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

How protected are Canadian stocks from a US or Greek government default and resulting global credit crunch? How far will oil prices fall if China pulls in its horns? How much will that pull down the loonie and Canadian investments in general? Is Canadian real estate a bubble? What happens to our Portfolio Holdings if the global economy slows?

Most Canadian stocks have lost ground since the market’s most recent peak in early May. True, half of the Canadian Edge Conservative Holdings are still trading above my buy targets. That’s despite the fact that I’ve raised them for several companies based on solid first-quarter results.

All of the Aggressive Holdings, however, are now selling below their respective buy targets. And so are all of the natural resource producers I’ve recommended as buys in How They Rate.

Why the pullback? Simply, the memory of 2008 is all too fresh. Since that crash every dip in stocks has many investors asking the questions listed above–and no wonder. The financial media continue to trumpet every pullback as the potential beginning of a greater crash.

Market psychology was much the same in spring and early summer 2010. Then, investors also worried about softer economic growth and global credit concerns as precursors to a steep drop for stocks.

Last year’s downturn eventually reversed by mid-summer, and stocks–including almost every Canadian Edge Portfolio recommendation–moved on to new post-crash highs by late April 2011. Rising prices calmed fears of a reprise of 2008, as investors again focused on growth and yield.

That’s pretty much what I expect to see this time around. For one thing, sovereign debt crises–whether in Greece or the US–don’t have the potential to sow panic the way the mass default of mortgage-backed securities did in late 2008.

With government bonds everyone knows where exposure lies. A real US default would no doubt hurt the US economy, not to mention the country’s credibility. But there would be no surprises about where exposure lies.

That’s a very stark contrast with the mortgage-backed security crisis in late 2008, when bombs went off repeatedly in places suspected by few, if anyone at all.

As for economic growth, for all the sturm and drang in the financial media, it’s still running basically the way it has since mid-2009. That is very lumpy and uneven with real pockets of weakness. But it’s growing nonetheless. Meanwhile, 1970s-style inflation remains impossible, due to very slack employment conditions.

In 2010 many investors were convinced Chinese growth was on the verge of slowing rapidly, and prices for commodities, including oil, dropped in anticipation of lower demand. That didn’t last long, as the world’s most populous nation soon drew down inventories of key supplies and ramped up imports once again.

The current selloff may go on for a while longer. But the bottom line is credit, economic and market conditions just aren’t anywhere close to as dire as they were in mid-2008, before the crash unfolded. That means we’re likely to see a third leg of the post-crash bull market begin sometime this summer, and that means still higher prices for our CE favorites.

What I feel best about, however, is that if I’m wrong, my favorite Canadian companies are protected. First, they have little if any refinancing risk, having basically cleared out all but a handful of obligations due to mature before the end of 2012. They’ve done this by using generation-low corporate borrowing rates to minimize interest costs. And should credit conditions tighten, they can simply delay bond offerings until things loosen up.

The Canadian economy as a whole is also far less leveraged than the US. The country’s federal budget is on track for balance in the next couple years. Debt has risen at the household level. But 69 percent of Canadian homeowners have at least 20 percent equity in their homes. Those just aren’t the right conditions for a wholesale crash as happened in the US.

With few exceptions, CE Portfolio companies operate in recession-resistant niches that proved their ability to generate consistent revenues during the 2008 crash and subsequent recession. And, mindful of the potential for a relapse, management has used the better economy of the past couple years to further cut risk by adding stable assets.

Even the Canadian dollar is no longer acting like the commodity-price proxy of yesteryear. Despite a sharp drop in oil prices last month and worries about slowing growth, the loonie held above parity versus the US dollar.

Of course there are circumstances where stocks of even the strongest companies will drop sharply. And some companies–such as Yellow Media Inc (TSX: YLO, OTC: YLWPF), which I review once again in the Dividend Watch List section of Tips on Trusts–have weakened in the current slow-growth environment. 2008 proved, however, that so long as a company remains solid on the inside, its stock will eventually recover any decline due solely to market factors. So long as CE recommendations measure up on the numbers, we’re going to want to continue holding on.

This doesn’t mean doubling down as prices drop. That strategy has the potential to kill a portfolio under the wrong conditions. In fact, you should be ready to sell any position if it makes sense to, regardless of the gain or loss.

But it does mean letting bets ride in a balanced and diversified portfolio of well-chosen, dividend-paying stocks backed by healthy and growing businesses, even if the market is in severe turmoil. Remember, this is a high-percentage strategy that worked in 2008. It will work again in 2011.

Portfolio Action

There’s only one change to the Canadian Edge Portfolio this month: I’m moving Provident Energy Ltd (TSX: PVE, NYSE: PVX) from the Aggressive Holdings to the Conservative Holdings. This reflects the company’s successful transition from a commodity-price sensitive producer of oil and gas to Canada’s leading pure play on natural gas liquids (NGL) infrastructure.

As management indicated in a recent analyst presentation, it may be a while before the company considers dividend growth, which may keep a lid on its share price. But the more NGL assets it adds and the faster this business grows, the better position it will be in. In the meantime, the stock pays out at a generous annual rate of 6.4 percent paid monthly in Canadian dollars.

I’m maintaining hold ratings on Colabor Group Inc (TSX: GCL, OTC: COLFF) and Yellow Media Inc (TSX: YLO, OTC: YLWPF).

Colabor has completed the acquisition of SKOR Foods, boosting its presence in Ontario substantially. That’s bullish, as is the stabilization in the stock following a plunge in the wake of announcing disappointing first quarter earnings. But I still want to see how the distributor of food and related products in eastern Canada handled its costs in the second quarter before turning positive again.

As for Yellow, I’ve covered the relevant issues many times over the past month–even as I’ve urged anyone who can’t look at the company dispassionately to get out. As far as I’m concerned, there’s been only one real development of consequence since the company announced what appeared to be solid first-quarter earnings back in early May.

That was the Jun. 29 announcement that Canadian regulators have approved the CAD745 million sale of certain assets operated by the company’s Trader Inc unit. The news seems to affirm management’s assertion that this asset sale is still on track and that Yellow will be able to use the proceeds to slash debt deeply when it closes at the end of July. And it flies right in the face of skeptics who’ve been telling the precise opposite to anyone who will listen.

That being said, Yellow has been a loser for us so far, and a recovery in the stock looks a long way off. Moreover, it’s far from a sure bet that this deal will go through, or that management’s assertion its Internet business will grow fast enough to offset print declines will hold up. This is a speculation. We’re still in the game, which is why I’m holding it. But this could also go up in smoke. No one and I mean no one should be doubling up here.

In stark and very happy contrast are the rest of the Canadian Edge Portfolio Holdings. In Portfolio Update I review the prospects of each company, what I expect to see for second-quarter results and the key catalysts and risks for each stock. I also show once again where to go to get my analysis of first quarter results.

Note the CE philosophy is basically to buy and hold dividend-paying companies, so long as the underlying business is healthy and growing. All but Colabor and Yellow passed the test with flying colors in the first quarter and should do so again in the second. But as always, 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 July. This month I highlight two current Portfolio Holdings that are building wealth with acquisitions.

Atlantic Power Corp (TSX: ATP, NYSE: AT) is acquiring Capital Power Income LP (TSX: CPA-U, OTC: CPAXF) in a CAD1.11 billion half-cash, half-stock deal that will boost production capacity by 143 percent and for the first time add operating employees and Canadian dollar assets.

The purchase, which is expected to close in the fourth quarter, is also immediately accretive to distributable cash flow and will result in an immediate 5 percent dividend increase for Atlantic. And it creates a substantial platform for future growth, centered on long-term sales contracts of green energy to creditworthy customers, mostly provincial authorities and utilities. My buy target is now USD16 for Atlantic Power, which yields around 7.3 percent.

Parkland Fuel Corp’s (TSX: PKI, OTC: PKIUF) latest acquisition is Cango Inc., a leading retail fuel marketer in Ontario with 155 retail sites and serving a 126 dealer network. The new assets fit nicely with the company’s existing system, which already make Parkland Canada’s largest independent fuel distributor and marketer.

And more growth is on the way, as the company consolidates an industry in which it currently holds just 5 percent of the market. Yielding 8.2 percent, Parkland Fuel is a buy up to USD13.

Feature Article

Show me a mutual fund and I can always show you an individual company I’d prefer to own. But for investors who want to own a basket of Canadian stocks without having to choose which ones, there are a large number of options among closed-end and exchange-traded funds (ETF).

Associate Editor David Dittman reviews a handful of funds and ETFs we’ve found of interest. Most of these we already cover in How They Rate. The rest we’ll likely add.

Note that many of these funds actually trade at a discount to the value of their assets. Unlike open-end funds, closed-ends sell on major exchanges, like stocks. Buying a fund at a 10 percent discount, for example, basically paying 90 cents for a dollar of assets. Canada-based open-end funds–which always trade at the value of their assets–are off limits to US investors due to securities regulations.

Canadian Currents

Associate Editor David Dittman breaks down the tax situation for US investors who own dividend-paying Canadian stocks.

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–This month three How They Rate companies trimmed dividends. The only shocker was Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF), which eliminated its payout after announcing very weak first-quarter earnings. The stock has now plunged more than 80 percent this year, and there’s little reason for anyone to hold it, particularly since management had pledged the safety of the dividend just a few weeks before as it issued a large volume of stock.

Dividend Watch List has information on how to get involved with a class action lawsuit against the company for anyone who bought it from the end of March to mid-June.

New Flyer Industries Inc (TSX: NFI-U, OTCL NFYIF) has declared its intention to convert to a corporation, most likely by the end of the year. The move will come with a 50 percent dividend cut, though the company will lessen the pain by issuing a special dividend of between CAD0.185 and CAD0.345 between conversion and August 2012.

The good news is New Flyer at its current price still pays a generous dividend, which is now set to hold even in the fact of tough industry conditions. And the company continues to replace backlog with new orders, including its first bus sale to a Quebec customer in 40 years. New Flyer Industries is still a buy up to USD10.

Westshore Terminals Investment Corp’s (TSX: WTE, OTC: WTSHF) 11 percent dividend cut from the prior quarter’s level is due to a combination of seasonal factors and the tax on specialized income flow-through entities Canada began to impose in January. The underlying business of providing fee-based terminal service to metallurgical coal producers for export remains very healthy and low-risk. Unfortunately the yield is low as well, but the stock is safe and a buy up to USD24. Note that seasonal factors will likely lift the dividend in the following quarter.

The current Watch List is as follows. Companies on the 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 VIP 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.

Tips on DRIPs–Reinvest your dividends paid by NYSE-listed Canadian companies–in some cases at a discount and without paying commissions.

How They Rate

The CE Safety Rating System is 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

There’s one coverage addition to How They Rate this month. We’re adding PetroBakken Energy Ltd (TSX: PBN, PKKEF) to coverage under Oil and Gas. Note that as of next issue, Peak Energy Services Ltd and TimberWest Forest Corp will drop off from coverage. Peak has now been acquired for CAD0.95 per share in cash, while TimberWest was purchased for CAD6.16 per share. The cash should show up in investors’ accounts shortly.

Advice Changes

Here are advice changes. See How They Rate for changes to buy targets. Rating system criteria are shown at the bottom of the document.

Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF)–Hold from Buy @ 2. A move to issue units to retire a convertible debenture will reduce leverage but is hardly a sign of strength. If you own this one, let it ride but I want to see some improvement before upgrading to buy again.

Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF)–SELL from Hold. The surprise elimination of the dividend in the wake of a poor first quarter earnings report is not only the sign of a weak company. But is a sharp reversal of management’s assurances just weeks ago that the dividend was safe.

NAL Energy Corp (TSX: NAE, OTC: NOIGF)–Hold from Buy @ 15. A change in the chief operating officer position causes some uncertainty as the company faces another quarter of lower gas prices.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–Hold from SELL. There’s no dividend yet, but first-quarter earnings were solid and the company won a new pact with lenders that will eventually allow a payout.

Northland Power Inc (TSX: NPI, OTC: NPIFF)–Hold from Buy @ 14. The stock has surged well above my prior buy target, even as its payout ratio remains relatively high, limiting dividend growth potential.

Premium Brands Holding Corp (TSX: PBH, OTC: PRBZF)–Buy @ 17 from Hold. Strong results, and the promise of more to come, make this company attractive and a buy for the first time in How They Rate.

Ratings Changes

Armtec Infrastructure Inc (TSX: ARF, OTC: AIIFF)–1 from 3. The company has eliminated its dividend and reported a 74.6 percent jump in interest expense in the first quarter of 2011.

Bonterra Energy Corp (TSX: BNE, OTC: BNEFF)–3 from 2. The company gets a bump up in its Safety Rating on a drop in its payout ratio. Growth remains leveraged to liquids prices, production of which continues to grow.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–1 from 2. The company drops a Safety Rating System point for lagging earnings, which could take another hit in the second quarter due to dragging natural gas prices.

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.”