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

Longtime readers know I tend to look for the bright side. And there’s been no shortage of cheerful developments in Canada, at least since early 2009.

Not every Portfolio stock has yet made it all the way back from the historic market crash/credit crunch/recession of 2008-09. But seven Conservative Holdings have blasted out to levels that far exceed any previous cycle high: Atlantic Power Corp (TSX: ATP, NYSE: AT), Brookfield Renewable Power Fund (TSX: BRC-U, OTC: BRPFF), Cineplex Inc (TSX: CGX, OTC: CPXGF), Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF), Keyera Corp (TSX: KEY, OTC: KEYUF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF) and Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF).

So have three Aggressive Holdings: Ag Growth International (TSX: AFN, OTC: AGGZF), Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) and Vermilion Energy (TSX: VET, OTC: VEMTF). Mutual Fund Alternative Blue Ribbon Income Fund (TSX: RBN-U, OTC: BLUBF) has done the same despite trimming its payout 21.4 percent last month in response to trust conversions.

Most of the rest of the Conservative Portfolio is at multi-year highs and pushing new all-time marks. That includes AltaGas Ltd (TSX: ALA, OTC: ATGFF), Artis REIT (TSX: AX-U, OTC: ARESF), Bird Construction (TSX: BDT, OTC: BIRDF), Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), Colabor Group (TSX: GCL, OTC: COLFF), Just Energy Group (TSX: JE, OTC: JSTEF) and RioCan REIT (TSX: REI-U, OTC: RIOCF).

The same can’t be said of most Aggressive Holdings, mainly because oil is still 40 percent below its mid-2008 high and natural gas is barely a third the level reached that same year. But ARC Resources Ltd (TSX: ARX, OTC: AETUF), Enerplus Corp (TSX: ERF, NYSE: ERF), Newalta Corp (TSX: NAL, OTC: NWLTF), PHX Energy Services (TSX: PHX, OTC: PHXHF), Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE), Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) and others are at their highest level in more than two years after staging furious recent rallies.

There have been several catalysts for these gains, including the resumption of the last decade’s bull market for natural resources, the steady appreciation of the Canadian dollar, the public’s zeal for high yields and the end of 2011-related uncertainty all factor prominently. Encouragingly, each of them is still pushing Canadian high-yield stocks higher this year as well.

Unfortunately, there is another side to the story. Higher stock prices reflect loftier investor expectations, which, in turn, are easier to disappoint. And the risk of falling short is never greater than when companies report earnings.

As of this writing eight How They Rate companies have announced their fourth-quarter and full-year 2010 numbers, none of them Portfolio companies. Some results were extremely positive, such as those from Canadian National Railway (TSX: CNR, NYSE: CNI) and Potash Corp of Saskatchewan (TSX: POT, NYSE: POT). Others were a mixed bag, like Canadian Oil Sands Ltd (TSX: COS, OTC: COSWF), which was hurt by maintenance costs.

None revealed any unseen weakness, however, for companies operating in Canada. Rather, the numbers painted a picture of a gradually improving economy in which financially conservative companies are gaining strength.

Over the next several weeks we’ll get a pretty good indication of whether or not that’s true of our 15 Aggressive and 21 Conservative Holdings. As always, I’ll be looking at the numbers to discern dividend safety, financial strength and above all whether key operations are healthy and growing, which is the key to building or destroying wealth.

Other market participants, of course, will be looking closely at whether or not these quarterly numbers–as well as management projections–meet, beat or lag consensus expectations.

And given how far and fast many of these stocks have run, there’s a fair likelihood at least some of them will be disappointed and will sell these stocks off.

We saw that last quarter with Bird Construction (TSX: BDT, OTC: BIRDF), which dived from CAD38 to under CAD29 on Nov. 9, 2010, after reporting a disappointing headline earnings number. Bird has since climbed all the way back to a price of just under CAD37.

That’s because investors soon recognized what was clear from the rest of the report, that the company’s underlying business was still solid.

Some panicked and sold. Others were stopped out at abysmal prices. But investors who kept their heads and stayed in have recovered.

The key to staying in Bird was being able to tell the difference between near-term disappointment and serious long-term weakness. That figures to be especially critical this earnings season, with stock prices higher and therefore more vulnerable to bruised expectations.

To be sure, there are Canadian Edge companies begging to be bought now, and I’ve highlighted them throughout the issue. For any company rated a hold or trading above my buy target, however, the best idea is to wait until we do have hard numbers that justify recent price gains.

The performance of the surging companies noted above is all the more remarkable, given that they also paid dividends several times higher than the typical US stock or bond. These stocks could well stage a repeat performance or better the next several years, but only if their underlying businesses remain healthy and growing.

I’ll get especially bullish if one of them sells off on a near-term disappointment in spite of still-strong core operations. Buying Bird in early November, for example, has already been good for a gain of nearly 30 percent, not including dividends.

Equally, however, I intend to maintain the discipline of selling any company where the underlying business is weakening. I’ll even act if such a stock takes a dive following the release of its fourth-quarter numbers, leaving it at a less than optimal price. That’s how we avoided unrecoverable losses in 2008-09, and it’s how we’ll do so in any future debacle.

One final piece of advice: Don’t be afraid to take partial profits in any stock that’s grown to an inordinate portion of your portfolio. Not doing so means relying too much on any individual stock to build wealth. That’s a sure way to lose it unless you’re very, very lucky.

Portfolio Action

For four-plus years the prospect of being taxed starting Jan. 1, 2011, hung like a dark cloud over Canadian income trusts–even the trusts that had already converted to corporations.

With the long-feared “day of doom” now past, both former and converted trusts have enjoyed a relief rally this year. Valuations have adjusted higher, as many investors have lost their fear and stepped up to the plate to buy.

The buy-in prices they get won’t be as good as long-time Canadian Edge readers have enjoyed the past couple years. But there’s still a wide range of companies selling with generous yields and backed by solid prospects for growth. And all of them offer upside from currency gains, as the Canadian dollar’s prospects remain strong against the US dollar despite surging to parity this year.

Over the past two months I sold Bell Aliant (TSX: BA, OTC: BLIAF) and Canfor Pulp Products (TSX: CFX, OTC: CFPUF). In their place, I added the speculative closed-end fund Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF) and Conservative Holding Extendicare REIT (TSX: EXE-U, OTC: EXETF).

This month I’m sticking with what we have and awaiting the release of fourth-quarter and full-year 2010 results for the recommended companies, which we’ll see over the next couple months. I’ll be reporting the numbers in Flash Alerts as they appear, with a full recap in the March and April regular issues of Canadian Edge.

This month’s Portfolio Update examines recent relevant news at recommended companies. I also tackle the issue of when conversions occurred for Portfolio Holdings, and the point at which dividends paid into IRA accounts should not have been assessed the 15 percent Canadian withholding tax.

Use the information in conjunction with this month’s Canadian Currents to handle any tax problems you might be having.

High Yield of the Month

Two familiar faces stand out as bargains in the February High Yield of the Month feature.

One is Conservative Holding IBI Group (TSX: IBG, OTC: IBIBF), which still boasts a monthly dividend yield of nearly 8 percent after converting to a corporation on Jan. 1, 2010. The company is global leader in the design phase of development of cities globally, with expertise in urban land, building facilities, transportation networks and systems technology. That’s an area promising robust growth in coming years as well as reliable revenue, as the company showed by producing steady results throughout the recent recession.

The other is Aggressive Holding Daylight Energy Ltd (TSX: DAY, OTC: DAYYF), which last month announced exceptionally bullish guidance for 2011. The company has gotten little attention from investors since converting to a corporation in spring 2010 and immediately cutting its distribution by 37.5 percent. That’s likely in part because of its heavy dependence on natural gas output in the past. But with a new push toward oil and attractive reserves, a return to cash flow growth looks set, as well as future dividend growth.

Buy IBI Group up to USD15, Daylight Energy Ltd up to USD11.

How They Rate

For a complete listing of what changed in the recent trust conversion wave, see the Jan. 12, 2011, Flash Alert. 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. All new symbols are now shown in 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 in CE’s Income Trust Tax Guide. Information on US taxation of How They Rate companies is 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

Two How They Rate companies are changing places this month. Fortis Inc (TSX: FTS, OTC: FRTSF) is moving to Electric Power, a more appropriate place than Financial Services given its status as Canada’s largest energy distribution utility. Royal Host Inc (TSX: RYL, OTC: ROYHF), meanwhile, moves to Financial Services, as the owner of a diverse portfolio of resorts and hotels in North America.

Advice Changes

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

Algonquin Power & Utilities (TSX: AQN, OTC: AQUNF)–Hold to Buy @ 5. Recent acquisitions made in partnership with 9 percent owner Emera (TSX: EMA, OTC: EMRAF) should give 2011 cash flow a boost. I look for either a takeover (probably by Emera) or dividend growth in the next year.

Arctic Glacier Income Fund (TSX: AG, OTC: AGUNF)–Hold to Buy @ 2. The packaged ice manufacturer and distributor hasn’t escaped its legal woes yet. But business appears to have stabilized, and the ongoing strategic review could fetch a generous takeover offer. This is also one of the few trusts that had very little exposure to 2011 Canadian taxation, thanks to a large presence in the US.

A&W Restaurant Royalties Income Fund (TSX: AW-U, OTC: AWRRF)–Buy @ 20 to Hold. The stock is nearly 20 percent above my buy target, which I recently raised. Management boosted the distribution 10.4 percent this month, and the franchise is very healthy. But that’s still a bit too pricey for new buys.

BCE (TSX: BCE, NYSE: BCE)–Buy @ 33 to Hold. The stock trades around 10 percent above my most recent buy target.

Bonterra Energy Corp (TSX: BNE, OTC: BNEFF)–Buy @ 40 to Hold. The small producer of oil continues to perform very well, increasing its distribution again last month by 9.1 percent. The catch is the stock has risen so fast it’s even outrun those very bright prospects.

Boyd Group Income Fund (TSX: BYD-U, OTC: BFGIF)–Hold to Buy @ 8. This operator of collision repair shops in the US and Canada elected not to convert to a corporation because it owes little tax. It’s also growing steadily and paying a solid dividend that’s been increased in each of the past two quarters.

Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF)–Buy @ 9 to Hold. This diversified fund will likely cut its distribution in coming months and trades roughly 10 percent above my last buy target.

Brookfield Asset Management (TSX: BAM/A, NYSE: BAM)–Buy @ 25 to Hold. The company’s investment strategy continues to progress but it now trades more than 30 percent above my last target despite no dividend increases since early 2008.

Brookfield Real Estate Services (TSX: BRE, OTC: BREUF)–Buy @ 13 to Hold. The reduced distribution looks sustainable even if the Canadian real estate market should slip, but the stock is 15 percent above my most recent target.

Canadian Natural Resources (TSX: CNQ, NYSE: CNQ)–Buy @ 40 to Hold. This is a great franchise, but the stock trades above my prior buy target and a recent accident at the Horizon oil sands facility could hurt first-quarter earnings.

Canadian Pacific Railway (TSX: CP, NYSE: CP)–Buy @ 65 to Hold. The stock trades roughly 10 percent above my last buy target. Fourth-quarter and full-year 2010 results were solid, but the stock’s a hold pending more dividend growth.

Canfor Pulp Products (TSX: CFX-U, OTC: CFPUF)–SELL to Hold. Management apparently made an eleventh-hour conversion not to follow Bell Alliant (TSX: BA, OTC: BLIAF) down the rat hole of cashing out its US investors. That’s encouraging, but there are still many questions about the pulp products company, including whether it will follow through on an earlier management statement to cut the dividend to CAD0.35 per quarter, a 53 percent cut from the level Canfor paid as a trust.

It ranks a hold until more details are available on its future, some of which should come with the Feb. 9 fourth-quarter and full-year 2010 earnings release.

Dundee REIT (TSX: D-U, OTC: DRETF)–Hold to Buy @ 32. The acquisition of Realex Properties will close this month and start to lift 2011 earnings. That’s more protection for the 7 percent-plus dividend, which hasn’t been increased in a decade.

Keyera Corp (TSX: KEY, OTC: KEYUF)–Buy @ 28 to Hold. This is one of my favorite companies, and there are no flaws in the business at this point. But the stock now sells more than 25 percent above my most recent target. I’ll need to see some dividend growth before I recommend at that price.

Precision Drilling (TSX: PD, NYSE: PDS)–Buy @ 8 to Hold. Prospects are improving for North American drilling, particularly horizontal and directional used to develop shale reserves. But the company is also hampered by a legacy business in traditional reserve development and is trading more than 30 percent above my last buy target.

Sun Gro Horticulture (TSX: GRO, OTC: SGHRF)–Hold to SELL. The company has fetched a takeover offer of CAD6.60 per unit and currently trades at CAD6.55. The deal is set to close in March. Selling now locks in a 30 percent premium to the pre-announcement price and a 60 percent premium to the mid-2010 price, while avoiding any complications from the transaction.

Vermilion Energy (TSX: VET, OTC: VEMTF)–Buy @ 40 to Hold. This company remains one of my favorite producers, but its share price is now about 20 percent above my last buy target. The Corrib project is on track, but I want to see some dividend growth before I recommend investors buy at these levels, which are well above the stock’s previous all-time high set in mid-2008. 

Ratings Changes

Here are CE Safety Rating changes. Note there are likely to be more as fourth-quarter and full-year 2010 numbers are released. Current Ratings reflect mostly data as of third-quarter 2010.

Bonterra Energy Corp (TSX: BNE, OTC: BNEFF)–2 to 3. The 9.1 percent dividend is a favorable harbinger of stronger earnings to come. The company now gets two points for payout ratio and one for having no significant debt maturities in the near future.

Feature Article

Before Oct. 31, 2006, there were 255 publicly traded Canadian income trusts, and many more nearing the launch phase. Since then, the vast majority of them have converted to corporations. But there are still 38 companies tracked in How They Rate that trade as income trusts or some equivalent, only 15 of which are real estate investment trusts exempted from the Canadian government’s Tax Fairness Act of 2007.

These are a mixed bag, and odds are many of them will either convert or be bought out over the next year. Several, however, are still very attractive for yield, including a dozen non-REITs that have neither converted nor reduced distributions with the onset of 2011 taxation. Here’s a look at the best of the unconverted.

Canadian Currents

For the most part, the Jan. 1 tidal wave of Canadian trusts’ conversions to corporations came off without a hitch. Only Bell Aliant (TSX: BA, OTC: BLIAF) wound up cashing out US investors, and it was able to get a good price between USD26 and USD27 per share, the highest level held by the stock since mid-2008. Some US brokerages wound up effectively freezing holding until symbols could be obtained, but most everything is now trading freely once again.

Unfortunately, US taxation issues concerning Canadian investments are still considerably less settled. For those holding them outside IRAs, the key is making sure their payouts are treated as “qualified dividends” for US tax purposes, assessed at a maximum rate of 15 percent. For those holding Canadian stocks inside IRAs, the key is not being withheld 15 percent per the provisions in the US/Canada tax treaty.

Settling both issues favorably means making sure your broker knows the facts, and possibly fighting until he or she does the right thing. Canadian Edge Associate Editor David Dittman again puts together the evidence to use to educate and push your case, should it come to that.

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–As I pointed out last month, the 39 trusts converting to corporations in early January have declared one more distribution as a trust. Consequently, our quotation service continues to reflect pre-conversion dividend rates for many former trusts. As these are typically higher than the actual payouts, the result in some cases is a posted yield that’s misleadingly high.

In this month’s DWL I’ve compiled a list of companies still showing up in How They Rate as paying higher yields than they really are. I also review closed-end fund Blue Ribbon Income Fund’s (TSX: RBN-U, OTC: BLUBF) 21.9 percent distribution reduction to a new monthly rate of CAD0.055 from the prior CAD0.07, an event many investors have apparently viewed as bullish. I also look at The Keg Royalties Income Fund’s (TSX: KEG, OTC: KRIUF) decision to remain a trust and reduce its payout to a monthly rate of CAD0.08 per unit from the prior CAD0.1065.

The current Watch List is as follows. Note that the list is likely to change as fourth-quarter and full-year 2010 earnings are released.

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

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

Tips on DRIPs–US securities laws restrict participation in dividend reinvestment plans (DRIP) of foreign-based companies that don’t register their offering with the Securities and Exchange Commission (SEC). Most plans of Canadian income and royalty trusts that do sponsor DRIPs aren’t registered under the United States Securities Act of 1933, as amended.

Baytex Energy Corp (TSX: BTE, NYSE: BTE) last month joined Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) and Provident Energy Ltd (TSX: PVE, NYSE: PVX) among the ranks of Canadian Edge Portfolio Holdings offering the convenience of DRIP investing to US investors.

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.