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

Canada’s economy grew at a robust 3.9 percent annual rate in the first quarter of 2011. That was faster than the fourth quarter of 2011’s healthy 3.1 percent clip, as rising business investment and exports offset less government spending.

The Northern Tiger’s strong results stand in sharp contrast to renewed sluggishness in the US, where growth slipped from 3.1 percent to 1.8 percent, and even manufacturing growth seems to be slowing. And it was largely superior to the rest of the developed world as well.

A stronger overall economy is, of course, bullish for Canadian companies in general. And it showed up in what overall were solid first-quarter 2011 earnings as well as the return to dividend growth that’s started to spread across a range of industries. Last month, for example, another dozen How They Rate companies raised their payouts. Their ranks included Canadian Edge Portfolio picks Newalta Corp (TSX: NAL, OTC: NWLTF) and TransForce Inc (TSX: TFI, OTC: TFIFF), which boosted payouts by 23 and 15 percent, respectively.

Strong earnings and dividend growth are the key catalysts for higher share prices and superior returns in a year where rising investor expectations have raised the risks. They’re also the best possible protection against the myriad “what ifs” that plague current market psychology, from Europe’s sovereign debt woes to the ups and downs of oil prices.

Solid results have earned several recommendations higher buy targets over the past month. These are indicated in the Portfolio tables and include Newalta and TransForce, as well as AltaGas Ltd (TSX: ALA, OTC: ATGFF), Artis REIT (TSX: AX, OTC: ARESF), Blue Ribbon Income Fund (TSX: RBN-U, OTC: BLUBF) and Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF).

For those who already own these and other buy-rated companies, the best strategy is just to let positions ride, adding to positions on dips as long as you’re not overweighting or “doubling down.”

For those who don’t already own these companies, I recommend one of two approaches, with the ultimate goal of building roughly equal positions in at least 10 to 12 Canadian Edge companies.

Option No. 1 is to pick out a dozen or so companies that meet your optimal combination of potential returns (yield plus growth) and acceptable risk.

The latter is best indicated by the CE Safety Rating System, which is based on six criteria. The more criteria met, the higher the rating and the safer the stock’s dividend. You then buy these stocks in roughly one-third increments, paying no more than the target price for any individual security. Make a third of your investment now, a third in a month or so and the final third a month after that.

Option No. 2 is simply to buy the two High Yield of the Month companies each issue until you have the number of stocks you want. HYotMs are the stocks I view as the best buys for any given issue month, based on potential returns and risks.

Unfortunately, not every company in the CE How They Rate universe–or even the CE Portfolio–is performing well in this environment. Last month we suffered another dividend cut at my super-aggressive natural gas play, Perpetual Energy Inc (TSX: PMT, OTC: PMGYF).

As I noted in a May 18 Flash Alert, I’m sticking with it in the Portfolio, precisely because it is such a high stakes bet. At this point, the same goes for Yellow Media Inc (TSX: YLO, OTC: YLWPF), the subject of a Jun. 1 Flash Alert. And I’m also sticking with Colabor Group Inc (TSX: GCL, OTC: COLFF), pending how it handles margin pressures.

These companies’ ups and downs, however, are a solemn reminder of the risks in this market and economy. I’m comfortable sticking with them as part of a broadly diversified portfolio, full of companies without so many question marks. But no one should go further out on the risk spectrum than their comfort level extends.

Being comfortable is the only way you’ll have the patience to let high-stakes bets either pay off or fail on the numbers and to ignore the volatility in market prices due to rumor and opinion. Remember, not every stock works out, no matter how carefully vetted.

Diversification, balance and knowing your own limitations as an investor are as essential as knowing your stocks’ strengths and weaknesses.

Portfolio Action

Last month I sold CML Healthcare Inc (TSX: CLC, OTC: CMHIF) from the Conservative Holdings. I also downgraded Colabor Group Inc (TSX: GCL, OTC: COLFF) and Yellow Media Inc (TSX: YLO, OTC: YLWPF) from buys to holds.

All three moves were made in response to developments at the companies that raised the risk the underlying businesses are weakening. CML’s first-quarter results confirmed my worries, as its US business continues to melt down before our eyes. Nothing has changed at either Colabor or Yellow. I highlighted the latter’s situation in a Jun. 1 Flash Alert. Both Colabor Group and Yellow Media remain holds.

The good news is the other 27 Canadian Edge Portfolio Holdings reporting first-quarter 2011 results thus far have turned in very good numbers. That includes the two most recent reporters, High Yield of the Month selections Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) and IBI Group Inc (TSX: IBG, OTC: IBIBF). There are still six companies left to turn in results. I’ll be reviewing them in Flash Alerts over the next few weeks.

The Canadian Edge philosophy is basically to buy and hold dividend-paying companies, so long as the underlying business is healthy and growing. The 27 reporting good results for the first quarter remain buys, as long as they trade below my buy targets. That’s my expectation for the remaining six, though I’ll let the numbers be my guide for whether to buy, hold or sell.

High Yield of the Month

High Yield of the Month features the two best buys for June.

This month I’m turning the spotlight on Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF), which reported extremely robust first-quarter results and still yields more than 8 percent. The company operates in an often-volatile business, specialty chemicals used in industrial processes. But extremely conservative financial policies have enabled it to maintain a lofty dividend in the toughest of times. Now business is starting to boom, and management is stepping up to expand and take advantage. Chemtrade Logistics is a buy up to USD15.50.

The other featured stock is IBI Group Inc (TSX: IBG, OTC: IBIBF), a Conservative Holding that also yields close to 8 percent. The company is a global designer of major infrastructure projects and, like Chemtrade has just announced robust first quarter results, including the highest quarterly revenue in its history and higher margins. Buy up to USD15.

Feature Article

Pick any measure you want, from a nearly balanced federal budget and stronger banking system to a better balance of trade and faster economic growth. Canada’s up and the US is down.

In last month’s Canadian Currents, associate editor David Dittman explored one side effect of the Northern Tiger’s ascendancy of recent years: Canadian companies using the Canadian dollar’s strength to buy choice foreign assets on the cheap, particularly in the US. Thus far the going has been tough, as US growth has lagged, and the greenback’s decline has reduced the Canadian dollar value of revenue from outside Canada. The demise of former CE Portfolio Holding CML Healthcare Inc (TSX: CLC, OTC: CMHIF) is one example of a company with a strong Canadian business hitting a brick wall with its US investment.

But at least for some companies, first-quarter results are starting to tell a different story, one of rising revenue at good businesses purchased from distressed owners, where growth potential can be locked in and currency risks minimized.

I highlight a basket of the most promising, including Portfolio pick Artis REIT (TSX: AX-U, OTC: ARESF) and former Holding Algonquin Power & Utilities Corp (TSX: AQN, OTC: AQUNF), which is rapidly building a power and water utility empire in the US with the backing of Emera Inc (TSX: EMA, OTC: EMRAF). Enerplus Corp (TSX: ERF, NYSE: ERF) is emerging as a major player in the US Bakken Shale (light oil), as well as the Marcellus Shale (liquids-rich natural gas).

Canadian Currents

Canada’s well-capitalized and conservatively managed banking system was key to weathering the recent recession and emerging quickly into a robust economic recovery. The good news is, based on generally solid fiscal 2011 second-quarter results up and down the line, the Northern Tiger’s financial system looks as strong as ever.

It’s both a catalyst for strong economic growth and a bulwark against the world’s continuing financial troubles. CE Associate Editor David Dittman highlights the results and what they mean for Canada’s economy.

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–All How They Rate listings now reflect post-conversion adjustments. Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) was the last to declare a dividend at the rate it has promised to as a corporation. That’s an annualized rate of CAD1.20 per share paid quarterly.

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) was the only company in the How They Rate universe to reduce its distribution last month. As I noted in a May 18 Flash Alert, we’re holding this stock as an aggressive bet on a revival of natural gas prices. The 50 percent reduction was basically made to finance a 50 percent increase in capital spending for 2011, as the company attempts to increase its production of liquids to reduce reliance on weak natural gas. There’s considerable potential upside here but also high risk. Invest according to your needs and tolerance.

Note I’ve added Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF) to the Watch List due to the rise in its payout ratio to over 90 percent (the danger zone for commodity producers) and its heavy reliance on natural gas.

The current Watch List is as follows. Companies on the Watch List can actually be buys, if potential returns are high enough. Also note a large number of companies’ earnings and cash flow are seasonal, which can push their payout ratios over 100 percent during specific quarters without being a threat to the payout:

• Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF)–Hold
• Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Hold
• CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–SELL
• Colabor Group Inc (TSX: GCL, OTC: COLFF)–Hold
• FP Newspapers Inc (TSX: FPI, OTC: FPNUF)–Hold
• Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Hold
• Interrent REIT (TSX: IIP-U, OTC: IIPZF)–SELL
• Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–Buy @ 5
• Yellow Media Inc (TSX: YLO, OTC: YLWPF)–Hold

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

The Long Way Home–There is an arduous road that should allow you to get a big chunk of cash wrongfully withheld from dividends or distributions paid in respect of units or shares of Canadian income trusts, SIFTs or converted corporations held in US IRA accounts. Here’s how to do it.

How They Rate

Coverage Changes

There are no coverage changes in How They Rate this month. There is one name change: Progressive Waste Solutions Ltd (TSX: BIN, NYSE: BIN) is the new name for IESI-BFC, covered in How They Rate under Business Trusts.

Advice Changes

Here are advice changes. See How They Rate for more information.

Aeroplan Group Inc (TSX: AER, OTC: GAPFF)–To Buy @ 14 from Hold. The company posted another round of strong earnings and lifted its dividend 20 percent, earning it a higher buy target.

Boyd Group Income Fund (TSX: BYD-U, OTC: BFGIF)–To Hold from Buy @ 8. The stock has surged nearly 40 percent above my buy target and needs a breather, despite very strong first quarter results and continued growth.

Canadian National Railway (TSX: CNR, NYSE: CNI)–To Hold from Buy @ 70. The stock has now run up more than 10 percent above my buy target and the yield is less than 2 percent.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF)–To Hold from Buy @ 16. The closed-end fund has taken a slightly more aggressive tack with its investments, focusing some 31 percent of holdings on natural resource companies and some non-dividend payers. That raises its risk slightly though the dividend still looks solid. I’m rating it hold for now until we see results of the change in approach.

Fortis Inc (TSX: FTS, OTC: FRTSF)–To Hold from Buy @ 35. The company is paying a hefty 44 percent premium to buy Central Vermont Public Service Corp (NYSE: CV) in the US. That’s worth a bit of caution on the stock, which has performed well of late.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Hold from Buy @ 18. The company’s shares have surged over the past month. However, its main business of collecting royalties while other companies produce natural gas on its lands saw a 29 percent drop in volumes. Meanwhile, the payout ratio surged over 90 percent.

Progressive Waste Solutions Ltd (TSX: BIN, NYSE: BIN)–To Hold from Buy @ 22. The stock has surged well above my buy target. The company needs to grow to the higher price.

Rogers Sugar Inc (TSX: RSI, OTC: RSGUF)–To Hold from Buy @ 5. The stock has jumped 10 percent above my target. Meanwhile, first quarter profit margins fell 12.3 percent, pushing up the payout ratio of 165 percent. The impact should be temporary, but it deserves caution nonetheless.

Ten Peaks Coffee Company Inc (TSX: TPK, OTC: SWSSF)–To SELL from Hold. Earnings won’t be released until June 8. But the risks appear to be vastly understated in the fourth quarter 2010 payout ratio and share price, and competitive pressures are growing.

Wajax Corp (TSX: WJX, OTC: WJXFF)–To Buy @ 40 from Hold. Robust first-quarter earnings and a 20 percent dividend boost earn the company a higher buy target. And second-quarter numbers should be even better.

Ratings Changes

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.

Here are CE Safety Rating changes, reflecting first-quarter 2011 numbers. Expect more next month as the last How They Rate companies report.

Aeroplan Group (TSX: AER, OTC: GAPFF)–To 4 from 3. The company posted another round of strong earnings and lifted its dividend 20 percent but still cut its payout ratio to 58 percent earning another Safety Rating System point.

Algonquin Power & Utilities Corp (TSX: AQN, OTC: AQUNF)–To 4 from 5. The company continues to grow rapidly but the first quarter payout ratio has risen to 163 percent. That’s likely due to heightened seasonality of earnings, due to recent acquisitions. But until there’s a clear pattern, the company deserves a slightly lower safety rating. Advice is still to buy up to USD6.

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–To 3 from 4. The cost of building out the company’s fiber-to-the-home network has pushed up the payout ratio of 122 percent for the first quarter, cutting a point from the Safety Rating though the ratio should decline in coming quarters.

Big Rock Brewery Inc (TSX: BR, OTC: BRBMF)–To 3 from 4. Seasonal factors likely drove up the company’s payout ratio and will likely bring the ratio down in the summer months. But the company drops a Safety Rating System point until conditions improve.

Boston Pizza Royalties Income Fund (TSX: BPF-U, OTC: BPZZF)–To 0 from 1. Management maintains it will maintain the current distribution despite the higher payout ratio due to Canadian taxes. But the business is competitive, and the margin for error is slender.

Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–To 4 from 3. A near doubling of distributable cash flow per unit has pushed the payout ratio down to just 37 percent.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–To 3 from 4. Not surprisingly, the company’s payout ratio soared in the first quarter, as its US business continues to evaporate.

Cominar REIT (TSX: CUF-U, OTC: CMLEF)–To 3 from 4. The REIT’s first-quarter revenues are higher on acquisitions, but margins are lower and the payout ratio over 100 percent, as it continues to absorb them. The distribution is not at risk, but the REIT, at least for now, meets fewer Safety Rating System criteria.

EnerVest Diversified Income Trust (TSX: EIT-U, OTC: ENDTF)–To 4 from 5. The closed-end fund has taken a slightly more aggressive tack with its investments, focusing some 31 percent of holdings on natural resource companies and some non-dividend payers. That raises its risk slightly, though the dividend still looks solid.

Liquor Stores NA Ltd (TSX: LIQ, OTC: LQSIF)–To 4 from 5. The payout ratio surged in the first quarter to 180 percent. That should moderate due to seasonal factors. But a new revenue mix after recent acquisitions leaves some uncertainty, earning a one-point cut in the company’s Rating.

Medical Facilities Corp (TSX: DR-U, OTC: MFCSF)–To 2 from 3. The payout ratio rose in the first quarter, shaving a point off the company’s Rating. But management has announced a plan to convert to a corporation that will leave the current dividend rate intact, a very bullish development.

Morguard REIT (TSX: MRT-U, OTC: MGRUF)–To 6 from 5. After another quarter of strong earnings numbers (funds from operations per unit were up 20.7 percent) the REIT’s payout ratio has slipped to 64 percent, and it now meets all six Safety Rating System criteria.

New Flyer Industries Inc (TSX: NFI-U, OTC: NFYIF)–To 2 from 3. A drop in revenue due to greater reliance on sales of lower-priced vehicles has run the payout ratio up to 101 percent for the first quarter of 2011. That reduces the Safety Rating, though an improvement in the new orders-to-deliveries ratio to 1-to-1 augurs profits have stabilized and the dividend should hold. This one is for aggressive investors only but still looks like a good shot, particularly given the nearly 13 percent yield is already pricing in a dividend cut.

Rogers Sugar Inc (TSX: RSI, OTC: RSGUF)–To 1 from 2. First-quarter profit margin fell 12.3 percent, pushing up the payout ratio of 165 percent. The impact should be temporary, but the stock loses a Rating point nonetheless.

Russel Metals Inc (TSX: RUS, OTC: RUSMF)–To 2 from 1. The company’s key markets are recovering quickly. First-quarter earnings were up 266.7 percent, pushing the payout ratio down to just 51 percent and earning the company another Safety Rating System point.

Ten Peaks Coffee Company Inc (TSX: TPK, OTC: SWSSF)–To 2 from 3. Earnings won’t be released until Jun. 8. But the current low payout ratio based on fourth-quarter 2010 numbers understates the risks in this highly competitive business.

The Keg Royalties Income Fund (TSX: KEG-U, OTC: KRIUF)–To 3 from 2. Solid first-quarter 2011 results on both sides of the border spurred a sharp drop in the payout ratio to 77 percent and a boost in the Safety Rating of the restaurant pool royalties company.

TransForce Inc (TSX: TFI, OTC: TFIFF)–To 3 from 4. The first-quarter payout ratio has surged on the dividend increase, costs of expansion and seasonal factors. That cuts the Safety Rating by a point, but the impact will be temporary for this strongly growing transport company.

Veresen Inc (TSX: VSN, OTC: FCGYF)–To 4 from 5. The cost of recent asset expansion pushed up the first-quarter payout ratio to 109 percent. That should be temporary, and the dividend is not at risk. But the company no longer earns that Safety Rating System point.

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 CE Weekly 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.”

Roger Conrad
Editor, Canadian Edge