Two Winners from Up North

Canaccord Adams analyst Yuri Lynk released a bullish report on Canada-based infrastructure opportunities, naming Bird Construction Income Fund (TSX: BDT.UN, OTC: BIRDF) among his top picks. A provider of building design and construction services primarily to institutional and industrial clients for more than 85 years, Bird converted to the trust format in February 2006.

There’s not much excitement on the yield front, though it does pay about 3.8 percent. The nature of the construction business requires Bird maintain a strong balance sheet, and it must allocate cash to working capital to support access to surety agreements. Bird’s payout ratio for 2007 was 55 percent.

Growth prospects, however, are supported by the recognition that Canada must address its aging infrastructure. On top of substantial opportunities on the institutional front, Bird is also benefiting from activity in the oil sands region in western Canada and the related infrastructure projects necessary to support it.  

The foundation of Lynk’s thesis is Canada’s solid balance sheet. Our neighbor to the north is well situated to use substantial public funds to strengthen roads, bridges, sewer systems and water treatment facilities.

Finance Canada said Monday that the federal government was running a CAD12.9 billion surplus for the 11 months ended Feb. 29, 2008. That number will come down after CAD2.5 billion in year-end adjustments based on allocation of funds for public transit and a project to demonstrate how companies may be able to capture and store carbon emissions.

Canada’s minority Conservative government pushed through a five-year, CAD60 billion tax-cut package last year to help shield the world’s eighth-largest economy from a slowdown in the US. The plan included immediate reductions in personal income taxes and a one percentage point cut in the federal sales tax as of Jan. 1. In the end, the 2007-08 surplus will come in about 16 percent below the CAD15.29 billion posted for 2006-07.

The government’s debt charges also fell in February, as well as in the first 11 months of the fiscal year, with public debt charges dropping 2.5 percent to CAD2.6 billion in February and 1.5 percent to CAD30.6 billion for the period between April 2007 and February 2008.

Various studies suggest Canada is staring at a CAD125 billion infrastructure deficit. The government has committed CAD33 billion to infrastructure funding over the next seven years; it has also committed CAD25 million to establish PPP Canada, an agency to encourage public-private partnerships (P3) across the country. Finance Minister Jim Flaherty has estimated that P3s could effectively triple the funds available to address the infrastructure deficit.

A February 2008 Statistics Canada report forecast a 23 percent increase in nonconventional oil and gas extraction investment to CAD19.7 billion in 2008. As of December 2007, there’s CAD66.3 billion in oil sands projects underway or approved and another CAD89.3 billion worth proposed.

Bird is well positioned to continue to benefit from its considerable exposure to government-funded projects as well as energy-sector spending in western Canada. As of Dec. 31, 2007, Bird’s backlog–an important indicator of a construction firm’s health–stood at CAD969.3 billion, up 108.6 percent during the preceding 12 months.  

Bird reported fourth quarter net income of CAD11.2 million on revenue of CAD223.4 million. That’s up from net income of CAD7.1 million on revenue of CAD147 million in the same period of 2006.

Total revenue for 2007 was CAD756.9 million, up from CAD533.4 million in 2006; net income increased to CAD33.4 million (CAD2.42 per unit), up from CAD22.2 million (CAD1.65 per unit) in 2006.

Bay Street heavyweight Gluskin Sheff recently acquired–on behalf of private clients–417,393 Bird Construction units on the open market. Gluskin Sheff now controls (but doesn’t own) 1,712,863, about 12.2 percent, of the fund’s units.

Another Canadian infrastructure play, Russel Metals (TSX: RUS, OTC: RUSMF), has returned more than 10 percent since we recommended it as part of our expanding non-trust coverage in Canadian Edge.

One of the largest metal distributors in North America, the company operates three lines of businesses. Through more than 50 Canadian and US metals service centers, Russel Metals’ primary business is providing carbon hot rolled and cold finished steel, as well as pipe and stainless steel and aluminum tubular products to the construction, shipbuilding and equipment manufacturing industries, among others.

The company also imports and exports steel products (steel plate, beams, rails and pipe) for large volume sales to steel mills and other distributors. Its energy tubular products unit distributes line pipe, tubes, valves and fittings to the oil industry.

Russel has boosted its dividend nine times in the last five years and now pays 45 cents Canadian per share per quarter. It paid out CAD1.75 per share in 2007, nearly 100 percent of its CAD1.77 annual earnings per share, but it’s operated that close to the razor’s edge before–in 2001, for example. Encouraging, free cash flow per share was CAD3.09 for 2007.

Bay Street analysts have also identified Russel as a potential takeover target, so there’s a possibility for a one-time windfall on top of the company’s consistent dividend performance.

Net earnings for the fourth quarter 2007 were CAD25.3 million, down 22.5 percent from CAD30.6 million in the same period of 2006. Net earnings for the year were CAD111.2 million, a decrease of 30 percent from fiscal 2006 net earnings of CAD158.7 million.

In the metals service center segment, steel prices and margins remained under pressure throughout 2007, but announced steel mill price increases in the first quarter of 2008 are expected to increase both selling prices and margins. The energy tubular products segment, a leading provider in the oil sands of northern Alberta, helped offset the decline in volume of western Canadian operations that distribute pipe primarily to gas-drilling customers. Lower active drilling rigs and excess pipe availability pressured volumes and margins.

We’ll be taking a deeper look at Canada’s strong balance sheet and what it means for infrastructure spending in the next Canadian Edge, which will be out Friday, May 9.

Speaking Engagements

It’s time: Vegas, baby! Neil, Elliott and I will head to the desert paradise May 12-15, 2008, for the Las Vegas Money Show at Mandalay Bay. Go to www.lasvegasmoneyshow.com, or call 800-970-4355 and refer to priority code 010495 to do the “what happens here stays here” thing as my guest.

The Roundup

Oil and Gas

Avenir Diversified Income Trust (TSX: AVF.UN, OTC: AVNDF) has entered into a definitive agreement with privately held Canoe Financial LP for the sale of its EnerVest Management unit for approximately CAD185 million. The total sale price will be satisfied through the cash payment at closing of approximately CAD140 million, the assumption of approximately CAD20 million in debt and working capital, and the provision of a promissory note with a scheduled payment of CAD25 million on Dec. 31, 2008.

The transaction has been unanimously approved by Avenir’s board. The management and staff of EnerVest will remain in their current roles, and Cypress Capital Management will continue as the investment manager of the EnerVest funds. The sale is subject to regulatory and commercial closing conditions and is anticipated to be completed on or about May 16, 2008.

Also, in the wake of the EnerVest sale, the ongoing process of selling its real estate division and the coming 2011 tax on trusts, Avenir has established a strategic review committee to consider alternatives and opportunities to provide the maximum value to unitholders. Avenir Diversified Income Trust is a buy up to USD8.

Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF) reported first quarter net income of CAD298 million (62 cents Canadian per unit), up from CAD262 million (54 cents Canadian per unit) in the first quarter of 2007. Revenue climbed 35 percent to CAD907 million from CAD674 million.

Cash flow from operating activities more than doubled to CAD441 million (92 cents Canadian per unit) from CAD202 million (42 cents Canadian per unit). The trust attributed the increased cash flow to a 46 percent increase in the net realized selling price for synthetic crude oil from Syncrude in northern Alberta. The higher prices offset a 9 percent decline in daily average sales volumes to about 99,200 barrels per day in the first quarter.

Higher operating costs and increased royalties also dragged. Syncrude, of which Canadian Oil Sands is the largest shareholder, suspended production in late January after extreme cold weather caused certain instruments to freeze. Production resumed in early February, but in March, the trust lowered its 2008 production forecast by 6 percent to 108 million barrels.

Canadian Oil Sands Trust, which also bumped up its distribution by 33 percent to CAD1 per unit per quarter, is a buy up to USD45.

Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN) has closed its previously announced convertible debenture financing. Upon closing, Harvest issued CAD250 million principal amount of 7.5 percent convertible unsecured subordinated debentures for total net proceeds of CAD240 million.

The underwriters may elect to exercise their overallotment option to purchase an additional CAD37.5 million principal amount of debentures at the same offering price, in whole or in part, for a period of 30 days following closing.

Harvest will use the net proceeds of this financing to repay outstanding bank indebtedness. Sell Harvest Energy Trust.

Electric Power

Primary Energy Recycling Corp (TSX: PRI.UN, OTC: PYGYF) reported operating income for the first quarter of USD2.1 million, compared to an operating loss of USD2.7 million for the same period of 2007. Distributable cash for the first quarter was USD8.7 million (23 cents per unit), of which Primary distributed USD7.4 million (20 cents per unit), a payout ratio of 85.9 percent.

The USD4.8 million improvement in operating income is primarily due to contract amendments at Harbor Coal, which converted the agreement to a simplified tolling formula and extended the term for 12 years to 2025. Primary Energy reported revenue of CAD16.2 million, a decrease of 3.1 percent from the first quarter of 2007 primarily because of a decline in energy service revenue at Harbor Coal.

Total operating and maintenance expense for the quarter was USD2.8 million, down 55.8 percent from the first quarter of 2007. General and administrative expense declined 5 percent.

At the end of the first quarter 2008, Primary Energy had CAD15.5 million in cash on hand and CAD12 million of undrawn revolving credit capacity. Primary Energy also announced that its board has decided to retain a financial advisor to evaluate options available to enhance unitholder value. Hold Primary Energy Recycling Corp.

Gas/Propane

AltaGas Income Trust (TSX: ALA.UN, OTC: ATGFF) is spending CAD55 million to increase volumes and boost efficiency at its Harmattan complex 100 kilometers northwest of Calgary. The plans include CAD24 million to construct a 30-kilometer pipeline to a gas plant in southern Alberta.

A new gathering system and extending an existing system will cost another CAD7 million, and CAD24 million will be devoted to efficiency enhancements to reduce operating cost and increase reliability at the complex. AltaGas also said it’s evaluating consolidation of other gas plants in the area. Buy AltaGas Income Trust up to USD28.
 
Spectra Energy Income Fund (TSX: SP.UN, OTC: SPFFF) unitholders have approved the proposed takeover of the trust by Westcoast Energy, a wholly owned subsidiary of Spectra Energy Corp. Unitholders were offered CAD11.25 per unit in a deal valuing the trust at CAD274 million.

The fund holds a 53.8 percent indirect interest in Spectra Energy Facilities LP, which owns Spectra Energy Midstream Corp. Spectra Energy Income Fund has been acquired.

Business Trusts

Parkland Income Fund (TSX: PKI.UN, OTC: PKIUF) has reached an agreement to acquire the fuel supply and marketing business of NOCO Energy Canada for CAD8.5 million. The acquisition includes approximately 56 independently owned and operated Esso, Sunoco and NOCO branded locations and 69 wholesale accounts outside the Greater Toronto area. The group had fuel volume sales of more than 300 million liters in 2007.

The acquisition is expected to be immediately accretive to the fund’s distributable income per unit. The all-cash transaction is expected to close at the end of May, subject to customary commercial closing conditions and regulatory approvals. Hold Parkland Income Fund.

Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF) reported a first quarter net loss of CAD1.8 million (12 cents Canadian per unit) as sales at its fast-food restaurants declined 3.2 percent from a year earlier to CAD77.6 million.

The operator of 465 KFC, Taco Bell and Pizza Hut restaurants in seven provinces lost CAD1.4 million (10 cents Canadian per unit) in the first quarter of 2007 on sales of CAD80.1 million. Priszm has closed 20 underperforming restaurants, and the fund has received “firm” offers to buy 80 stores for total proceeds of CAD10 million to CAD15 million. Priszm Income Fund is a buy up to USD7.  

Real Estate Trusts

Lanesborough REIT (TSX: LRT.UN, OTC: LRTEF) is buying a 66-suite luxury apartment property in Fort McMurray, Alberta, for CAD30 million, subject to the usual closing adjustments. The property is 100 percent leased to a major oil sands operating company until May 1, 2012.

The lease agreement provides the tenant with an option to extend the lease in 2012 for an additional five years at the current market rents at that time. The purchase price of CAD30 million represents an estimated average capitalization rate of 7.5 percent over the term of the lease.

The acquisition will be financed with a CAD21 million new first mortgage loan, a vendor take-back mortgage loan of CAD4 million and the balance in cash. The first mortgage loan will bear interest at an estimated rate of 5.5 percent for a five-year term and will have a 20-year amortization. The vendor take-back mortgage loan will be a 5 percent interest-only mortgage due July 1, 2010.

The acquisition will close July 2, 2008. Lanesborough also has a right of first refusal to acquire Phase II of the property, which is currently under construction and will consist of 58 suites. Phase II will also be 100 percent leased to a major oil sands operating company on a net-rent basis for a five-year term. Hold Lanesborough REIT.