Last month, Canada became the world’s first major country to raise interest rates coming out of the Great Global Financial Crash of 2008.

The Bank of Canada’s (BoC) increase in its benchmark lending rate from 0.25 to 0.50 percent was hardly dramatic. And banks’ follow-up boosts in the prime lending rate–Bank of Montreal (TSX: BMO, NYSE: BMO) raised from 2.25 to 2.5 percent–still leaves borrowing costs near historic lows.

But the BoC’s move IS a compelling vote of confidence in Canada, particularly as investors fret about a European sovereign debt contagion plunging the world into a reprise of late 2008. And that has major bullish implications for the high-yielding equities we favor at Canadian Edge.

It’s not hard to see why the BoC is upbeat. This week, Statistics Canada reported the country’s economy grew at a sizzling 6.1 percent rate in the first quarter of 2010. That was on top of 4.9 percent fourth-quarter growth–and far exceeded the 3 percent managed by the US economy.

In fact, Canada’s growth of the past two quarters was far faster than that of any other developed nation. Equally remarkable, it’s actually accelerated at the same time Ottawa has begun cutting back on stimulus.

Overall growth in government expenditure slowed to just 0.5 percent in the first quarter, down from increases of 1.6 percent and 1.7 percent in the third and fourth quarters of 2009. Government capital expenditure growth slowed to 1.1 percent, from an average of more than 4 percent over the past five quarters. The contrast with what’s happening in the US and Europe could scarcely be more stark.

What’s setting Canada apart? For one thing, it has an extremely sound financial system. Only half of the country’s mega-banks managed to top Bay Street’s lofty first-quarter earnings expectations. But all reported vastly strengthened capital ratios and profitability, as everything from investment banking to consumer services boomed. Corporate Canada remains reliably conservative and debt-light, as the column “Debt/Assets” in How They Rate attests.

Then there’s the budding relationship with Asia, rooted in natural resource exports but increasingly extending to cross-border investment as well. In US recessions past, Canada practically sank into depression as its sole major export market contracted. This time around, as StatsCan noted in its April report, the recession was “shallow” and did not disrupt “the production and employment cycle.” That’s in large part because it had another major market that didn’t falter, namely developing Asia.

Most encouraging, Canada’s ongoing recovery has extended to almost every sector. Not only are natural resource exports booming, but there’s accelerating production in manufacturing, robust consumer spending, job creation and even a healthy real estate market. Both export and import volumes rose for a third consecutive quarter.

That’s a pretty strong suggestion that this resurgence has legs, and that there are going to be a lot of beneficiaries in corporate Canada.

Given the level of fear in the current market, it’s hardly surprising that few investors are really paying attention to this bullish story. The broad-based S&P/Toronto Stock Exchange Income Trust Index (SPRTCM) is still up for 2010, by 1.8 percent in US dollar terms and 1 percent in local currency.

That’s slightly better than the 1.5 percent loss in the S&P 500. But the SPRTCM is still more than a third off the high set in mid-2006 and briefly visited again in mid-2008. And even the most secure companies’ equities have repeatedly been subject to wild volatility, particularly during last month’s Flash Crash.

Clearly, Canada is still in that “everything else” camp, which is sold off in favor of US Treasury paper every time there’s a doubt about the health of the global economy. And with the “Four Horsemen” of BP’s (NYSE: BP) Gulf of Mexico oil spill, European debt crisis and rising regulation and taxes in the US still raising fears of a “Big W” recession, I fully expect those ups and downs to continue.

As I said repeatedly in late 2008, however, good businesses always recapture lost value in the market place. What happened in 2009 was a good start in restoring values of Canadian trusts and the high-yielding common stocks most are transitioning into. But there’s a lot more ahead for patient investors who buy good companies below my targets–without using self-destructive strategies like stop-losses–and waiting for the inevitable rally/recovery.

Yes, it’s hard to stick to your plan when the market seems to be running off the track on a daily basis and the talking heads are prophesying Armageddon. But buying and holding good businesses is the income investing strategy that stood the test of late 2008. And whatever today’s problems and worries, they’re still not in the same ballpark with the potential collapse of the US financial system, the threat we were most assuredly facing then.

Below is the executive summary of the June issue. If you have questions about anything related to Canadian Edge, please drop us a line at canadianedge@kci-com.com.

Portfolio Action

First-quarter earnings season concluded a couple weeks ago. But the favorable portent the numbers brought for what’s to come is still very much with us. Mainly, all Canadian Edge Portfolio companies came in with solid numbers that were in line with management’s prior guidance. And with the Canadian economy running strong, they’re likely to exceed those expectations the rest of the year and into 2011.

The only change to the Portfolio this month is the addition of Cineplex Galaxy Income Fund (TSX: CGX, OTC: CPXGF) to the Conservative Holdings. Along with fellow High Yield of the Month Just Energy Income Fund (TSX: JE-U, OTC: JUSTF), it’s this month’s best buy. Readers should continue to observe buy targets and not succumb to the temptation to really load up on a favorite.

With fear still running high in the markets, we’re likely to see a lot of volatility as summer wears on. That will keep a premium on patience. But as long as a holding remains solid as a business, it will bounce back from whatever the market throws at it. That’s the lesson of the crash of 2008 and recovery of 2009. And no matter how grave the threats may seem now, it remains true in 2010.

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

• Artis REIT (TSX: AX-U, OTC: ARESF)
• Atlantic Power Corp (TSX: ATP, OTC: ATLIF)
• Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF)
• Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF)
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)
• Innergex Renewable Energy (TSX: INE, OTC: INGXF)
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)
• Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF).

I also review the following Aggressive Holdings:

• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)
• Newalta Corp (TSX: NAL, NWLTF)
• Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)
• Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)
• Trinidad Drilling (TSX: TDG, OTC: TDGCF).

Just Energy and Cineplex Galaxy are reviewed in High Yield of the Month.

Note I continue to advise holding Provident Energy Trust (TSX: PVE-U, NYSE: PVX) though the planned spinoff/merger of its oil and gas production operations. After the split, Provident investors will own shares in two companies. Provident Energy Midstream will continue to trade under the same symbol and will pay the same monthly distribution of CAD0.06 per share, at least through the end of 2010 when it will convert from a trust to a corporation.

Investors will also receive 0.12225 shares of a new company composed of the combined oil and gas production assets of Provident and Midnight Oil (TSX: MOX, MDOEF), an estimated value of CAD1.74 per current Provident unit. The result should be a higher combined value for Provident investors than the current share price of roughly USD7.08 per unit.

High Yield of the Month

In the June High Yield of the Month I feature two more trusts that have put their 2011 risk behind them by declaring no-cut conversions to corporations by the end of the year. New Conservative Holdings addition Cineplex Galaxy Income Fund (TSX: CGX-U, OTC: CPXGF) has been a frequent recommendation in How They Rate coverage since we began covering it several years ago. The aftermath of last month’s Flash Crash has given us a solid entry point in this leading owner of Canadian theaters, which last month also reported robust first quarter earnings.

Just Energy Income Fund (TSX: JE-U, OTC: JUSTF) is well off the lows it hit last month. But the marketer of power and gas to unregulated markets in the US and Canada is still on the bargain rack, paying a yield of nearly 10 percent that management has pledged to maintain after converting to a corporation later this year. Note that both are still withheld 15 percent by the Canadian government. That will end for IRAs when they convert to corporations, triggering what amounts to a 17.6 percent dividend boost for US investors.

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 (see this month’s Feature Article) is included regularly in a separate table in the Income Trust Tax Guide. We’ll update 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.

Additions and Subtractions

This month we’re adding two companies to How They Rate coverage. Note that we’re no longer covering the former KeyStone America, which has now been fully acquired for CAD8 per share in cash by Service Corporation International. We’re also dropping Dynamic Strategic Yield Fund, an open end fund which acquired the former DiversiTrust Income Fund at a ratio of one unit per 0.835 units of the latter.

Also note that several trusts have successfully converted to corporations. The tipoff is there is no longer a “-U” or a “.UN” suffix attached to their TSX symbols. Converted corporations should no longer be withheld 15 percent Canadian tax if they’re held in IRA accounts.

TransCanada Corp (TSX: TRP, NYSE: TRP) joins the Energy Infrastructure group as a buy up to 37. The owner of power and natural gas assets in US is rapidly expanding in both the US and Canada, boosting cash flows and dividends. It’s best suited for conservative growth and income investors.

Westjet Airlines (TSX: WJA, OTC: WJAFF), featured for the first time in the May Feature Article, is the Southwest Airlines of Canada and is also in a rapid expansion mode. It rates a buy up to USD12 for aggressive investors who want to bet on a continued Canadian economic recovery. Westjet will be tracked regularly in How They Rate under Transports.

Advice Changes

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

Avenir Diversified Income Trust (TSX: AVF-U, OTC: AVNDF)–Hold to Buy @ 6. Management hasn’t clearly stated what its dividend policy will be when trust taxes kick in and Avenir presumably converts to a corporation.

But the combination oil and gas producer/energy marketer/real estate company’s cash flows did cover its payout by nearly a 2-to-1 margin in the first quarter, just as it did in the fourth. And after a 34 percent cut, debt is only 10 percent of assets with no near-term refinancing needs.

Finally, the units trade at book value and a massive yield only a bit under 14 percent. That’s pricing in a lot of bad news that’s clearly not in Avenir’s numbers. Note that the company gets a CE Safety Rating of just 2, however, so it’s only suitable for aggressive investors.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–Acquired. Whether you take advantage of the offer by parent Boralex Inc (TSX: BLX, OTC: BRLXF) or elect to sell your units in the market place before the buyout, it will be a taxable event. That should help many investors monetize long-standing losses, as Boralex trades a less than half the levels it held as recently as late 2007.

The offer is attractive for growth and income investors. Each unit will be swapped for a convertible bond with a par value of CAD100 at the rate of 20 units per bond. Anything left over will be paid in cash at the rate of CAD5 per unit. The bonds will pay interest at a coupon rate of 6.25 percent semi-annually on June 30 and December 31. They’ll be exchangeable for 5.88235 Boralex Inc shares at the holder’s option. If not exercised, they’ll mature at par value (CAD100) on June 30, 2017.

At Boralex Inc’s current price of CAD8.80 a share, the bonds’ conversion value is about CAD51.77. That means Boralex shares will have to roughly double from here for these bonds to be worth converting. They did hold that level in early 2008, and I’m optimistic they’ll reach it again.

What I’m concerned about is US brokers being able to effectively track them. As a result, I recommend US Canadian Edge readers try to sell their Boralex Power Income Fund units as close to CAD5 as they can between now and June 28, when Boralex Inc has stated its offer will end. I’ll begin tracking Boralex Inc in How They Rate when the deal closes.

Canadian Natural Resources (TSX: CNQ, NYSE: CNQ)–Buy @ 70 to Buy @ 35. A move of this magnitude in buy targets always merits a comment. In this case, fortunately, the change is due to a 2-for-1 stock split at the company, which took place on May 28.

Essential Energy Services (TSX: ESN, OTC: EEYUF)–SELL to Hold. The company no longer has any long-term debt, and an acquisition of assets last month is a good sign of returning financial stability. There are still better plays on the battered energy services sector, however, such as Aggressive Holding Trinidad Drilling (TSX: TDG, OTC: TDGCF; see Portfolio Update).

First Quantum Minerals (TSX: FM, OTC: FQVLF)–Buy @ 80 to Hold. The copper miner is the latest victim of resurgent resource nationalism, which is apparently reaching the level of expropriation in the Democratic Republic of the Congo.

The government of that country has awarded rights to First Quantum’s Kingamyambo mine to an “unspecified third party.” The company disputed the decision, with the result that the Congo’s Supreme Court has now annulled a letter from the government’s Ministry of Mines granting First Quantum and its partners rights at two other sites.

One of these is the Frontier mine, the company’s second most important asset after the Kansanshi copper and gold mine in Zambia.

If management can defuse the situation, First Quantum shares will bounce back. If not, they could sink a lot more. Only aggressive investors should hang on.

Medical Facilities Corp (TSX: DR-U, OTC: MFCSF)–Buy @ 9 to Hold. Revenues rose for this owner of hospital facilities in the first quarter. So, unfortunately, did expenses, which are now at 67.3 percent of revenue, up from 61.3 percent a year ago.

The payout ratio has also moved up to an uncomfortable 101 percent. That could retrace in the second quarter, which has historically been a better one for the company. Until that’s clear, however, caution is in order.

Swiss Water Decaffeinated Coffee Income Fund (TSX: SWS-U, OTC: SWSSF)–SELL to Hold. This company still faces some severe competitive challenges. And strength in the Canadian dollar is always a threat to upend profits. But a very strong first quarter has brought the payout ratio down to a quite conservative level (38 percent). And, while management hasn’t confirmed a post-conversion dividend policy, the yield seems to be pricing in a great deal of risk.

Ratings Changes

Following is a list of companies whose safety ratings changed last month and why.

Essential Energy Services (TSX: ESN, OTC: EEYUF)–0 to 1. Massive debt reduction earns an upgrade, though the risk profile is still high.

First Quantum Minerals (TSX: FM, OTC: FQVLF)–4 to 1. The politics of resource nationalism have dramatically increased the risk with this company, despite posting some very solid numbers lately.

Medical Facilities Corp (TSX: DR-U, OTC: MFCSF)–4 to 3. A sizeable increase in the payout ratio means the company only meets three CE ratings criteria now.

Swiss Water Decaffeinated Coffee Income Fund (TSX: SWS-U, OTC: SWSSF)–1 to 2. A lower payout ratio lessens the risk for this niche player, though it still faces considerable competitive pressures.

Feature Article

Most income trusts still haven’t converted to corporations. But more and more have announced their intention to do so, as well as what their post-conversion dividends will be. I look at where we stand with completed, ongoing and future conversions, from price performance to what happened to distributions.

My table has the facts on every completed or announced conversion to date where the dividend policy has been set. I also look at prospects for the handful of Canadian Edge Portfolio recommendations yet to set their policy.

Canadian Currents

The Canadian dollar’s exchange value is a very big part of non-Canadians’ investment returns. When the loonie is on the rise against the US dollar, for example, the US dollar value of Canadian investments and the dividends they pay rises. When the loonie falls, the opposite happens.

Happily, the prognosis for Canada’s currency is bullish, thanks to a favorable confluence of factors. CE Associate Editor David Dittman explores these, including a healthier economy, demand for natural resource exports and a stronger overall financial system. And he lays out our bullish forecast for the loonie over the next several years.

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–The only distribution cut last month in the How They Rate universe was a trust that converted to a corporation: Aggressive Holding Daylight Energy (TSX: DAY, OTC: DAYYF). The cut from a monthly rate of CAD0.08 per unit to a monthly dividend of CAD0.05 per share was well anticipated by the market, as Daylight shares are actually up slightly over the past month. It’s also typical of what natural gas-focused energy producers have almost across the board, as they deal with the current weak price environment.

In contrast, oil-focused producers have held distribution steady, and even raised them with conversions. I discuss why I’m still bullish on Daylight. I also look at how the other How They Rate companies on our Watch List fared with first-quarter earnings:

• Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF)
• Consumers’ Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF)
• FP Newspapers Income Fund (TSX: FP-U, OTC: FPNUF)
• InnVest REIT (TSX: INN-U, OTC: IVRVF)
• InterRent Properties REIT (TSX: IIP-U, OTC: IIPZF)
• Phoenix Technology Income Fund (TSX: PHX-U, OTC: PHXHF)
• Primaris Retail REIT (TSX: PMZ-U, OTC: PMZFF)
• Royal Host REIT (TSX: RYL-U, OTC: ROYHF)
• Swiss Water Decaf Coffee Income Fund (TSX: SWS-U, OTC: SWSSF)

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

The Withholding Vanishes–Here’s what US IRA investors can expect to see for their holdings in Canada per the Fifth Protocol of the US-Canada Tax Treaty.

When Brokers Say No–A certain brokerage is claiming US investors aren’t allowed to buy AltaGas Income Trust (TSX: ALA-U, OTC: ATGFF). Consistent five-digit share volume under the symbol ATGFF alone demonstrates that’s bunk. But you can fight back and win.

New Feature

New information is included below. Please read:

We’re happy to announce a new set of free links for the How They Rate table on the Canadian Edge website. Clicking on the Toronto Stock Exchange symbol will now take you directly to the Google Finance page for every How They Rate component. Google’s page is superior to both archrival Yahoo! Finance and the offering of our Canadian partner Toronto-based MPL Communications, both for news and price charts. It’s an easy compliment to the research and advice-intensive information we provide you in Canadian Edge. Let us know what you think.

I also encourage all readers to check out the live quote feed in How They Rate for US dollar prices, distributions and percentage yields of trusts and high-yielding corporations intraday. Note that our quote service sometimes includes special annual distributions along with the regular monthly payments.

As before, clicking on the US symbol of a company takes you 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 dividend paying equities. 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. Dominion Bond Rating Service is the pre-eminent credit rater in Canada.

The Bank of Canada has 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.” Find it on the top bar on the Home Page under the subhead Resources. Eye on Trusts and How They Rate are accessible on the shaded box in the middle column.

Roger Conrad
Editor, Canadian Edge