingly roiling the markets.

Canadian trusts and high-yielding stocks haven’t been immune from the downside volatility of recent days. And losses are even greater for US investors, as money has moved into the US dollar and out of the Canadian, just as it did during the crash of 2008.

The most important lesson of 2008 is that as long as underlying businesses stay healthy, stocks will eventually recover, even from the worst imaginable debacle. Strong businesses continued to pay dividends during the last crisis and have made investors whole or nearly so in the 14 months since the market bottomed.

That’s absolutely critical to keep in mind should the selloff of recent days and the panic that gripped the market Thursday afternoon turn into something much bigger, as so many fear. Equally important, each of these four horsemen actually has a positive side–at least as far as high-quality Canadian investments are concerned.

The horrific accident at BP’s (NYSE: BP) deepwater well won’t end offshore drilling, no matter how much devastation it causes. But it will definitely increase the cost of drilling such wells, as governments force companies to employ numerous safeguards to ensure it doesn’t happen again. US authorities, for example, exempted BP from drilling a “relief well” in advance, a step that would have halted the spill.

Higher costs for offshore drilling make development of Canadian oil sands and shale deposits that much more competitive. And they also ensure a higher price for oil in the long term–also good for Canadian energy producers.

The fiscal problems facing Greece and potentially other euro countries are not shared by Canada. The country’s debt-to-GDP ratio is the lowest of any major nation. Moreover, the ruling Conservatives’ budget plan expects a surplus by fiscal 2014-15, and the largest opposition party Liberals have promised not to oppose.

Canada is also growing GDP faster than any other G7 country this year and is expected to in 2011, a forecast that’s already led the Bank of Canada to essentially end the quantitative easing that’s still ongoing in the US.

Investment taxes are going higher next year for upper income Americans, defined as couples making more than USD250,000 a year. The best-case is a boost in the top rate to 20 percent, as proposed by the president. The worst is a reversion to ordinary tax rates, as Senate Democrats have offered. Some analysts have gone so far as to forecast wholesale selling of all dividend-paying stocks as rates rise.

I have my doubts.  But in any case, Canadian income stocks are unlikely to be much affected by higher US tax rates. Mainly, Canadians dominate their ownership, particularly of companies traded only over the counter (OTC) in the US. And taxes on Canadians will drop dramatically as trusts convert to corporations. US IRA investors will also get a tax cut, as Canada drops the 15 percent withholding rate for dividends paid by converted trusts.

The threat of a double-dip recession is by far the most dangerous of the four horsemen. For the past two years-plus, income investors have faced a bifurcated market. On the one hand are US Treasury securities that rally whenever fears of a global downturn à la the late 2008 stir. On the other is pretty much everything else, which rallies when the fear level subsides.

Since early March 2009 it’s been the broad mix of income plays that have held sway. The market behavior of recent days, however, is a pretty clear sign that if there is a double-dip, it will be US Treasuries and the US dollar that again rule the market, with everything else suffering, including most investments in Canada.

How likely is another debacle for global markets? In my view, real catastrophes like late 2008 are only possible if enough investors are leaning in the wrong direction with leverage. That’s certainly not the case today with so many investors either sitting out this market or utilizing such self-defeating strategies as setting tight stop-losses that amount to almost guaranteed whipsaws.

Even if this selloff does accelerate, however, the robust first-quarter earnings our picks and other How They Rate companies are putting up seem to suggest things are moving in an entirely different direction. Moreover, once feared as an impending doomsday, the wave of conversions of trusts to corporations continues to proceed in a benign way, giving birth to a new breed of top-quality, high-yielding corporations on track for robust growth in the years ahead.

Trusts that set very conservative post-conversion dividend policies are still selling off initially. But within days virtually all of them have been pushing new highs. For example, Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)–which announced a post-conversion dividend cut of 35 percent back in March–is up 10 percent from its pre-announcement unit price. Eliminating 2011 uncertainty, it seems, is still bullish, and it remains a powerful catalyst for more gains as 2010 plays out.

As I wrote frequently during 2008, I’m not a fan of “doubling down” on investments in a downturn, no matter how solid the underlying business is. There’s just too much potential to get too emotional–and therefore too paralyzed–to make a move when you have to.

One consequence of a selloff, however, is a better entry price for new investors, or those looking to add to their holdings. My favored strategy for those getting started is to buy the High Yield of the Month selections. The main thing is not to overload on any one security, but to have a balanced portfolio of high-quality investments. That’s how you’ll build wealth over time, as well as weather the worst the four horsemen now rampaging can dish out.

Below is the executive summary of the May issue. If you have questions about anything related to Canadian Edge, please drop us a line by going to www.CanadianEdge.com and clicking on the “Contact Us” item at the top of the page.

Portfolio Action

In stark contrast to fourth-quarter earnings season, first-quarter releases are coming fast and furious. In fact, all Portfolio picks will announce their numbers within the next two weeks.

This month’s Portfolio Update reviews numbers from the following companies. I’ll be tracking the rest in Flash Alerts, with a full recap in the regular June issue. Note that several trusts also announced plans to convert to corporations, along with future dividend policies. 

There are no changes to the Portfolio this month. With markets as volatile and fearful as these, however, it’s critical that readers observe buy targets. Your best bets for new buys, as always, are found in High Yields of the Month.

The following Conservative Holdings are reviewed in this month’s Portfolio Update:

• Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)
• CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF)
• Davis + Henderson Income Fund (TSX: DHF-U, OTC: DHIFF)
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)
• Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)
• RioCan REIT (TSX: REI-U, OTC: RIOCF)
• TransForce (TSX: TFI, OTC: TFIFF)
• Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF).

I also review the following Aggressive Holdings:

• ARC Energy Trust (TSX: AET-U, OTC: AETUF)
• Daylight Resources Trust (TSX: DAY-U, OTC: DAYYF)
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)
• Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE)
• Vermilion Energy Trust (TSX: VET-U, OTC: VETMF).

AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF) and Colabor Group (TSX: GCL, COLFF) are profiled 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. Note Innergex Renewable Energy (TSX: INE, OTC: INGXF) now pays a quarterly dividend, with the next payment likely in June at the rate of 14.5 cents Canadian per share. Trust unitholders should now hold 1.46 shares of the new company for every unit of the trust they formerly held. Also, as noted in last month’s Flash Alert, Provident Energy Trust (TSX: PVE-U, NYSE: PVX) is splitting into two companies in a deal investors will vote on in June.

High Yield of the Month

May’s High Yield of the Month picks are two trusts that have put their 2011 risk behind them.

Food distributor Colabor Group (TSX: GCL, COLFF) completed its conversion to a corporation last year. AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF) plans to make its move on July 1, following a unitholder vote on June 3. Unlike Colabor, AltaGas will reduce its payout to an annual rate of CAD1.32 per share but will continue to pay out monthly. The new rate is on the high side of management’s prior guidance of CAD1.10 to CAD1.40 and still implies a yield of close to 8 percent.

Note that after conversion US IRA accounts will no longer be assessed 15 percent Canadian withholding tax.

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.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Buy @ 5 to Acquired. Parent Boralex Inc (TSX: BLX, OTC: BRLXF) has offered to buy the trust for CAD5 per unit, in the form of a debenture with an interest rate of 6.25 percent, paying out semi-annually on June 30 and December 31.

The exchange ratio is one debenture per 20 units of Boralex Power, with any leftover paid in cash. The debentures will be exchangeable for 5.88235 Boralex Inc shares at the holder’s option and will mature at par value (CAD1,000) on June 30, 2017. That’s a 70 percent premium over the 30-day weighted average price as of May 3.

I’m optimistic for the combined Boralex Inc as a major producer of carbon-neutral electricity in the US and Canada. And a return in its share price to its level of late 2007 would result in a sizeable gain for the debentures. On the other hand, these are likely to be illiquid securities and US investors may have trouble getting quotes.

The vote on this deal is slated for June, and a close is likely later that month. My advice for US investors is to try to sell Boralex Power Income Fund as close to CAD5 per share as possible before maturity. We can always buy the merged company at a later date, which I’ll begin tracking in How They Rate when the deal closes.

Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)–Hold to Buy @ 15. This one looked like it might be out of gas but first-quarter earnings and the 66.7 percent distribution increase indicate there’s more upside for more aggressive investors in this pulp producing company, which has yet to announce a post-conversion dividend policy.

New Flyer Industries (TSX: NFI-U, OTC: NFYIF)–Hold to Buy @ 11. Backlog remains very strong for this maker of advanced busses. And as an income deposit security (IDS) combining equity with a bond (CAD5.53 principal), it’s not exposed to 2011 taxes.

Primaris REIT (TSX: PMZ-U, OTC: PMZFF)–Sell to Hold. First-quarter results show solid growth and have brought the payout ratio down to 87 percent. A major investor has purchased 10 percent of the units, which also adds stability.

Priszm Income Fund (TSX: QSR-U, OTC: PSZMF)–Hold to Sell. Sales fell 8.2 in the first quarter, and same-store sales fell 7.1 percent. That’s a clear sign its brand name restaurants are still struggling as this trust tries to survive.

Ratings Changes

Here are the CE Safety Rating changes for this month.

Acadian Timber (TSX: ADN, OTC: ATBUF)–1 to 2. First-quarter results saw the payout ratio contract again, as cost controls and the prior distribution reduction offset a still weak North American market for timber.

AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF)–5 to 6. One of May’s High Yield of the Month selections has finally announced details of its conversion to a corporation. Not only is the new dividend rate of CAD1.32 per share starting in July safe. But it’s at the high end of the range management set some months ago.

A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF)–4 to 5. First-quarter earnings were extremely robust, with distributable cash per unit rising 14.1 percent as the company’s restaurant brand continues to thrive. The payout ratio of 67 percent backs up management’s claim to be able to hold dividends steady in 2011.

Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF)–4 to 5. Management has released details for its planned conversion to a corporation in late 2010. The dividend cut of 34.5 percent is higher than I expected, but cash will go to building out the company’s fiber network, which is bullish for growth.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–5 to 6. The power trust is being acquired by its parent, which limits risk to changes in the Canadian dollar exchange rate.

Enbridge Income Fund (TSX: ENF-U, OTC: EBGUF)–4 to 5. The payout ratio has come well off previous levels after robust asset growth and the no-cut conversion to a corporation is now set.

Feature

As in the US, the health of transportation stocks is an excellent barometer for the economy as a whole. And with Canadian transports reporting generally robust first-quarter 2010 earnings, the prognosis is good for the Northern Tiger’s overall economy going forward.

There’s also a wide variety of ways to play this massive business, with much of the growth coming from facilitating Canada’s booming trade with Asia

Canadian Currents

2011 is also bringing significant tax changes for Canadians, with potentially profound implications for Canadian Edge Portfolio values. We look at what investors to the North will be facing next year, and how that will affect us in the US as well.

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–For the past several months, the only distribution cuts we’ve seen in the How They Rate universe have been the result of trust conversions to corporations. Some were in fact unavoidable, as businesses were either not strong enough to absorb the new taxes or were paying out very aggressively.

All of the cutters this month, however, did so for a different reason: the desire to keep financial policies as conservative as possible given the panoply of economic and market risks in the current environment. As a result, a lower payout immediately following conversion makes a higher one down the road more likely.

That’s the case for Bell Aliant Regional Communications Fund (TSX: BA-U, OTC: BLIAF), which is reviewed in Portfolio Update. It’s also true of North West Company Fund (TSX: NWF-U, OTC: NWTUF) and Zargon Energy Trust (TSX: ZAR-U, OTC: ZARFF), which are now indicating they’ll make modest payout cuts when they convert in late 2010.

I also review Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF), which boosted its distribution by 42.9 percent last month but simultaneously stated that rate may not be sustainable.

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

Tips on DRIPS–Not many Canadian companies allow US investors to participate, particularly trusts, but there are exceptions.

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