First, I want to thank everyone who took part in our reader survey. Your suggestions are critical to making Canadian Edge the best it can be.

The average Canadian Edge Portfolio holding is up nearly 10 percent thus far in 2008. That relatively tranquil number, however, masks some tremendous divergences among the individual holdings.

Not counting new addition Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF), the eight oil and gas producer trusts—all of which are housed in the Aggressive Portfolio—are up an average of 31.8 percent. Energy services holding Trinidad Drilling (TSX: TDG, OTC: TDGCF) and environmental/energy pick Newalta Income Fund (TSX: NAL.UN, OTC: NALUF) are up an average of 22.5 percent.

After a horrible start, our eight infrastructure trusts have actually broken into the black for the year. The four REITs have thus far bucked a powerful downdraft from the US property market, turning in a solid 6.4 percent gain. And our three mutual funds of trusts are up an average of 9.4 percent.



Offsetting that solid showing are dismal performances by five trusts. Arctic Glacier Income Fund (TSX: AG.UN, OTC: AGUNF) is lingering under a cloud from an antitrust investigation in the US and is down roughly 25 percent for the year (see below). Energy Savings Income Trust (TSX: SIF.UN, OTC: ESIUF) is off 14.7 percent on fears it’s exposed to US economic weakness. Meanwhile, concerns about Canada’s economy have knocked GMP Capital Trust (TSX: GMP.UN, OTC: GMCPF) down by 20.8 percent, TransForce Income Fund (TSX: TIF.UN, OTC: TIFUF) by 11.3 percent and Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) by 20.4 percent.

The first thing to note is that, except for TransForce, these laggards of 2008 were among the very top performers in 2007. Conversely, many of this year’s leaders were under water last year or close to it.

Income investing is a long-term game. You can’t collect dividends unless you’re willing to hold. In addition, trading multiplies your taxes and brokerage commissions. And you miss out on the benefits of rising distributions, which always push up share prices over time.

The key is holding Canadian income trusts backed by healthy, growing businesses. There will be ups and downs. But over time, distributions will rise and carry share prices up along with them.

That’s the clear lesson from the Portfolio table at the bottom of this article. Despite the stress tests of the past two years, the longer we’ve been able to hold individual trusts, the higher our returns have been.

One of the main reasons to diversify between sectors is that, at any given time, some will do better than others. You can ride out the weaknesses with a lot less emotion if you also have positions in the stronger fare.

Reality Check

Of course, not every recommendation winds up worth holding. Sometimes, a seemingly healthy business goes into reverse. That’s when you take the lumps (or profits) and look for something else.

Myriad factors affect a trust’s price from week to week or even month to month. Ultimately, however, business health is what’s important. And nothing measures that better than earnings reports.

The last round of earnings reports for trusts—fourth quarter and full-year 2007—wound up just days before the first quarter ended. That’s because end-year filings entail very time-consuming requirements. Happily, they generally confirmed the underlying good health of Canadian Edge Portfolio trusts. Unfortunately, the lag robbed the good numbers of most of their impact, as investors focused instead on the US slowdown and its potential to hurt trusts’ prospects.

The good news is we don’t have to wait nearly so long this time around. As this issue of CE goes to press, roughly half our recommended trusts have reported first quarter results. And by the end of next week (May 16), we should have numbers for the rest, which we’ll recap in a flash alert and the weekly e-zine Maple Leaf Memo.

Better, what we’ve seen thus far is decidedly bullish. First to report of our energy producers were ARC Energy Trust (TSX: AET.UN, OTC: AETUF), Penn West Energy Trust (NYSE: PWE, TSX: PWT.UN), Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF) and Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF). As expected, rising energy prices translated into strong cash flow and pointed the way to even better numbers for the rest of 2008.



Penn West reported a solid gain in distributable cash flow despite a 58 percent increase in outstanding shares because of acquisitions. The trust’s payout ratio sank to 58 percent, as it boosted output to 201,800 barrels of oil equivalent (boe) per day. Operating costs were flat sequentially with the fourth quarter, and debt fell slightly to 1.44 times cash flow.

During the quarter, Penn West faced criticism from some investors that it had forgotten about shareholder value in its drive to gain scale. The results betray some rough spots in integrating recent acquisitions. Higher energy prices, however, are doing a lot to grease the wheels, and there’s considerably more upside, as well as downside protection. First quarter realized oil prices were just CAD88.77 per barrel for oil and CAD7.98 per thousand cubic feet for natural gas, some 25 percent below current spot prices.

Management has pledged to use any surplus to further cut debt. But Penn West continues to face pressure to perform in coming quarters. Fortunately, still trading for just 1.66 times book value and an increasingly protected yield of nearly 13 percent, it’s still trading at a sizeable discount to its peers that seems less and less justified. Penn West Energy Trust is a buy up to USD38 for those who don’t already own it.

Peyto’s numbers were basically flat with year-earlier totals, the result of management’s decision to build inventories rather than ramp up output. The good news is that should mean stronger results in future quarters. Buy Peyto Energy Trust up to USD21.

Vermilion Energy, meanwhile, continues to prove why it deserves its rich premium to other producer trusts. The trust’s payout ratio shrank to just 33 percent, as funds from operations per share surged 50 percent. The key was a 14 percent increase in global production, combined with higher selling prices in Europe and Australia, as well as North America. Operating costs per boe also fell slightly from last year’s levels.

The most impressive thing about Vermilion is its ability to grow without issuing more shares or debt. First quarter distributable cash flow, for example, exceeded capital spending plus distributions by nearly a 2-to-1 margin, and total debt has fallen to just 0.8 times annual cash flow. That’s enabled the trust to increase its capital spending plans by 15 percent this year, as well as hike its distribution at a double-digit rate.

Looking ahead, Vermilion has numerous opportunities to expand output. Its 42.4 percent-owned affiliate Verenex is completing promising wells in newly opened Libya. A new pipeline in France will slash transport costs and make possible more production there. And tie-in wells in the Netherlands have boosted output there 14 percent over fourth quarter levels. All in all, it’s a pretty picture for Vermilion Energy Trust, which remains a buy on dips to USD40 or lower.



Best of all were ARC’s numbers, chiefly an 18.1 percent boost in cash flow per share that enabled a 20 percent jump in distribution. Rising production on tap for coming years and solid cost management make ARC Energy Trust a buy up to USD30.

Turning to services, Newalta Income Fund posted its best quarter in a very long time. The recent expansion in eastern and Atlantic Canada continued to pay off, as margins there rose 232 percent. The recently acquired lead-acid battery recycling operation was a particular standout, overcoming the negative impact of severe cold weather on waste operations to nearly double overall eastern revenue.

The real positive surprise, however, came from the trust’s western operations, which posted a 12 percent jump in margin as conditions in the natural gas patch at last showed signs of life. Newalta also benefitted from higher prices for its recycled products and successful expansion of operations in the oil sands region. The latter especially promises to key strong growth going forward.

The trust’s hallmark has always been cost controls. In that vein, selling, general and administrative expenses were reduced to just 9.9 percent of revenue—not including a foreign exchange gain—from 10.6 percent the year before. The trust realized proceeds of CAD4.5 million from the sale of noncore assets. And despite the increased use of debt to finance growth, interest coverage actually improved.



Overall, revenue rose 27 percent, and earnings before interest, taxes, depreciation and amortization (EBITDA) was up 35 percent. Funds from operations (FFO) rose 21 percent, and cash flow from operating activities was up 266 percent. Finally, cash distributed as a percentage of FFO was just 70 percent, down from 83 percent. And the payout ratio, including noncash disbursements, was also vastly improved, coming in at only 86.1 percent of FFO.

Newalta’s not out of the woods yet. Management has pledged to continue the current distribution at least to the end of 2008 and repeatedly states that the outlook for the rest of the year is very positive. But the trust is still dependent on oil patch cleanup contracts, and that area remains weak. Moreover, interest expense has grown 172 percent over the past year.

The long and short of it is we still need to watch this one closely to ensure it stays on track. The good news: These were very strong numbers. Yielding nearly 11 percent, Newalta Income Fund is a buy up to USD25 for patient, risk-tolerant investors.

Trinidad Drilling posted solid results in its first quarter, during which it converted from a trust to a corporation. Headline earnings per share were off slightly from year-earlier levels, largely because of an unrealized foreign exchange loss and higher depreciation because of a larger rig fleet. But profits were more than twice fourth quarter 2007 levels as rig activity picked up in both the US and Canada. Meanwhile, cash flow from operations—a prime indicator of ability to finance growth—nearly doubled from fourth quarter levels.

Drilling rig utilization in the US—where the company has boosted its fleet by 30 percent over the past year—rose to 87 percent. Drilling days rose by more than 49 percent. And while the rig count in Canada remained flat, drilling days nearly doubled from fourth quarter levels and were 5 percent above first quarter 2007 tallies.

Thanks to a focus on long-term contracts, US expansion and deep drilling, Trinidad survived its sector’s two-year stress test. Now organized as a corporation with industry conditions sharply improving, it should add to the gains it’s already piled on this year. Buy Trinidad Drilling for growth and income up to USD14.

Wires and Pipes

In the infrastructure department, Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) posted another round of strong numbers, as High Yield of the Month attests. So did our other sector trusts to report thus far, including AltaGas Income Fund (TSX: ALA.UN, OTC: ATGUF), as reported in the Feature Article, and Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF).

Boralex enjoyed a solid improvement in river flows to its hydroelectric plants, as output rose 6 percent from last year and was 19 percent above the historical average. Operator Boralex (TSX: BLX)—itself a 23 percent owner of the income fund—reported solid performance at all facilities. Meanwhile, high oil prices led to fatter profits from steam sales, and natural gas power plant operations’ cash flow rose 32.4 percent.

The results also showcased the reasons why management elected to trim the distribution earlier this year. Production in the biomass business slid 17 percent because the Senneterre power station was forced to shut for 10 days for emergency repairs on a Hydro-Quebec high voltage power line. Meanwhile, the closure of sawmills in eastern Canada and the US threatens to push up woodwaste costs. And favorable currency hedges are set to expire in February 2009.

The good news is the distribution now appears well covered. Cash levels are rising again, and interest expense is falling. Boralex still trades at just 97 percent of book value and has a yield of more than 12 percent, thereby pricing in a great deal of risk. Boralex Power Income Fund is a buy again for the aggressive and patient up to USD6.

Macquarie Power & Infrastructure Income Fund (TSX: MPT.UN, MCQPF) boosted first quarter revenue 50.7 percent and operating income 40.8 percent. Last year’s Clean Power takeover boosted output 65 percent, as hydro, biomass and wind plants ran well. Income from 45 percent ownership in retirement home operator Leisureworld rose 8.1 percent, as it, too, added assets and ran efficiently.

Macquarie’s distributable cash flow (DCF) per share actually fell 17.9 percent from year-earlier levels because of the 66.1 percent increase in outstanding units to absorb Clean Power. That investment, however, will become accretive to DCF in coming quarters.

Meanwhile, the trust’s payout ratio came in at just 80 percent for the quarter, providing plenty of protection for the recent distribution increase. Debt remains modest at 39.3 percent of total capitalization, providing a stable foundation from which to build growth and acquisitions.

All in all, this trust has proved itself again. Yielding more than 12 percent, Macquarie Power & Infrastructure Income Fund is a buy up to USD12.



Bell Aliant Regional Communications Income Fund (TSX: BA.UN, OTC: BLIAF) posted 1.1 percent growth in first quarter revenue and upped cash flow 1.6 percent. The rural phone company trust’s growth in broadband services once again outpaced steady erosion in basic local and long distance telephone customers.

The 7.7 percent increase in distributable cash flow was mostly due to a 17.5 percent drop in capital spending. That was thanks to the completion of the fiber network buildout the previous quarter. But with the trust continuing to successfully manage costs, cash flow should continue to increase going forward, providing more opportunity to increase distributions. Yielding nearly 10 percent and trading for 89 percent of book value, Bell Aliant Regional Communications Income Fund remains a solid buy up to USD33.

Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) posted an outstanding first quarter, as online revenue surged 48 percent and the directory business posted record margins. Growth in distributable cash flow per share actually accelerated from the fourth quarter’s robust totals, rising 12.9 percent.

This trust has climbed a wall of worry in recent months. These results should lay to rest any worries about long-term viability. Buy Yellow Pages Income Fund up to USD16.

Missing the Mark

RioCan REIT’s (TSX: REI.UN, OTC: RIOCF) FFO slipped to 32 cents a share from 35 cents the year before. That, in turn, pushed up its payout ratio to more than 100 percent.

The fault wasn’t the Canadian retail environment, which remains solid. And RioCan’s occupancy rate remains very strong at 96.6 percent. Rather, the shortfall concerns onetime items relating to the REIT’s expansion program, which includes net ownership interests of 3.5 million square feet in a series of projects near completion and another 4.9 million square feet in the development pipeline.

New projects include a development in suburban Ontario anchored by Cosco, a greenfield project lifestyle center in Quebec housing 155 stores and services and two home-improvement stores in Ontario to be built and run for Lowes. These deals demonstrate RioCan’s unmatched ability to attract strong partners in highly profitable projects and point the way to fatter profits ahead for the rest of 2008 and beyond. Still on track to meet its full-year projections, RioCan REIT is a buy up to USD25.

TransForce Income Fund (TSX: TIF, OTC: TIFUF) continues to face difficult market conditions on the eve of a May 12 shareholder vote to convert to a corporation. As I wrote last month, approval looks certain. Less sure is how Canada’s largest transporter is handling a slowing economy.

First quarter results certainly weren’t all rosy. Revenue rose 13.2 percent, reflecting acquisitions and other expansion initiatives over the past year. Operating expenses, however, rose even faster (up 16.1 percent). And although outstanding share growth was basically flat, debt interest expense surged 61.5 percent.

TransForce has continued to expand rapidly over the past couple years, even as rivals have pulled in their horns. That’s given it unmatched scale, which it’s using to grow even faster, the primary reason for converting to a corporation.

On the other hand, the slowing economic environment means it could be a while before management’s solid moves show up in earnings and the share price. The post-conversion distribution will certainly be safe. And despite being cut roughly 75 percent, it remains generous for a trucking company in the 5 to 6 percent range. I look for TransForce shares to make their way back into the low teens by early 2009, as the North American economy cycles out. Until then, however, TransForce Income Fund is for patient investors only up to USD9.

Two other portfolio trusts reported significant developments last month. In the April 18 flash alert, we relayed the highlights of a conversation with Arctic Glacier CEO Keith McMahon. McMahon affirmed the trust expected solid results in first quarter 2008, with little erosion from either the weaker US economy or US dollar. He also asserted the US Dept of Justice (DoJ) investigation of the US ice industry—and the wave of class-action lawsuits filed in conjunction with it—wouldn’t cripple his trust’s financial health or its long-run ability to expand.

Since then, there have been no real developments on the DoJ front. Arctic still hasn’t been named a target of the investigation, despite nearly a month of sending information. That’s no guarantee it won’t be ultimately. But two other developments back up McMahon’s optimism.



First, Arctic announced May 5 another decent-sized acquisition: the USD8.5 million purchase of Oregon’s Koldkist Ice. The deal involves keeping Koldkist’s founding Procelli family on board to lead the trust’s growth in the region. Koldkist is also a bottled water franchisee, which could presage a move in that direction for Arctic.

The fact that Arctic would announce such a deal now is certainly no guarantee the DoJ investigation is going away anytime soon. But clearly, it’s being made with the advice of counsel with what’s going on legally very much in mind.

The second positive development is the reaction of Arctic’s principal lenders to this purchase: increasing their commitment under existing revolving term credit by USD26 million to a total of USD161 million. Again, I’m no mind reader. But no one is lending in this fearful environment without real surety they’ll be paid back, and that also argues for the legal issues being less than they seem.

This is still a trust for patient, aggressive investors, and it’s critical to monitor developments carefully. For now, however, what we have seen is a good reason to stick with Arctic Glacier Income Fund.

Finally, Avenir Diversified Income Fund (TSX: AVF.UN, AVNDF) is selling its management interest in the EnerVest fund family. It’s too early to see if new owner Canoe Financial LP will run the funds—including Portfolio pick EnerVest Diversified Income Fund (TSX: EIT.UN, OTC: EVNDF)—differently from Avenir, i.e., focus on closing the fund’s yawning discount to net asset value by buying back shares instead of widening it by issuing new ones.

But the possibility remains a good reason to hang onto EnerVest, which has rallied sharply off its lows and still trades at nearly 16 percent below the value of its assets. EnerVest Diversified Income Fund remains a buy up to USD6.