Even after two years of torrid gains and income trust conversions, Canadian stocks continue to offer the highest yields in the world. Dividend growth, however, is increasingly the primary attraction of the best and brightest.

On its face, an 8 percent yield that’s growing may not look as attractive as a 12 percent or even a 10 percent yield that’s not. In practice, however, the 8 percenter is almost always the better buy, particularly for investors seeking a high, reliable yield.

First, growing dividends always make for superior returns. It will take five years for an 8 percent yield growing 5 percent a year to best the annual income of a 10 percent yielder and nine years to best a 12 percent yield. Every one of those dividend increases, however, effectively sets a higher benchmark price for the stock. That adds up to total returns that dwarf those of the higher yielding, non-growing fare.

Equally important, growth is the surest indication of dividend safety. A dividend that’s not growing doesn’t always indicate danger. But more often than not it’s a tipoff the company’s underlying business isn’t growing, and/or that cash flow can be interrupted. And as anyone who’s ever owned a dividend-cutting stock knows, the loss in income is generally accompanied by steep capital losses.

Those couple of extra percentage points of yield you chased can be wiped out in a matter of minutes. And if the business really is weakening, you’ll not likely to get it back no matter how long you hold on.

Here in early 2011, it’s become highly fashionable among some investors to chase high, juicy yields and ignore dividend growth. As a result, both March High Yield of the Month picks are still on the bargain counter, despite registering solid returns the past couple years. They’re safer and higher potential as well.

I’ve had Acadian Timber Corp (TSX: ADN, OTC: ACAZF) rated a “buy” in How They Rate for some months. I’ve decided to add it to the Aggressive Holdings now for two reasons. First, the company has increased its quarterly dividend to 20.62 cents Canadian per share from a previous CAD0.05, pushing the annualized yield up to 8 percent. And second–but equally important–management stated its intention to grow the dividend further as business conditions permit.

Both are signs of a strong underlying business on track to produce robust total returns for investors, in addition to a high current yield. In Acadian Timber’s case, that’s the business of harvesting and marketing forest products.

Part of the Brookfield Asset Management (TSX: BAM/A, NYSE: BAM) group of companies, Acadian Timber is the second-largest timberlands operator in New Brunswick and Maine (29 percent of sales). The company owns approximately 1.1 million acres and provides management services for another 1.3 million “Crown licensed” (state-owned) lands. Roughly 87 percent of its properties are in Canada, where “principles of sustained forestry” have been in place longer than in the US. As a result, the company has a solid environmental record. It also recorded an 11th consecutive accident free year in 2010 for Maine operations.

Products include softwood and hardwood sawlogs, pulpwood and biomass by-products. These are sold to over 110 regional customers, including pulp (19 percent of sales) companies, paper manufacturers (19 percent), power producers (9 percent), hardwood lumber companies (7 percent) and softwood lumber companies (34 percent).

That’s an extraordinary amount of diversification, both geographically and economically. Fourth-quarter 2010 output was 382,000 cubic meters of forest products, up 12 percent from 2009 levels. Most of that gain was due to a boost in softwood products, which is used heavily in the pulp and paper business. Fourth-quarter volume was approximately 36 percent sawlogs, 46 percent pulpwood and 18 percent biomass. That’s basically consistent with the 30 percent sawlogs, 48 percent pulpwood and 22 percent biomass mix last year.

What’s considerably less steady is the price and demand for these products, as the company’s stock and dividend history demonstrate. Acadian Timber was launched in early 2006 as an income trust as a vehicle for parent Brookfield to operate forestry holdings in Atlantic Canada and New England. The initial public offering (IPO) price was CAD10 with a monthly dividend of 6.875 cents Canadian per unit.

That payout rate held until November 2009, when the recession finally caught up to the company and forced a dividend cut to monthly rate of 1.667 cents Canadian per unit. That became a quarterly dividend of CAD0.05 a share with an initial payment on Apr. 15, 2010, as the company converted from an income trust to a corporation. The increase to a quarterly 20.62 cents starting Apr. 15, 2011, represents the effective restoration of the original 6.875 cents.

Acadian’s share/unit price reflects every bit of that volatility. Spurred by a strong road show following the IPO, the stock price overcame selling in the wake of the Halloween 2006 trust tax announcement, hitting an all-time high of over USD12 by late 2007. The economic/market/credit meltdown of late 2008 took shares down to a low of barely USD4 in March 2009, as investors anticipated the dividend cut to come. As conditions improved in the timber market, the stock began to climb again, finally besting its IPO price of CAD10 again last month, following the strong fourth-quarter results.

This record of price and dividend volatility is the main reason Acadian Timber belongs with the Aggressive Holdings rather than the Conservative Holdings. That being said, it’s about as low-risk a play on timberlands you’re ever going to find.

Though independently run with its own board, management has consistently followed the conservatism of the Brookfield group, with all of the top executives being part of that organization. CEO Reid Carter, for example, is a managing partner of Brookfield Timberlands and is responsible for Brookfield’s overall timberlands management strategy. Brookfield itself continues to hold 45 percent of Acadian Timber’s shares.

That conservatism and long-term focus held the company’s fortunes together throughout the past years’ slump, brought on in large part by the collapse of the US homebuilding market. And those same financial policies will hold the company in good stead in any future slump.

Being able to rely on a deep-pocketed parent has helped in other ways as well, as Brookfield has effectively been able to buy up the assets of bankrupt Fraser Papers (OTC: FRPPF)–keeping assets running that accounted for 28 percent of Acadian Timber’s total sales last year.

In raising the dividend last month management expressed its belief that the market for its products had at last stabilized and that it expected to see continued recovery in 2011.

That seems borne out in the numbers for the fourth quarter: a 23 percent boost in sales, a jump in cash flow margins to 31 percent of sales from 12 percent a year ago, a quadrupling of free cash flow to 32 cents a share. And all this occurred in the fourth quarter, traditionally a period of seasonal weakness owing to weather conditions and demand patterns.

Management also noted, however, that the current dividend rate was sustainable even if conditions didn’t continue to improve. That’s an important distinction for an industry where selling prices are often quite volatile, and where costs can vary sharply with the price of gasoline, wages and other factors. And with a new credit deal inked this month, there’s little balance sheet risk either.

Given the company’s strong position, its ability to make acquisitions and improving markets, there’s every sign that earnings are ready to lift off–and take the dividend and stock price with them. Buy Acadian Timber up to USD11.

My upgrade of Keyera to a buy up to USD38 may surprise some, given the stock’s massive total returns and my “hold” rating the past couple months. Two factors turned it for me: the company’s robust fourth-quarter results–which if anything indicate an acceleration of profit growth from what are essentially low-risk, fee-based businesses–and the boost in the distribution to CAD0.16 per share from CAD0.15 the month after the company converted to a corporation and started paying taxes.

Starting with the earnings, numbers were impressive from top to bottom. Cash flow from operating activities–the key unit of profitability–was up 135.7 percent in the fourth quarter from year-earlier levels. That pushed up distributable cash flow–the account from which dividends are paid–by 43.9 percent on a per-share basis. That, in turn, took the payout ratio down to just 47 percent from 68 percent a year ago.

Gathering and processing throughput rose 22.5 percent and natural gas liquids’ (NGL) contribution to margins rose 7.3 percent, while the inventory value of the company’s energy marketing operation rose 60.4 percent.

This growth was due primarily to Keyera’s ability to spot and take advantage of opportunities to build and buy assets that were immediately accretive to cash flow. And the company also increased capital spending nearly five-fold during the quarter, putting the pieces in place for robust growth in 2011 with more such activity.

That 2010 growth took place despite what management called “significant maintenance turnarounds” at several large facilities is particularly impressive and hopeful for 2011, when assets can be kept running longer. This year’s profits will also be augmented by acquisitions of additional interests in several gathering and processing facilities for natural gas, all located in areas where the oil and liquids-rich gas development is accelerating. The company also significantly expanded its NGL processing ability with a series of plant expansions.

Projects slated for development in 2011 include a condensate pipeline expansion program from Keyera’s Fort Saskatchewan facility to the Polaris diluent pipeline, a project that will take advantage of the revived growth of Canada’s oil sands. Looking further out, a newly inked agreement with Husky Energy (TSX: HSE, OTC: HUNKF) also promises vast new revenue sources from the latter’s Sunrise Oil Sands Project beginning in 2014. And the company is in prime position to bid on the likely flood of midstream projects resulting from Encana Corp’s (NYSE: ECA) recent alliance with PetroChina Company Ltd (NYSE: PTR) to develop natural gas.

Keyera isn’t likely to post 40 percent-plus distributable cash flow growth every quarter, as it did in the fourth of 2010. But these projects–as well as others yet to be announced–point to an uninterrupted stream of fee-based growth from North America’s highest-potential energy development projects. That’s both in the near term and for years to come as well.

To be sure, the torrid gains of the past two years are not likely to be repeated in 2011. Mainly, the stock is no longer coming off lows that were only possible during an historic market/credit/economic crackup. But coupled with the 5 percent-plus yield, the pieces are in place for extremely reliable 10 to 12 percent annual total returns–paid in the commodity-leveraged Canadian dollar–for years to come.

That’s still an exceptional package. And with management now committed in deeds as well as words to robust dividend growth, it makes Keyera Corp worthy of a buy-up-to price of USD38 for those without a position now.

What could go wrong for Acadian Timber and Keyera Corp? The biggest risk to the former is the health of the global economy. A relapse or deeper slump in the US for whatever reason would hurt demand for timber products as well as selling prices, hitting cash flow. Management has protected the raised dividend well with conservative policies. But ultimately, like any commodity producer, the company depends on commodity prices.

Acadian Timber has proven its ability to weather the worst possible environment and is unlikely to crack. It’s not even likely to cut dividends unless a renewed slump is truly catastrophic. But the stock price will almost certainly be volatile if economic worries intensify.

As for Keyera, it proved in 2008-09 that its business can take a punch. One reason is management’s ability to locate assets in areas where production is growing and avoid the vast swaths of Canada where particularly conventional natural gas drilling activity has dried up. The worst thing that could happen to the company would be a loss of that acumen, though that seems highly unlikely.

Other than that, the biggest danger is the rising investor expectations for the company, as reflected in its rising share price the past couple of years. Of the eight analysts now covering the company, three rate it a “buy,” while four have “holds” and one rates it a “sell.” Not surprisingly, the reservations are valuation related.

In my view, no company that offers a prospective 10 percent to 12 percent annual return to its long-term investors is overvalued. Unfortunately, for many in this market long-term is the end of the week. Any disappointment–no matter how trivial–can trigger a selloff. And if there are enough stop-losses in place, the action can be quite violent.

Should that happen to Keyera–or any stock–the key is always to ascertain what happened and whether it’s a genuine threat to the underlying business. Anything short of that is ephemeral and will be reversed, in some cases on the same day. The only losers will be those who put stops in place or who panicked out. The rest of us will ride out the volatility on the way to higher highs.

For more information on Acadian Timber and Keyera, see How They Rate. Click on the trusts’ names to go directly to their websites. Acadian Timber is covered under Natural Resources, while Keyera is tracked under Energy Infrastructure. Click on their US symbols to see all previous writeups in Canadian Edge and CE Weekly. 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.

Keyera is larger, with a market capitalization of some CAD2.586 billion. Acadian Timber is smaller at roughly CAD170 million. Both stocks trade with good volume on their home market, the Toronto Stock Exchange, and trade in the US with over-the-counter (OTC) symbols as well.

No brokerage should have trouble buying either stock. If yours quotes an antiquated “blue sky” law as a reason not to buy, simply point out that you are initiating the trade and there’s no law against that. US investors are generally not permitted to take part in secondary offerings or dividend reinvestment plans.

Distributions paid by both companies should be considered 100 percent qualified for US tax purposes. Keyera converted from an income trust to a corporation on Jan. 1, 2011. Acadian Timber completed its conversion much earlier, on Jan. 4, 2010.

Both provide tax information to use as backup for US filing–whether or not there are errors on your 1099–on their websites. For direct links see 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. If you hold these 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.

Both companies’ dividends, however, will not be withheld the 15 percent if they’re owned in IRAs. The first payment for Keyera to IRA accounts that’s exempt from withholding is the Feb. 15 disbursement, declared on Jan. 10 to shareholders of record Jan. 24. All of Acadian Timber’s dividends paid this year are exempt.

For more information on IRAs and withholding, see the February Canadian Currents article and related items in Tips on Trusts. Portfolio Update lists the first exempt dividend payments for all current Conservative and Aggressive Holdings. We’ll continue to follow up on this topic in future issues of Canadian Edge and CE Weekly.