Strong and occasionally spectacular earnings and economic numbers, and stubbornly negative investor sentiment: Those are two big reasons why I’m bullish as ever on our favorite high-yielding Canadian stocks, particularly those in the Canadian Edge Portfolio.

The merits of sticking to good businesses were demonstrated in graphic relief this summer. The jagged volatility and downside of May’s Flash Crash was frightening at the time. But it’s been almost completely erased by the July rally, with many favorites at their highest levels since the recovery began in early 2009.

Prices are still well below mid-2008 levels, when soaring energy prices pushed the broad-based S&P/Toronto Stock Exchange Income Trust Index (SPRTCM) to new heights. And despite Canada’s demonstrated ability to transcend US woes thanks to its budding Asian connection, the North American economy is far from robust.

That’s mainly why there’s such pervasive pessimism and fear in this market. And it’s why so many investors continue to ask what to sell, rather than what to buy.

Back in May, I highlighted “four horsemen” that were then roiling the markets: The Gulf of Mexico oil spill, the crisis of confidence in European government debt, the threat of higher US taxes/more regulation and worries about a double-dip recession. Since then, we’ve seen these specters progressively melt away.

BP (NYSE: BP) didn’t cap its oil spill until it became the worst in history, and it still poses a serious threat to its solvency. But neither did its woes become a deadly peril to the rest of the industry. In fact, onshore developers such as oil sands producers have benefitted from greater interest and even offshore looks back on the table for companies that can afford it.

Corporations are again borrowing at record low rates, and even troubled European debt is finding a market. The approach of November elections in the US has nixed potential for significant new regulation. Soaking the rich increasingly looks like a losing campaign issue. And though the economy is hardly running on all cylinders, the data clearly show improvement, particularly corporate earnings.

In an emotional market like this one, it wouldn’t take much to trigger another selloff. But weathering the storm–sticking with positions backed by strong businesses–was clearly the right move this spring. And those who bought more when others panicked have done even better. Sticking was also the best policy in 2008-09, though it required considerably more patience and fortitude to ride out that one.

Looking ahead to the rest of 2010 and beyond, I see little potential for reprise of 2008. But credit risk is still a concern for our Canadian income trusts and high-yielding corporations. As long as underlying businesses continue to perform, we have little worry about. But if a company’s numbers weaken, we’ll swap out for something stronger.

In contrast, you’re better off worrying about who wins this year’s World Series than either inflation or 2011 trust taxation. For one thing, performance of high-yielding Canadian stocks and trusts has been decoupled from benchmark interest rates for more than two years now. In fact, they’ve gone in opposite directions, often rallying hard on days when benchmark interest rates have risen and falling when rates have dropped.

The reason is everything this side of bonds has become economic rather than interest rate sensitive. And that means a lot of upside as the economy gets back on its feet, even if benchmark interest rates move markedly higher.

As for 2011 taxation risk, 90 percent of How They Rate entries have now set their post-corporate conversion dividend rates. Most of the rest are oil and gas producers whose ability to pay depends heavily on where energy prices are when they convert. That means very little remaining risk from trust conversions. In fact, I see considerable upside as it sinks in to investors that the former trusts have already adjusted and that today’s still lofty yields are sustainable.

So, what would I sell now? No doubt some investors are over-weighted in favorites like Atlantic Power Corp (TSX: ATP, NYSE: AT) after riding them up the past couple years. That’s not a reason to wholly cash out, but it may merit some rebalancing. I also continue to rate roughly 10 percent of How They Rate listings as sells. And the most conservative investors should generally avoid anything with a Canadian Edge Safety Rating of 2 or less, even if they are in the Portfolio.

But for the most part, we’re going to want to stick with what we’ve got, unless there’s a compelling reason not to in second-quarter numbers. That’s always the case when market sentiment is more pessimistic than warranted. And right now, the level of fear is as out of whack with reality as I’ve ever witnessed.

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

Portfolio Action

High Yield of the Month Parkland Income Fund (TSX: PKI-U, OTC: PKIUF) is a new addition to my Aggressive Holdings this month. The diversified downstream petroleum company currently yields nearly 12 percent, and management has pledged to pay between 75 and 110 percent of that after converting to a corporation in Jan. 2011. It also continues to grow its business both organically with strategic acquisitions, and sells at a third less than its Oct. 2007 high. Buy up to USD13.

Trinidad Drilling (TSX: TDG, OTC: TDGCF) is the lone hold-rated stock in the Portfolio. I’ll decide what to do about it pending an analysis of second quarter results, which are due out Aug. 11. Note the company remains a favorite of Bay Street, with 14 analysts rating the stock a buy, three holds and no sells.

Note that AltaGas Ltd (TSX: ALA) and Perpetual Energy (TSX: PMT, OTC: PMGYF), the former Paramount Energy Trust, have completed their conversions to corporations and rate buys up to USD20 and USD6, respectively.

I continue to advise holding onto shares of both Provident Energy Trust (TSX: PVE-U, NYSE: PVX) and Pace Oil & Gas (TSX: PCE, MDOEF), which Provident holders received in the recent spinoff.

Pace does not and will not pay dividends, and I’m not adding it to the Portfolio. But I expect shares to move up in coming months on higher oil and gas prices and as remaining dividend-focused holders of Provident cash out. There’s also the potential for a takeover.

Provident, meanwhile, is now a major energy midstream player with a focus on natural gas liquids. Cash flow remains heavily impacted by spreads between refined products and raw commodities. But the company will still be able to pay an outsized dividend after converting. Buy Provident Energy Trust up to USD8.

Second-quarter earnings season is in full swing. I highlight results on the following companies. Note Colabor Group (TSX: GCL, OTC: COLFF) results are reviewed in the July issue, and Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF) is a High Yield of the Month selection.

Conservative Holdings highlighted are:

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)
• Bell Aliant Regional Communications Income Fund (TSX: BA-U, LOTC: BLIAF)
• IBI Income Fund (TSX: IBG-U, OTC: IBIBF)
• Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF)
• Northern Property REIT (TSX: NPR-U, OTC: NPRUF)
• Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)
• RioCan REIT (TSX: REI-U, OTC: RIOCF)
• TransForce (TSX: TFI, OTC: TFIFF).

I also highlight results from the following Aggressive Holdingss:

• ARC Energy Trust (TSX: AET-U, OTC: AETUF)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)
• Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)
• Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF)
• Newalta Corp (TSX: NAL, OTC: NWLTF)
• Penn West Energy Trust (TSX: PWT-U, NYSE: PWE).

High Yield of the Month

The August High Yield of the Month picks are new Aggressive Holding Parkland Income Fund (TSX: PKI-U, OTC: PKIUF) and Yellow Pages Income Fund (TSX: YLO-U, OTCL YLWPF).

Parkland hasn’t set its post-conversion distribution but has set a range of 75 to 110 percent of the current rate, ensuring at least a 9 percent payout and probably something well north of 10 percent.

Yellow Pages yields more than 11 percent, based on the dividend level set by management for its planned conversion to a corporation on Nov. 1. Meanwhile, business is improving and the company continues to expand its reach with acquisitions. With Yellow Pages units trading at 55 percent of book value, expectations are clearly very low and easy to beat.

Buy Parkland Income Fund up to USD13, Yellow Pages Income Fund up to USD8.

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 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 three selections to How They Rate coverage: Empire Company Ltd (TSX: EMP/A, OTC: EMLAF), Enbridge Inc (TSX: ENB, NYSE: ENB) and Fortis Inc (TSX: FTS, OTC: FRTSF). CE Associate Editor David Dittman reviewed all three in the July Canadian Currents.

Empire is tracked under Food and Hospitality. Enbridge is highlighted in the Energy Infrastructure group. Fortis is now listed under Financials, owing to its wide range of investments throughout the Canadian economy. I’m also tracking Pace Oil & Gas Ltd (TSX: PCE, OTC: MDOEF) under Oil and Gas. Provident Energy Trust (TSX: PVE-U, NYSE: PVX) moves to Energy Infrastructure to reflect the fact that it’s now a pure midstream energy company.

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

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)–Acquired to SELL. Parent Boralex Inc (TSX: BLX, OTC: BRLXF) has sweetened its offer for the income fund in two ways, and extended it to Aug. 13. That’s in response to continuing opposition from O’Leary Funds and its 8.87 percent stake.

First, the interest rate on the new convertible notes (CAD100 par value) is raised to 6.75 percent from the prior 6.25 percent. Second, the conversion price is cut to CAD12 from CAD17. That’s the level Boralex Inc must surpass to push the conversion value of the bonds above their face value of CAD100. This dramatically increases the odds that they’ll be worth converting to common stock before their maturity date of June 30, 2017. The exchange is still 20 units per convertible bond, with the balance paid to investors in cash.

In my view, this makes the deal all the more attractive to Canadian investors. US investors, however, are still advised to sell, as most US brokers won’t be able to handle a foreign bond. That could lead to not being paid dividends, as well as liquidity issues. There are still better ways for investors on this side of the border to score a high yield.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Hold to SELL. Parent and 25 percent owner Xstrata Plc (London: XTA, OTC: XSRAF) is offering to buy out income fund unitholders for CAD3.40 per unit in cash. The deal is in the form of a non-binding letter of intent rather than a hard agreement. The price is barely a quarter of Noranda’s trading range in 2006.

The fund’s only asset is a royalty stream from a zinc processing plant owned and operated by Xstrata, the value of which is now at a cyclical low. As a result, the offer price–though advertised as a 33 percent premium to the prior price of the dividend-less units–is hardly top dollar, and it may go higher before negotiations are through. That’s already somewhat reflected in Noranda’s unit price, which is well above the prospective takeover price. In view of the units’ recent gains and the company’s lackluster second quarter earnings, however, my advice for investors is to move to other opportunities.

North West Company Fund (TSX: NWF-U, OTC: NWTUF)–Buy @ 18 to Hold. Judging from the trust’s current price, investors seem to have forgotten that management plans a substantial dividend cut when the company converts to a corporation on Jan. 1, 2011. Specifically, the old annual rate of CAD1.36 per unit will be slashed to just CAD0.94 a share, leaving a current yield of just 4.7 percent. That’s hardly attractive for what’s basically a reliable but slow-growth distributor of food and family apparel in Canada and Alaska.   

Primary Energy Recycling (TSX: PRI, OTC: PENGF)–SELL to Hold. Second-quarter earnings indicate that business conditions are improving, particularly with regard to the company’s primary customers, US steelmakers. The company is also making progress cutting debt (down 32.9 percent year over year). There’s no dividend and isn’t likely to be one anytime soon, though.

Ratings Changes

Following is a list of companies whose Canadian Edge Safety Rating changed last month and why. Note that many companies have yet to announce second-quarter earnings, while a lesser number still haven’t decided on a post-conversion dividend policy. Both could change future ratings of listed companies.

Provident Energy Trust (TSX: PVE-U, NYSE: PVX)–3 to 4. Management has clarified some details about earnings, and therefore the company merits another Safety Rating boost.

Rogers Sugar Income Fund (TSX: RSI-U, OTC: RSGUF)–2 to 3. The trust has confirmed its post-conversion distribution policy, cutting its current monthly rate of CAD0.03833 to a new quarterly rate of CAD0.085. That represents an effective cut of 26 percent but eliminates uncertainty surrounding 2011. Rogers is highlighted in Dividend Watch List.

Feature Article

US real estate is still mired in a deep slump, and some still fear a further collapse, particularly in commercial property values. In stark contrast, activity is brisk in Canada, especially in the residential sector but increasingly in office, retail and industrial sectors.

Cities such as Vancouver have scarcely felt any downturn at all, and even traditional laggards like Quebec have performed well. That strength is reflected in Canada’s real estate investment trusts (REIT), which, unlike US REITs, maintained conservative postures during the last decade and emerged from the downturn stronger than ever. The best are well off their lows of early 2009 but still yield 6 to 9 percent and are poised for dividend growth, as investments made during the downturn start to pay off.

Here are my favorite buys: the four Canadian Edge Conservative Holdings–Artis REIT (TSX: AX-U, OTC: ARESF), Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and RioCan REIT (TSX: REI-U, OTC: RIOCF)–as well as Crombie REIT (TSX: CRR-U) and Morguard REIT (TSX: MRT-U, OTC: MGRUF).

Canadian Currents

CE Associate Editor David Dittman has second-quarter earnings highlights for How They Rate companies that have reported thus far.

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–Once again, the only distribution cut last month in the Canadian Edge How They Rate universe was a trust that announced its conversion to a corporation: Rogers Sugar Income Fund (TSX: RSI-U, OTC: RSGUF). The cut was well in line with market expectations and won’t take place until Jan. 1, 2011, when the conversion will occur.

Here’s the rest of the Watch List, which continues to exclude trusts yet to announce post-conversion dividend policies. Again, these are at the discretion of management and are impossible to truly predict. Portfolio companies yet to announce conversion policies are listed at the bottom of Portfolio Update.

• 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)
• 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 Fund (TSX: SWS-U, OTC: SWSSF)

Taxing Questions–Taxes continue to dominate the questions we receive at Canadian Edge. Here are answers to what you asked.

Broker-Dealers’ Dodge–More often than not assertions by your broker that it’s illegal to own a particular OTC-listed company are driven more by a desire to get you to invest in equities for which his or her broker-dealer house is making a market.

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

For More

How They Rate offers several free links. Clicking on the Toronto Stock Exchange (TSX) symbol will now take you directly to the Google Finance page for every How They Rate holding.

We also offer a live, intraday quote feed in 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 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.

Editor’s Note: For additional information on this topic, check out Roger Conrad’s latest report on Top Canadian Income Trusts.