Editor’s Note: In Brief is the executive summary of the January 2011 issue of Canadian Edge. Please use it as a guide to points of interest.

It’s hard to believe. But Jan. 1, 2011–the day so many feared would be doomsday for Canadian income trusts–has now come and gone, largely without incident.

The market is still sorting out a handful of symbol changes. By and large, however, Canadian Edge Portfolio favorites have added to the considerable gains they rolled up in 2009 and 2010. That was an average return of 40.3 percent last year, on top of 60 percent-plus the year before.

Such a happy outcome to a four-year-old market worry is, of course, no surprise for CE readers. As I’ve demonstrated repeatedly since, income trusts’ management took full advantage of the 50-month grace period they had to prepare for the new taxes.

There are still some 39 entities in How They Rate coverage trading under Toronto Stock Exchange (TSX) symbols with trusts’ signature “-U” or “.UN” suffix. Roughly half are taxed as SIFTs, or “specialized investment flow-through” entities.

The rest of the former trust universe has now converted to corporations. But no matter how they’re organized, these companies are benefitting from some of the lowest corporate tax rates in the world.

After the fourth cut in as many years, Canada’s official corporate tax rate is just 18 percent, barely half the US rate of 35 percent. And Canada’s levy will drop to 15 percent next year, bringing total provincial and federal tallies to just 25 percent, down from 42.6 percent a decade ago.

Lower rates are a major reason why more than a third of trusts converting to corporations have been able to absorb new taxes without cutting dividends. And they’ve helped other companies cut far less than expected.

Recent clarifications for real estate investment trusts (REIT) have helped that sector make a seamless transition as well.

Best of all, these low taxation policies are here to stay. As we’ve pointed out recently in CE’s weekly supplement Maple Leaf Memo, the government of Prime Minister Stephen Harper is closer than ever to gaining its long-sought majority in the House of Commons, which would guarantee at least five more years in office.

That’s an outcome many investors pulled against in the wake of the Halloween 2006 surprise trust tax announcement. Ironically, Conservative Party policies of lower taxes, fiscal discipline and less regulation have been very bullish for investors from both sides of the border ever since. And extending them with a majority would be very promising indeed.

Other likely positives in 2011 include the revival of the US economy–still Canada’s biggest trading partner–and tight global supplies for the country’s natural resource bounty. The latter is a powerful argument for more strength in the loony, which will boost the US dollar value of all things Canadian.

If there is a negative in all this, it’s price. After a second consecutive year of explosive gains, many if not most CE Portfolio holdings are selling for more than my buy targets.

In fact, a growing number either recently made new all-time highs or are rapidly approaching them. The double-digit yields that were so common a year ago are now relatively scarce, even among riskier fare.

This is balanced by rising growth potential and reduced risk in the macro environment, as the 2008 market crash/recession/credit crunch recedes further into the rearview mirror. But higher prices mean greater expectations, which are easier to miss. And that means focusing on business quality is more important than ever.

We won’t see fourth-quarter and full-year 2010 numbers until early February, at the earliest. I fully expect to see strong results, dividend growth and higher share prices as we move into 2011. But until we get hard numbers, the best policy is to stick with recommendations that trade below my buy targets and to wait for the rest to prove they’re worth a higher price.

I also advise investors to take partial profits in any stock that’s grown to an inordinate portion of their portfolios–a standard practice of all successful professional portfolio managers. “Buy and hold” is the best way to build real wealth and capture high income.

Relying too much on a single stock in a market with substantial gains under its belt is a good way to lose both.

Portfolio Action

All things considered, the so-called trust doomsday of Jan. 1, 2011, created about as much turmoil as the Y2K “crisis” did 11 years earlier. Unfortunately, as it turned out there were two exceptions, both of which were, until recently, CE Portfolio holdings: Bell Aliant Inc (TSX: BA, OTC: BLIAF) and Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF).

As I pointed out in a Dec. 20, 2010, Flash Alert, Bell Aliant and Canfor Pulp announced they would cash out all US investors not meeting the definition of “qualified investor” under the Investment Company Act of 1940, i.e. to have USD5 million in investments. US investors who proved they did meet that description, meanwhile, were to be issued “restricted shares” that could only be sold to another qualified investor.

At this point it’s unclear how much of this policy has been carried out. Shares of the converted Bell Aliant, for example, have been changing hands in the US under the symbol BLIAF. And given that many US investors have been able to buy Canadian limited partnerships with US over-the-counter (OTC) listings–most notably Inter Pipeline Fund (TSX: IPL-U, OTC: IPPLF) over its objections–it’s questionable how much control either company could have over the trading of its stock once the conversion process is complete.

My general policy, however, is to avoid what I’m not sure of. In this case, I advised all investors–qualified or not–to sell both stocks in the Dec. 20 Flash Alert. Both Bell Aliant and Canfor Pulp Products have been removed from the CE Portfolio, and my advice remains to avoid them.

Last month I recommended Precious Minerals & Mining Trust (TSX: MMP-U, OTC: PMMTF) as an Aggressive Holdings alternative to Canfor Pulp. This month I’m adding Extendicare REIT (TSX: EXC-U, OTC: EXETF) to the Conservative Holdings to replace Bell Aliant. The company yields more than 9 percent–two percentage points better than post-conversion Bell Aliant–and has reorganized as a corporation for US tax purposes, so US investors can avoid the 15 percent withholding from IRA accounts. I review it in High Yield of the Month.

With all but a tiny handful of trust conversions behind us, the Canadian Edge Safety Rating System criterion regarding post-conversion dividends is now moot. As a result, I’m tweaking the System again, replacing that point with the criterion of no dividend cuts the past five years. I discuss the new system and how I’ll be using it in Portfolio Update, where I also detail performance highlights for 2010.

High Yield of the Month

New Conservative Holding Extendicare REIT (TSX: EXE-U, OTC: EXETF) and newly converted Macquarie Power & Infrastructure Corp (TSX: MPT, OTC: TBD) are my featured companies in January’s High Yield of the Month feature. Neither will see a change to its lofty distribution as a result of 2011 tax changes.

An owner of long-term care facilities in the US and Canada, Extendicare didn’t qualify as a “real estate investment trust” with the meaning of the Canadian government’s 2011 rules. Nonetheless, it has been paying the SIFT tax since 2007, as the result of non-compliance with growth restrictions. And management has no plans to convert to a corporation at this time.

Macquarie Power & Infrastructure, meanwhile, expects its “dividend level to be sustainable through 2014,” even in the unlikely event it fails to grow its business with new projects.

Both companies will continue to pay monthly dividends. Buy Extendicare REIT, yielding more than 9 percent, up to USD10. Macquarie Power & Infrastructure Corp, yielding more than 8 percent, is a buy up to USD9.

How They Rate

For a complete listing of what changed in the recent trust conversion wave, see the Jan. 5 Flash Alert, Conversions: So Far, So Good. In all 39 companies restructured to corporations, changing their names and symbols. The table “Symbol Switch” lists name changes, post-conversion Toronto Stock Exchange (TSX) symbols and post-conversion US symbols, where available. We’ll be updating How They Rate with this information as it’s available.

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 CE’s 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, described in the text below the How They Rate table, 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 debt-to-assets ratio meets “Very Safe” criteria for the sector.
• One point if the company’s debt maturing before Jan. 1, 2013, is less than 20 percent of its market capitalization.
• 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 has not cut its distribution over the preceding five years.

I list trusts and high-yielding corporations by the following sectors:

• Oil and Gas–All producer trusts are included here.
• Electric Power–Power generators.
• Gas/Propane–Distributors from propane to package ice.
• Business Trusts–A range of businesses involved principally with consumers.
• Real Estate Trusts–All qualified Canadian REITs and real-estate related corporations.
• 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–Canadian banks, investment houses, and other trusts and corporations providing support to these businesses.
• 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–These trusts and corporations ship freight and move passengers by bus, truck, rail or air.

Coverage Changes

I’m adding Boyd Group Income Fund (TSX: BYD-U, OTC: BFGIF) to coverage under Business Trusts. I’m deleting the former Menu Foods Income Fund, which has now been taken over by Simmons Pet Food for CAD4.80 per unit in cash.

Advice Changes

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

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–Buy @ 28 to SELL. We made this change with the Dec. 20 Flash Alert. At this point it’s unclear whether US investors’ trading is inhibited in any way. The stock yields 7 percent based on the post-conversion dividend rate, which will be paid quarterly. That’s not unattractive, given how conservative this business is. But until it’s clear that US investors aren’t trading restricted stock, there’s no reason for anyone on either side of the border to own Bell Aliant.

Canfor Pulp Products Inc (TSX: CFX-U, OTC: CFPUF)–Hold to SELL. Not only is the company apparently walling out its US shareholder base. But the new dividend rate will apparently be just CAD0.35 per quarter. That still leaves a yield of around 10 percent. But there are plenty of other alternatives with less business risk and no ownership complications.

CE Safety Rating Changes

Here are CE Safety Rating changes, which reflect the changes in the System noted above.

ACTIVEnergy Income Fund (TSX: AEU-U, OTC: ATVYF)–4 to 3. The fund of trusts cut its distribution from CAD0.07 to CAD0.05 per month, but the payout ratio is still high.

Ag Growth International (TSX: AFN, OTC: AGGZF)–4 to 5. Dividend growth earns this very strong agricultural equipment company a boost.

AltaGas Ltd (TSX: ALA, OTC: ATGFF)–6 to 5. The company misses a perfect “6” only because of its post-conversion dividend cut last year.

ARC Resources Ltd (TSX: ARX, OTC: TBD)–3 to 4. Debt reduction and a low payout ratio key this upgrade.

Artis REIT (TSX: AX-U, OTC: ARESF)–4 to 5. This one misses only on a payout ratio that should come down as funds are invested.

Atlantic Power Corp (TSX: ATP, NYSE: AT)–5 to 6. Management has taken advantage of a record-low cost of capital to put pieces in place for robust cash flow growth.

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–5 to 4. A quarter of earnings as a corporation will provide a clue for the rural phone company’s strength. US over-the-counter (OTC) shares may be restricted to qualified investors at this point.

Bird Construction Inc (TSX: BDT, OTC: BIRDF)–5 to 6. The numbers are solid, despite economic weakness, and are poised to get a whole lot better.

Boardwalk REIT (TSX: BEI-U, OTC: BOWFF)–4 to 5. Dividend growth and strong operating numbers key a higher rating.

Brookfield Real Estate Services (TSX: BRE, OTC: BREUF)–5 to 4. Yes, the payout after conversion is still generous, but the company loses on its post-conversion dividend cut.

Calloway REIT (TSX: CWT-U OTC: CWYUF)–3 to 4. The Canadian government did this company a huge favor by writing more liberal investment rules.

Canfor Pulp Products Inc (TSX: CFX-U, OTC: CFPUF)–2 to 1. Leaving aside the daffy conversion policy vis-à-vis US investors, the apparent 53 percent distribution cut is more than expected and worrisome.

Davis + Henderson Corp (TSX: DH, OTC: DHIFF)–5 to 4. The post-conversion dividend cut lops a point off the Safety Rating of this otherwise very strong company.

Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)–3 to 4. Debt reduction and a low payout ratio earn this fast-growing producer a boost.

Enbridge Income Fund Holdings Inc (TSX: ENF, OTC: EBGUF)–5 to 6. This company makes it on the numbers and hasn’t cut its dividend.

Enerplus Corp (TSX: ERF, NYSE: ERF)–3 to 4. A low payout ratio and low debt are keys to success. Cost of equity capital is the lowest in years after recent run-up.

Futuremed Healthcare Products Corp (TSX: FMD, FMDHF)–4 to 3. The post-conversion dividend should hold, but the company loses a point for the reduction nonetheless.

IBI Group Inc (TSX: IBG, OTC: IBIBF)–5 to 4. A large 2012 debt maturity and the post-conversion dividend cut take down this strong company’s Safety Rating a notch.

Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–4 to 5. This one missed a perfect “6” only because of its modest conversion-related dividend cut last year.

Just Energy Group Inc (TSX: JE, OTC: JSTEF)–5 to 6. Little debt, a low payout ratio and recession-resistant business are great strengths. Only dividend increases in the past five years are the proof.

Liquor Stores NA Ltd (TSX: LIQ, OTC: TBD)–5 to 4. The post-conversion dividend cut takes a point off the distributor’s Safety Rating.

Macquarie Power & Infrastructure Corp (TSX: MPT, OTC: TBD)–5 to 4. A large debt refinancing in 2012 misses a criterion but the power trust is still one of the safest 8 percent-plus yields around.

North West Company Inc (TSX: NWF, OTC: NWTUF)–5 to 4. The company loses a point for its post-conversion dividend cut, though it remains very solid.

Parkland Fuel Corp (TSX: PKI, OTC: TBD)–3 to 2. The dividend looks solid at this rate, and the business is on track for growth. But the company misses for business volatility, debt maturities and the conversion-related dividend cut effective with the February payment.

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–1 to 2. Debt maturities are increasingly less daunting and recent gas price volatility has boosted the odds cash flow will be steady this year.

Peyto Exploration & Development Corp (TSX: PEY, OTC: TBD)–3 to 4. The post-conversion payout ratio is well covered, even at low gas prices and with hefty capital spending needs.

Provident Energy Ltd (TSX: PVE, NYSE: PVX)–4 to 3. The company will be tested by volatile natural gas liquids spreads.

RioCan REIT (TSX: REI-U, OTC: RIOCF)–5 to 6. New contracts with Wal-Mart Stores (NYSE: WMT) shore up an already very strong portfolio that’s backed by a falling payout ratio and little debt.

Ten Peaks Coffee Company Inc (TSX: TPK, OTC: SWSSF)–3 to 2. The post-conversion dividend cut takes a point from the former Swiss Water Decaffeinated Coffee Income Fund.

Trinidad Drilling Ltd (TSX: TDG, OTC: TDGCF)–3 to 2. The company has a fair amount of debt coming due in 2012 it will have to pay off or refinance. That shouldn’t be a problem, but it does knock off a Rating System point.

Veresen Inc (TSX: VSN, OTC: TBD)–5 to 6. The former Fort Chicago Energy Partners LP is now a corporation and is open to US investors, with few risks and a big yield to boot.

Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–4 to 5. The company’s ability to hold its dividend through the 2008 crash and 2010 conversion to a corporation demonstrate it’s truly a breed apart among energy producers.

Yellow Media Inc (TSX: YLO, OTC: YLWPF)–2 to 4. The numbers are good and the company has proven its ability to migrate business to the web.

Feature Article

A boost from the long-awaited economic recovery in the US, a run to USD100 and beyond for oil prices, more spending on renewable energy and the end of 2011 tax worries: All are bullish for Canadian Edge recommendations this year and beyond.

Even rising interest rates are still not a real threat, thanks to economic slack and the decoupling of high-yield equities from benchmark rates for the past three years.

I explore these trends and the likely winners and losers in our Canadian Edge coverage universe.

Canadian Currents

After years of waiting, Canada’s real estate investment trusts at last have clear rules for maintaining their tax status in 2011 and beyond.

Better, the rules are considerably more flexible than many expected, eliminating red tape and enabling the best-run REITs to keep growing. Associate Editor David Dittman has highlights and how they affect the prospects of our favorites in the sector.

Tips on Trusts

This section features short bits on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide.

Dividend Watch List—ACTIVEnergy Income Fund (TSX: AEU-U, OTC: ATVYF) cut its distribution from CAD0.07 to CAD0.05 per month. The fund cited trust conversions, but the real reason was the 200 percent payout ratio. It remains a good aggressive fund choice for holding commodity-sensitive trusts.

Most of the 39 trusts converting to corporations in early January have declared one more distribution as a trust. That means the January payment will be at the old rate.

Conversion-related reductions will be reflected first in the February payment for those continuing to pay monthly, in April for those switching to quarterly disbursements.

The Dec. 20 Flash Alert features a table titled “Dividends to Change,” listing all dividend changes for converting companies. The only update concerns Canfor Pulp Products Inc (TSX: CFX, OTC: TBD), which will apparently pay on a quarterly basis at a rate of CAD0.35 per share rather than the 18.75 cents Canadian paid monthly, as shown in the table. The current Watch List is as follows:

• Canfor Pulp Products Inc (TSX: CFX, OTC: unknown)–SELL
• Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Hold
• FP Newspapers Inc (TSX: FPI, OTC: TBD)–Hold
• InterRent REIT (TSX: IIP-U, OTC: IIPZF)–SELL
• Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–Hold
• Royal Host REIT (TSX: RYL-U, OTC: ROYHF)–Hold
• Superior Plus Corp (TSX: SPB, OTC: SUUIF)–Hold
• The Keg Royalties Income Fund (TSX: KEG-U, OTC: KRIUF)–Hold

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

IRA Issues–Just because the income trust era is winding up doesn’t mean we’re spared the aggravation cross-border taxation provides. Cleaning up, or attemptin to, a vestige of the old era, David Dittman recounts a way you may be able to recover amounts wrongly withheld from distributions made in respect of shares held in your IRA.

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.