As was the case last month, I’m featuring an old favorite and a new Portfolio member as October’s High Yield of the Month selections. The newcomer is the highest-yielding trust I’ve ever recommended, Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF), which weighs in with a truly extraordinary 20.8 percent yield at last count.

The trust’s sole asset is a 49.8 percent interest in Canfor Pulp Limited Partnership, a leading global supplier of pulp and paper products operating three mills in Prince George, British Columbia. The partnership is the largest North American and third-largest global producer of NBSK pulp–northern bleached softwood kraft. It’s also one of the world’s lowest-cost operators and the leading producer of fully bleached, high-performance kraft paper.

Canfor’s competitive advantage lies in the proximity of its facilities to British Columbia forests that are rich in high-strength, fine Northern Fibres.

These assets are run by the majority (50.2 percent) partner Canfor Corp (TSX: CFP, OTC: CFPZF), a resource giant with more than CAD2.5 billion in annual revenue.

These fibers are essential for the manufacture of high-performance papers as well as high-porous papers used for multi-wall bag applications requiring rapid air release during filling.

Annual paper production capacity is 142,000 tonnes. All three company mills also produce softwood kraft pulps, from residual chips produced at local sawmills. Primary species used include white spruce, lodgepole pine and alpine fir, all of which are found in abundance in timber-rich British Columbia. End-use products include everything from mechanical publication papers, insulating papers, industrial specialty papers and fiber cement to tissues and towels and hygienic applications. And the company has an intensive and ongoing research and development effort to discern more cost-effective and efficient products and uses for existing fare.

As essentially a high-tech processor/refiner of Canada’s vast forestry wealth, Canfor’s profits ultimately depend as much on factors beyond its control as on its internal operating efficiencies and marketing abilities. The former are essentially the cost of sawmill residual chips it refines and the ultimate cost of its paper and pulp products.

At the depths of the 2008-09 recession the company was squeezed by weak pricing for its products and the shutdown of much of the Canadian timber industry, which reduced the availability of cheap sawmill residual chips. That crunch has lessened considerably over the past year, as global demand for softwood pulp has ratcheted up and the timber industry has at least partly revived, both thanks in large part to growing Asian demand that’s offset continued weakness in North America.

For Canfor, some of that favorable impact has been offset by strength in the Canadian dollar, which reduces the value of export revenue. Also, fiber costs have risen 4 percent over the past year. The company, however, continues to spend heavily on improvements, including CAD122.2 million to be spent on qualifying energy and environmental capital projects between now and Mar. 31, 2012, much of which will be funded by the federal government As a result production capacity has risen even as operating costs have fallen and capital costs have remained modest.

The most important question, of course, is how Canfor can possibly pay out a yield of 20 percent plus indefinitely. The answer, in my view, is it can’t–but management will continue to dish out a yield comfortably in the double-digits while providing a way for yield-seekers to play the rebound in Canada’s asset-rich forestry industry.

One reason is management’s policy is essentially to pay out 90 percent or better of cash flow after debt service and maintenance capital costs. That’s in large part driven by parent Canfor Corp, which considers these operations to be an immensely profitable cash cow. And it will survive the planned conversion to a corporation in Jan. 2011, as management states “we do not plan to accumulate cash in the Corporation and expect to pay as dividend substantially all distributions received from the partnership,” though the company also notes it will be less the “effective cash tax rate of between 25 and 30 percent.”

More encouraging, Canfor has just survived a very difficult time for its market and–while conditions are still not ideal–it’s now enjoying some of the fruits of recovery. Product prices have risen sharply and remain firm, even as the British Columbia timber industry has remained healthy enough to keep a supply of affordable chips available.

Reflecting that profitability, the current distribution was raised another 13.6 percent last month, the sixth increase in the past 10 months. Even with that, the partnership’s current distribution rate of CAD0.25 per month was still just 85 percent of distributable cash flow (DCF), and very likely a smaller percentage of third-quarter DCF.

We’ll have a lot more clarity on future cash flows and distributions when third-quarter results are released Tuesday, Oct. 26. Based on management’s statements, no one should be surprised if business conditions and cash flow weakened, or if management cautions on market conditions for the rest of the year and beyond. Asian demand slowed early in the fourth quarter.

Also, Canfor’s position as the low-cost producer has allowed it to operate almost alone over the past year, while higher-cost pulp processors have shut in capacity. Now some of these rivals are rumored to be to resuming operations, which could create slack in the market and drive down profit margins.

It’s this latter point that investors have likely reacted to this summer, as Canfor’s unit price has since stopped following its distribution higher. However, at this point it’s clear the company isn’t paying out above its means, nor will it ever.

And even assuming a slump and taking out as much as 30 percent of cash flows in taxes from second-quarter DCF, a 90 percent payout ratio still leaves a yield of more than 15 percent based on Canfor’s current price.

In short, no one should count on Canfor continuing to pay out at a 20 percent-plus rate into 2011. But there’s plenty of reason to expect it will continue to both yield double-digits and hit new highs long after its conversion date, even if the pulp and paper market does weaken, as some fear.

That’s more than enough to justify buying Canfor Pulp Income Fund up to my long-standing target of USD15 as well as my expectation for annual total returns of 15 to 20 percent going forward.

Compared to Canfor, the Portfolio veteran I’m featuring this month, Enerplus Resources Fund, is a paragon of stability. But with promising stakes in some of North America’s most prolific oil and gas producing regions, Canada’s oldest income trust is also on the cusp of a new era of profitable growth, even if natural gas prices remain in the doldrums for several more years.

Like all income trusts, Enerplus will convert to a corporation next year and for the first time have to pay income taxes. Thanks to years of following a disciplined development strategy and conservative financial policies, however, the trust will be able to make the leap without cutting its current monthly distribution of CAD0.18 per share.

Despite making several major acquisitions this year, Enerplus’ debt-to-cash flow ratio remains among the lowest in the industry, 0.9-to-1 as of second-quarter numbers.

There are no major debt maturities due until 2014, and cash flow in the seasonally weak second quarter nonetheless nearly covered distributions plus all capital spending.

At the heart of the company’s post-conversion strategy is a plan to develop long-life reserves from recently acquired properties in the Bakken trend–mostly highly valuable light oil–and the Marcellus Shale, which holds the promise of immense, cheap natural gas. The company has devoted CAD1.3 billion to the task this year alone, last month closing the purchase of an additional 46,500 net acres in the Fort Berthold area of North Dakota. That expanded its land position in the US Bakken to more than 70,000 acres.

The company will have a greater than 90 percent working interest in the development of the properties, enhancing its ability to control costs. Current production is at 800 barrels per day of light oil and there are proven plus probable reserves of 10 million barrels of oil equivalent (boe). Drilling is primarily using horizontal techniques that control costs and maximize yields. Minimum oil prices of between USD40 and USD60 are needed to produce a 12 percent return on Enerplus’ investment. But at current levels those returns on wells expand to the 40 to 100 percent range.

All told, Enerplus expects to boost output from its North Dakota properties from 3,300 boe/d post acquisition to 5,000 by year’s end. Over the next five years it expects to expand that to more than 20,000 boe/d from the Fort Berthold area alone, despite relatively high decline rates of individual wells. And that’s not including what’s happening in the Bakken trend on the other side of the border.

Enerplus’ other major investment push recently has been in the Marcellus Shale natural gas play in the US. The company bought another 58,500 acres for development in northwest West Virginia and Maryland in August, bringing its total 2010 investment in the region to CAD150 million. The new lands have yet to be fully explored, so they’ve yet to add to the company’s reserve totals. But management estimates 50 billion to 60 billion cubic feet per 640 acres, and the property is concentrated geographically, giving management ability to control the pace of development and, therefore, costs.

All of Enerplus’ Marcellus output to date is only about 15 million cubic of natural gas per day (MMcf/d). And while its properties are mainly in states with pro-shale development policies, there’s still some question as to how much will ultimately be developed, given the public opposition in some areas to non-conventional drilling techniques. Equally, however, this asset is not factored into Enerplus’ unit price, meaning it’s all upside.

As it’s added these promising plays Enerplus has been simultaneously selling assets deemed non-core to its long-term strategy. The company has either already sold or reached agreements to divest 5,900 boe/d of a targeted 14,000 boe/d of production at a solid price of CAD63,400 per flowing boe of output. The average operating cost of these properties ranges from CAD19.40 to CAD23 per boe, which will help reduce Enerplus’ overall operating costs further. And the cash proceeds have further reduced debt as well.

The other major divestiture was the garnering of CAD405 million in proceeds from the sale of the company’s interest in the Kirby steam-assisted gravity drainage oil sands lease. That represents a sizeable return on the CAD203 million initial purchase price and the CAD58 million invested since. Proceeds will go to retire bank debt.

Meanwhile, Enerplus will continue to hold 4.3 million shares of Laricina Energy. The oil sands company developing reserves in situ is privately held and can only be purchased by holding units of companies that own shares, such as Enerplus and closed-end fund EnerVest Energy & Oil Sands Trust (TSX: EOS-U, OTC: EOSOF). Again, like the Marcellus raw land, Enerplus’ Laricina investment isn’t factored into its unit price. But it does offer the possibility of sizeable returns down the road if Laricina hits it big, and with no risk to Enerplus or its unitholders.

After this year’s acquisitions and asset sales, Enerplus expects to exit 2010 with production of 80,000 to 82,000 boe/d and outstanding debt of CAD850 million. At current oil and gas prices, that leaves plenty of room to finance growth and distributions after absorbing the new taxes–as well as massive upside from the potential for higher natural gas prices.

As for yield, Enerplus will throw off more than 8 percent after conversion, based on its current unit price. That’s 2 to 3 percentage points higher than most other healthy trusts either completing conversions or announcing post-conversion dividend levels. And it’s likely to go quite a bit higher in coming years, particularly if energy prices rise again. Buy Enerplus Resources Fund up to my new target of USD28.

What can go wrong for Canfor and Enerplus? Both stocks were hit hard in the second half of 2008, as the credit market froze up and the North American economy faltered. Enerplus gave up 57 percent, while Canfor’s unit price performance was an even more horrific 74 percent. Canfor hacked its monthly distribution from CAD0.12 per unit in mid-2008 to just a penny by early 2009. Enerplus, meanwhile, took its payout from CAD0.47 in September 2008 to CAD0.18 by February 2009.

Those losses have been followed by strong total returns of 560 percent for Canfor and 56 percent for Enerplus since. But it’s clear that cash flow for both companies as well as their distributions and unit prices are sensitive to the ebb and flow of the economy. And that’s not going to change when they convert to corporations in January.

Sensitivity to economic ups and downs is, of course, both the fuel for superior long-term returns and why both companies are in the Aggressive Portfolio rather than the Conservative Portfolio. Importantly, however, both also proved in 2008 that as companies they could weather the worst credit crunch and economic/market downturn in 80 years. That’s the strongest possible testimony that they could survive an unlikely reprise of those conditions.

In fact, after a year and a half of conservative financial management, they’re in better shape to weather another downturn they were in 2008. Neither, for example, faces any significant debt maturities before at least 2014. And both are financing current capital spending and dividends with internal cash flows. Even during the depths of the 2009 credit crunch, both companies’ banks kept their lines of credit open. But even were those lending windows shut, both would have the resources to keep growth going.

Each company is also exposed to the health of a particular commodity, Canfor to softwood pulp prices, Enerplus to natural gas. At this point, the market for the first is far stronger than for the second. That basically explains why Enerplus hasn’t rallied as much as Canfor since the beginning of 2009. On the bright side, management of both companies is very comfortable it can operate profitably at lower prices for their key products. And lower prices are certainly baked into their share prices, which limits share-price risk if that does happen. But the health of both commodity markets will be key to future performance in both the short and long-term, and I’ll be watching closely.

One thing investors in these companies won’t have to worry about, however, is their conversions to corporations, now slated for Jan. 2011. Enerplus clarified the details of its planned conversion on Sept. 30, including management’s decision to continue paying monthly dividends at the current rate. That eliminates all 2011 risk from the stock, a factor in its recent outperformance even in the face of weak natural gas prices.

Canfor, meanwhile, has repeatedly stated its intention to distribute on average 90 percent of distributable cash generated, i.e. cash flow after debt service and capital expenditures. Starting in 2011, management has affirmed that amount will be reduced by the company’s effective tax rate of between 25 and 30 percent. But as last month’s 13.6 percent distribution increase demonstrates, the health of the pulp market will be at least as important setting the level of cash available to pay out. And in any case, management’s clarity on the issue has eliminated uncertainty about post-conversion dividend policy.

For more information on Canfor and Enerplus, see How They Rate. Click on the Toronto Stock Exchange (TSX) symbol to go to their Google Finance pages for a wealth of information ranging from news releases to price charts. These are substantial companies that trade frequently in both the US and Canada. Canfor is smaller at a market cap of about CAD512 million, and its units trade over the counter (OTC) in the US. Enerplus is listed on the New York Stock Exchange (NYSE) as well as on the Toronto Stock Exchange and comes in at a market cap of roughly CAD4.74 billion.

No broker should have problems buying an NYSE-listed stock like Enerplus. Some states have “blue sky” laws that may not allow your broker to pitch Canfor to you. But the laws won’t prevent you from placing the order. US investors are generally not permitted to take part in secondary offerings but that has nothing to do with shares that are already traded either on the TSX or OTC in the US.

In How They Rate, Canfor is listed under Natural Resources, while Enerplus can be found under Oil and Gas. Click on the trusts’ names to go directly to their websites. Click on their US symbols to see all previous writeups in Canadian Edge and its weekly companion Maple Leaf Memo. Note Enerplus has been in the Portfolio since December 2006, while Canfor is a new addition to the Aggressive Holdings.

Distributions paid by both companies are considered 100 percent qualified for US tax purposes. Both provide tax information to use as backup for US filing–whether or not there are errors on your 1099–on their websites. Tax information to use as backup for US filing–whether or not there are errors on your 1099–is available in the Income Trust Tax Guide.

As is customary for virtually all foreign-based companies, the host government–in this case Canada–withholds 15 percent of distributions paid to US investors at the border. If you hold these trusts outside an IRA, the tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can generally be carried forward to future years. Form 1116 recovery will also be possible after the trusts convert to corporations.