The Next Act

The investing public hasn’t really caught on yet. But the threat of a global credit crunch spurred by US mortgage mayhem is already diminishing rapidly. In fact, with the Federal Reserve and other central banks pouring liquidity on any fires that erupt, global markets are already looking to the next act.

When world economic growth is robust as it is now, a flood of liquidity usually brings inflation and higher interest rates. That’s what happened in 1999, following the Greenspan Fed’s move to counter the Asian contagion and collapse of Long-Term Capital.

If history repeats, there’s no class of income investments I’d rather own than Canadian income trusts. As second quarter results again prove, top-quality trusts are still growing cash flows and distributions rapidly. Many will actually accelerate growth should inflation turn up, particularly in the energy patch.

Trusts continue to pay the highest dividends in the world. Many won’t be able to after 2010, should Canada’s current law to tax trusts in 2011 hold up. But many others do have the tools to keep dishing out generously well beyond that date, no matter how they’re taxed.

And the Canadian dollar is fundamentally a resource currency. Natural resources do well when economic growth is robust and they’ll push the Canadian dollar much higher in coming years. Every upward basis point move increases American investors’ wealth by lifting the US dollar value of trust distributions and share prices.

Last but not least, Canadian trusts are cheap. As the graph “Weathering Summer’s Storms” shows, they’ve recovered from the early 2007 lows. But expectations are still rock bottom. They’ve nowhere to go but up, and trust prices will rise with them. And as trusts’ generally solid performance during the summer shows, low expectation investments tend to hold their own in bad times.

Many investors still can’t get past the question of how trusts will be taxed in 2011. To them, I say this: If the current law is changed, any and all Canadian trusts are in for a windfall. The trouble is we have no way of knowing enough one way or the other to bet intelligently.

Moreover, we don’t have to make this bet to make big money in trusts. The worst on taxation is already priced in to this sector, as it’s been for several months. Any change will be hugely positive. But the key to winning with trusts is identifying healthy and growing underlying businesses. If we can do that, we’ll make money no matter what Ottawa does or doesn’t do.

Doing that is, of course, the primary focus of Canadian Edge. And this month’s really good news is our picks’ businesses are still healthy and growing. Some are already recovering nicely from their lows. Others in the energy patch have further to go because of slumping natural gas prices. All, however, are headed a lot higher.

I don’t generally like to make near-term market forecasts. But by the end of the year, I’m betting we’ll see new 2007 highs for most trusts that are well beyond pre-Halloween 2006 levels. And it won’t be because of politics or taxation rumors, but on trusts’ superior and consistent business results. That’s the only reason to hold any investment, whether your objective is growth or income.

Portfolio Action

I’m adding two real estate investment trusts to the Conservative Portfolio holdings: Artis REIT (AX.UN, none) and Canadian Apartment REIT (CAR.UN, CDPYF). With second quarter earnings generally meeting my expectations–and no takeovers currently in the works–I’m not removing anything from the portfolios this month. Conservative Portfolio holdings fared well throughout the subprime-induced selloff and are again rallying toward post-Halloween 2006 highs.

Aggressive Portfolio holdings are still weak, mostly because of weak natural gas prices. Our picks are generally holding, however, and I’ll stick with them for the time being for their ability to double and more when gas prices recover.

High Yields of the Month

I’m featuring two Conservative Portfolio picks in the High Yield of the Month section. One is an old friend: Altagas Income Trust (ALA.UN, ATGUF). The other, Artis REIT (AX.UN, none), is a newcomer to the portfolio. Both Altagas Income Trust and Artis REIT are cheap, growing rapidly and paying solid distributions.

How They Rate

I’m adding three real estate investment trusts to coverage: Huntingdon REIT (HNT.UN, HURSF), InStorage REIT (IS.UN, IGREF) and Interrent REIT (IIP.UN, IIPZF). I’m also picking up coverage of Canfor Pulp (CFX.UN, none). Countrywide Power (COU.UN, COUUF) and Versacold (ICE.UN, VCLDF)have now been acquired in all-cash deals and will come off the list next month. Note that Shiningbank Income Fund (SHN.UN, SBKEF) has completed its merger PrimeWest Energy Trust (PWI.UN, NYSE: PWI) and has been dropped already.

Here are advice changes. See the How They Rate or the Portfolio tables for changes in buy targets. Price and yield information is updated every 15 minutes on both tables.

  • Chartwell Senior Housing (CSH.UN, CWSRF) from a buy up to USD15 to a hold. This REIT is allegedly near a major strategic move, either involving a takeover or being taken over. The price, however, no fully reflects the possibility, even while cash flow still lags the distribution.
  • Daylight Energy (DAY.UN, DAYFF) from a buy up to USD12 to a hold. It’s not the one-third distribution cut that bothers me. That was expected. Rather, it’s potential problems rolling over bank loans in November. This one needs higher gas prices in the worst way.
  • IPC REIT (IUR.UN, IPCUF) from a buy up to USD13 to a sell. Management has sold out investors cheap, very likely due to fears about the US office property market. There’s no reason to hang around here, particularly with so many other more attractive REITs (see Feature Article).
  • Legacy Hotels (LGY.UN, LEGYF) from a hold to a sell. Management has sold out investors cheap. There’s not a lot of risk the takeover bid will fail, but there’s no real reason to hang around either.

Feature Article

Canadian real estate investment trusts have been big winners over the past year, in large part because the Conservative government excluded most from 2011 trust taxation. That’s hardly their only appeal, however, with the Canadian economy and property market on fire, share prices low and yields high. Moreover, Canadian REITs’ portfolios are healthy and are growing rapidly, in stark contrast to stagnating US REITs. Here are the best and worst.

Canadian Currents

Many investors were shocked when their trusts recorded second quarter charges against income, related to prospective 2011 taxation. The key thing to remember is these are one-time, non-cash charges and don’t impact profitability, cash flow or distributions. Canadian Currents looks at the nature of the writeoffs, and what they do and don’t mean.

Tips on Trusts

This section features short bits on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide “Subscriber Tips” section.

Dividend Watch List–The collapse of Canada’s natural gas patch remains the primary cause of distribution cuts in the trust universe. Lower gas prices are offsetting the strength in oil prices. This month, gas producer Daylight Resources Trust (DAY.UN, DAYYF)  and energy services trust Peak Energy Services Trust (PES.UN, PKGFF) cut distributions. Daylight appears the more vulnerable to further troubles. Both are holds. Outside energy, Connors Brothers Income Fund (CBF.UN, CBICF) suspended its distribution indefinitely last month, due to possible botulism from one of its product lines. Unfortunately, the threat of deeper legal problems makes it best avoided.

Bay Street Beat–How the Canadian analyst community views trusts, and how to use that information.

Non-Trust Stars–As we’ve pointed out in prior issues, trusts aren’t the only high-profit action in Canada. Here’s an update on our recommendations.

More Information

The following is a regular repeat from prior issues.

Use our live quote feed on the How They Rate Table for US dollar prices of trusts intra-day. For other information, go directly to a trust’s website by clicking on its name in the table. Clicking on the Toronto symbol (suffix “.UN”) will take you to the web site of our Canadian partner Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8) http://www.adviceforinvestors.com/, which has price charts and access to press trust releases. 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 income and royalty trusts. The Web site http://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 on trusts. Dominion Bond Rating Service is the pre-eminent credit rater for trusts. The Bank of Canada Web site features 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.

Roger Conrad
Editor, Canadian Edge