Editor’s Note: In Brief is the executive summary of the February 2012 issue of Canadian Edge. Please use it as a guide to reading the issue. — RC

2012 has opened with a bang for several Canadian Edge Portfolio stocks. Provident Energy Ltd’s (TSX: PVE, NYSE: PVX) takeover offer from Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF), for example, netted investors in the Conservative Holding a 16 percent gain for January. And those who hold through the deal will also get a 27.5 percent dividend increase.

TransForce Inc (TSX: TFI, OTC: TFIFF) has done better still, surging more than 25 percent on the year thanks to a successful acquisition and bullish assessments from Bay Street analysts. Bird Construction Inc (TSX: BDT, OTC: BIRDF) and Newalta Corp (TSX: NAL, OTC: NWLTF) are both up double-digits, adding to rallies that caught fire in the fourth quarter.

Of the 22 current Conservative Holdings, 12 have surged above my buy-under target. And most Aggressive Holdings either are above target or are rapidly closing in.

Unfortunately, we’re also seeing the emergence of a handful of laggards.

Front and center are companies with perceived exposure to this year’s crash in natural gas prices. In 2011 Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) was the second-best performer of the 32 Oil and Gas producers I track in How They Rate.

This year the stock has dropped 18 percent, third-worst behind Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF) and Perpetual Energy Inc (TSX: PMT, OTC: PMGYF).

Peyto and Progress are far stronger companies than Perpetual. Neither faces any debt maturities in 2012. Peyto’s operating costs were just CAD2.16 per barrel of oil equivalent (boe) in the most recent quarter, while Progress’ were CAD5.56 per boe. That’s versus Perpetual’s CAD10.86 per boe operating costs and ticking time bomb of CAD98.07 million drawn on a credit agreement that must be rolled over by May 29 as well as CAD75 million of convertible debt maturing Jun. 30.

Perpetual’s slide under CAD1 a share this year reflects rising speculation of a bankruptcy filing. That’s not something Peyto or Progress shareholders have to worry about. In fact, most of Peyto’s slide this year is simply a reversal of last year’s rally that pushed the stock well above my buy target of USD22.

The drop in gas prices, however, will make it very hard for producers and, quite probably, energy services stocks to make real headway this year. And the same appears to be true for many of the stocks that led the way the past couple years, including energy midstream and pipeline stocks.

Pembina Pipeline shares have moved up slightly since the company announced its takeover offer for Provident, a testament to how solid the deal is. The torrid gains of recent years, however, have cooled at least some investors on its prospects, as well as those of AltaGas Ltd (TSX: ALA, OTC: ATGFF) and Keyera Corp (TSX: KEY, OTC: KEYUF).

The good news is these three companies are stronger than ever as businesses. And all three are set for dividend increases this year, with Pembina set to boost 3.8 percent following the close of the Provident merger. The same goes for our real estate investment trusts, all big winners last year but laggards thus far in 2012.

This year’s biggest gains, however, are likely to come from stocks that dragged last year, despite solid business performances from underlying companies. Good candidates include any Canadian Edge Portfolio stock trading below its buy target.

Looking down the Portfolio, only two stocks currently rate holds. One is Provident Energy, which is now fully priced to the Pembina deal. The other is Enerplus Corp (TSX: ERF, NYSE: ERF) which, as I pointed out in a Jan. 18 Flash Alert and the January Feature Article, is the Aggressive Holding whose dividend is most leveraged to natural gas prices. The company beat its exit production target for 2011 and laid out a 2012 capital spending plan with solid support for the payout this year.

The crash in gas prices in recent months, however, is a major event with as yet unknown consequences. I don’t anticipate selling Enerplus or any other Portfolio company at this time. But I want to be absolutely clear with Canadian Edge readers that there are risks at the company that can’t be fully assessed at this time. And that’s a reason for caution on this stock.

Hindsight is always 20-20. And viewed that way there were definitely signs of trouble early in 2011 for all three of my losers last year, Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF), Perpetual Energy and Yellow Media Inc (TSX: YLO, OTC: YLWPF).

Last year’s macro environment of slow, uneven economic growth in North America proved positive for the vast majority of Canadian Edge companies but deadly for these three. This is pretty much the scenario I see for 2012. My resolution for this year, therefore, is to be faster about shedding companies that show real weakness as businesses.

I’m still going to take my cues from business numbers. This means I’m going to continue advising living with volatility when those numbers are still solid. But when a company issues unexpectedly negative guidance–or, worse, cuts its dividend–I’m going to get out quickly and move onto something else, even if it means booking a loss.

The key to last year’s solid Canadian Edge Portfolio returns was being broadly diversified and balanced, so the losers didn’t drag us into the red. Shedding losers earlier, however, would have sharply limited their overall impact, even as most of the Portfolio fared well. My resolution this year is to do just that. That’s how I intend to improve our performance in what’s likely to be an equally challenging year.

Portfolio Action

I’m making one change to the Canadian Edge Portfolio this month, adding High Yield of the Month Dundee REIT (TSX: D-U, OTC: DRETF) to the Conservative Holdings as a buy up to USD35.

Note that all four of the other REITS in the Portfolio are currently trading above buy targets, Artis REIT (TSX: AX-U, OTC: ARESF), a buy under USD15, Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF), a buy under USD20, Northern Property REIT (TSX: NPR-U, OTC: NPRUF), a buy under USD30, and RioCan REIT (TSX: REI-U, OTC: RIOCF), a buy under USD25. Those planning an investment should wait until those targets are revisited.

In the meantime, Dundee features a yield north of 6.5 percent, paid monthly.

The following Conservative Holdings also trade below buy targets and are therefore ripe for purchase by those not already overloaded on them:

• Atlantic Power Corp (TSX: ATP, NYSE: AT)–USD16
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)–USD28
• Cineplex Inc (TSX: CGX, OTC: CPXGF)–USD26
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–USD20
• IBI Group Inc (TSX: IBG, OTC: IBIBF)–USD15
• Just Energy Group Inc (TSX: JE, NYSE: JE)–USD16
• Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF)–USD28
• Shaw Communications Inc (TSX: SJR/B, NYSE: SJR)–USD22
• Student Transportation Inc (TSX: STB, NSDQ: STB)–USD7

The following Aggressive Holdings are trading below targets:

• Acadian Timber Corp (TSX: ADN, OTC: ACAZF)–USD13
• Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–USD40
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)–USD26
• Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–USD48
• Extendicare REIT (TSX: EXE-U, OTC: EXETF)–USD10
• Newalta Corp (TSX: NAL, OTC: NWLTF)–USD15
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–USD6
• Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–USD13
• Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)–USD25
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–USD22
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–USD14
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–USD50

Note that Just Energy Group now trades on the New York Stock Exchange (NYSE).

High Yield of the Month

High Yield of the Month features the two best buys for February. If you’re starting a portfolio, buying these selections each month is one good strategy, provided the picks meet your own risk-reward preferences.

This month’s choices are two companies that announced mergers last month. One is current Conservative Holding Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF), which is joining forces with fellow Conservative Holding Provident Energy Ltd (TSX: PVE, NYSE: PVX). The deal is on track to close in the first quarter of 2012, shortly following shareholder votes slated for Mar. 27 and what should be quick approval from regulators.

Pembina shareholders will receive an immediate 3.8 percent boost in the monthly dividend, followed by 3 to 5 percent annual payout increases. The stock is also slated to list on the New York Stock Exchange (NYSE) when the deal closes. My new buy-under target for Pembina Pipeline is USD28.

Provident shareholders get 0.425 shares of Pembina for every share they now own as well as an effective 27.5 percent dividend increase when the deal closes. Provident Energy rates a hold now, as it’s basically trading at takeover value and a failure of this deal for any reason would almost surely trigger a retreat to under USD10 a share.

The other High Yield of the Month is new Conservative Holding Dundee REIT (TSX: D-U, OTC: DRETF), which is acquiring Whiterock REIT (TSX: WRK-U, OTC: WRKUF). The deal is strongly accretive to Dundee, which will become Canada’s fourth-largest REIT with a broadly diversified commercial property portfolio.

The units currently yield north of 6.5 percent, and management will be in position to announce an increase when the new properties are absorbed. Dundee currently trades at just 1.16 times book value. Buy Dundee up to USD35.

Whiterock unitholders get either CAD16.25 per unit in cash (up to a total of 60 percent of the total bids) or 0.4729 Dundee units. That’s a premium of 20 percent to the pre-deal price. Whiterock rates a hold. The current price is close to the takeover price and there’s an effective 7.4 percent distribution reduction when the deal is completed, which is expected shortly after unitholders meet Feb. 27, 2012.

Feature Article

The strength of Canada’s financial system was a major reason the country avoided a steep recession in 2008-09. Sector stocks generally underperformed in 2011, as many investors worried the big banks as well as niche companies would suffer from a collapse in Europe. This year, meanwhile, there’s a growing consensus Canadians are taking on too much debt, exposing banks to a new risk.

Ironically, Canada’s financial institutions big and small are stronger than ever and, thanks to so much worry about systemic risks, few companies are taking the kind of chances that could trigger a real meltdown.

The upshot is there are stocks in this sector trading at good values. They’re strong enough to weather another global relapse, even if Canadian growth is a casualty. And they’re in prime position to profit if North America remains on a path to growth.

Canadian Currents

CE Associate Editor David Dittman takes a look at Australia’s Big Four banks, which have been compared favorably to Canada’s Big Six but have their own set of challenges.

This edition of Canadian Currents was previously published in Australian Edge, CE’s sister letter, which provides comprehensive coverage of dividend-paying Australian 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—NAL Energy Corp (TSX: NAE, OTC: NOIGF) was the only Canadian Edge How They Rate company to announce a dividend cut in January. The oil and gas producer included a 29 percent reduction to its monthly payout during on the agenda of a “forecast teleconference” held Jan. 11. The new rate of CAD0.05 per share should be well covered by distributable cash flow on the fourth quarter based on the low payout ratio of the third quarter and management’s statements about production.

On the other hand, natural gas prices remain only around USD2.50 per million British thermal units (MMBtu) as of this writing. Given the company’s capital spending needs to boost liquids production–as well as CAD382 million-plus in debt maturities starting Apr. 30–there are no guarantees it will have the cash to do everything it wants to. And the distribution is always the first thing to be cut.

Consequently, NAL Energy is still on the Dividend Watch List and continues to rate a sell.

Here’s the rest of the Watch List.  Note the List is basically the same as last month, as we’re waiting on fourth-quarter and full-year 2011 results. I’ve noted when such releases have either been announced or are expected below:

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF)–Advice: SELL. This closed-end fund still has the same problem: Its investment income is far less than what it’s paying out in dividends. Sooner or later it’s either going to have to increase investment income or cut the payout, and risks are high it will be the latter.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–Advice: Hold. Pulp and paper market prices seem to have firmed up a bit, despite the slow down in the eurozone. That’s a positive, as is being a low-cost producer. But  the margin for error is small with the payout ratio so high. Feb. 7 (confirmed.)

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Advice: SELL. We’re still waiting for management to clarify the cash flow guidance warning it gave last year. What is almost certain is there will be a dividend cut. Mar. 8 (confirmed)

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Advice: Hold. I’m almost ready to take this one off the Watch List, but I want to see more progress with debt reduction and some solid dividend coverage the next couple quarters, given the shrinking US Medicare budget. Mar. 1 (confirmed)

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–Advice: Hold. It doesn’t look like a resolution of the company’s dispute with Air Canada (TSX: AC/A, OTC: AIDIF) is going to happen soon. Until there’s some certainty the risk of a dividend cut is high. Feb. 21 (confirmed)

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Advice: Hold. This company appears increasingly likely to come off the Watch List. But I’m still concerned about the ability of remaining operations to support the dividend level without US growth. The next couple quarters of earnings will tell the tale. Mar. 5 (estimate)

Data Group Inc (TSX: DGI, OTC: DGPIF)–Advice: Buy @ 4. The stock has rallied in the past month following its conversion from a corporation without cutting its dividend. The key is whether the company will go digital fast enough to hold the hefty level of payout.

The stock is still priced for a sizeable cut. But we’ll know more in coming quarters if management can deliver on its prior pledge to hold the payout. Mar. 2 (estimate)

EnerVest Energy & Oil Sands Total Return Trust (TSX: EOS, OTC: EOSOF)–Advice: SELL. The closed-end fund has recently paid a dividend from capital, not investment income. There are better ways to play growth in the energy patch.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: SELL. The key here is advertising sales, and particularly whether they hold at the company’s core newspapers. My view is the best investors can realistically hope for is a small dividend cut. Mar. 19 (estimate)

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Advice: Hold. The company’s main hope is royalties from what are primarily oil-producing properties continue to be robust, offsetting the exposure it has to natural gas prices. Meanwhile, the payout ratio is quite high for such a volatile industry. Mar. 2 (estimate)

GMP Capital Inc (TSX: GMP, GMPXF)–Advice: Hold. The company’s fortunes wax and wane with activity on the Toronto Stock Exchange (TSX) as well as mergers and acquisitions. Management’s admission that continued horrific conditions in its industry could trigger a dividend cut has raised risk. Fourth-quarter results and new guidance for 2012 will be telling. Mar. 2 (estimate)

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–Advice: SELL. The company has released preliminary numbers about sales and order backlog, and the numbers definitely are not pretty. The posted yield still does not reflect the projected 50 percent dividend cut. Mar. 21 (estimate)

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF)–Advice: SELL. This closed-end fund has paid all of its distribution in recent quarters from capital rather than investment income, which is  currently non-existent. The fund could still rally if mining stocks do. But the payout could also be cut at any time, should management elect to save capital for investment.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF)–Advice: SELL. Business seems to have stabilized for now. But an 80 percent dividend cut since the July 2002 initial public offering is a pretty clear sign producing and marketing decaffeinated coffee this isn’t a good business model for paying dividends long term. Mar. 19 (estimate)

Bay Street Beat—Bay Street is excited about a Canadian airline stocks, and we take a look at how analysts perceive CE Portfolio Holdings on the eve of earnings reporting season.

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

How They Rate

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 are described in the text below the How They Rate table and are as follows:

• One point if Payout ratio meets “very safe” criteria for the sector.
• One point if Payout ratio has longer-term visibility.
• 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 10 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 energy producers are included here.
• Electric Power–Power generators.
• Gas/Propane–Distributors from propane to packaged ice.
• Business Trusts–A range of businesses involved principally with consumers.
• REITs–All qualified real estate investment trusts.
• 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–Canada’s banks, investment houses and other trusts and corporations feeding that business.
• 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

I’ve dropped Daylight Energy from coverage, as China Petroleum & Chemical Corp, better known as Sinopec (NYSE: SNP), has completed its acquisition of the company for CAD10.08 in cash. The cash proceeds should now have been paid into investors’ accounts. There should be no 15 percent withholding from US investors’ accounts, as this isn’t a dividend.

Note I’ll continue to cover Arctic Glacier Income Fund (CNSX: AG-U, OTC: AGUNF) in How They Rate. The stock is now trading on the Canadian National Stock Exchange (CNSX), and price quotes are still available. My strong advice, however, is still to sell this stock if you haven’t already.

It’s very hard to see what value there is for the common shares after bankruptcy, which appears inevitable by Feb. 10, 2013, when a CAD57.5 million credit line matures, on which CAD29.68 million is now drawn.

Advice Changes

Here are advice changes for this month. I also note expected and confirmed earnings announcement dates. See How They Rate for changes to buy targets and other data.

Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)–To Buy @ 14 from Hold. Canada’s property market may flatten this year but isn’t likely to crash even in a major global catastrophe as leverage and speculation are still modest. Moreover, 68 percent of this company’s income is from fees and is therefore secure even if conditions soften. Mar. 14 (estimate)

CurrencyShares Canadian Dollar Trust (NYSE: FXC)–To Hold from Buy @ 96. The Loonie is back near parity with the US dollar. It should go higher in the long run but from this level the best way to play its strength is with individual stocks.

H&R REIT (TSX: HR-U, OTC: HRUFF)–To Hold from Buy @ 21. The unit price has surged since the beginning of fourth-quarter 2011 to more than 10 percent above my most recent buy target. Nonetheless, there’s still uncertainty about the company’s stapled share structure, combining debt and equity. And falling natural gas prices have raised some questions about the long-run health of Encana (TSX: ECA, NYSE: ECA), the REIT’s cornerstone tenant at The Bow office building. Feb. 24 (estimate)

HOMEQ Corp (TSX: HEQ, OTC: HEITF)–To SELL from Hold. The company is growing rapidly, boosting reverse mortgage originations by 42 percent in the fourth quarter. Its portfolio is now 17 percent bigger than a year ago. That’s good news for near-term profits, but rapidly growing companies in the mortgage business have a way of stumbling. And shares have surged to a multi-year high recently. Mar. 7 (estimate)

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–To Hold from Buy @ 10. This stock has had a mercurial rise, reflecting its vastly improved prospects (see Ratings Changes, below). As is the case all rapid risers, however, it’s likely to take a break. Mar. 8 (estimate)

Potash Corp of Saskatchewan (TSX: POT, NYSE: POT)–To Hold from SELL. The global potash market looks more likely to surprise on the upside than the downside, and this stock has backed well off its mid-2011 high. Jan. 26 (announced)

Provident Energy Ltd (TSX: PVE, NYSE: PVX)–To Hold from Buy @ 9.50. The company’s planned merger with Pembina Pipeline (TSX: PPL, OTC: PBNPF) should close shortly after the special meeting slated for March 27. The stock, however, already trades at takeover value and an unlikely rejection of the deal would send it back toward my most recent buy target. Mar. 9 (estimate)

Whiterock REIT (TSX: WRK-U, OTC: WRKUF)–To Hold from Buy @ 13. The REIT’s units have soared to more than 20 percent above my buy target following the takeover offer by Dundee REIT (TSX: D-U, OTC: DRETF). Approval of the merger is highly likely, but the REIT’s price will slide if it isn’t. Mar. 21 (estimate)

Ratings Changes

Here are CE Safety Rating changes, reflecting third-quarter 2011 results, debt maturities for 2012 and 2013, and recent weakness in energy prices. I’ve also listed expected and confirmed reporting dates for fourth-quarter and full-year 2011 earnings.

Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV)–To 0 from 1. It’s all about crashing natural gas prices and rapidly approaching debt maturities. There’s still CD165 million coming due June 16, 2012. My view is still that it will be successfully rolled over at a decent rate. But until it is, there’s uncertainty and a lot of risk. Mar. 22 (estimate)

Equal Energy Ltd (TSX: EQU, NYSE: EQU)–To 0 from 1. Falling natural gas prices, small size and more than CD141 million in approaching debt maturities (June 29, 2012) are considerable risks. Mar. 23 (estimate)

GMP Capital Inc (TSX: GMP, OTC: GMPXF)–To 2 from 3. This company sinks or swims based on activity on the Toronto Stock Exchange (TSX). That’s made future earnings visibility quite cloudy in early 2012. Mar. 2 (estimate)

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–To 2 from 1. The company finished 2011 with a vast improvement in production. It’s also been able to issue USD875 million in bonds to pay off maturing debt and pay down its credit line. Mar. 8 (estimate)

Trilogy Energy Corp (TSX: TET, OTC: TETZF)–To 3 from 4. The rapid drop in natural gas prices will take some of the shine off recent rapid gains in production, and it clouds the picture for 2012 earnings. Mar. 6 (estimate)

More Information

How They Rate has automatically updated US dollar unit/share prices, dividend payment rates in US dollars, yields, most recent dividend dates, dividend frequency and debt-to-capital ratios. Note that our quote service sometimes includes special annual distributions along with the regular monthly payments. How They Rate also includes several free links. Clicking on the Toronto Stock Exchange (TSX) symbol will now take you directly to the Google Finance page for every company in the How They Rate coverage universe.

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