Power plants, water mains, bridges, pipelines, roads: You literally can’t have a healthy, growing economy without them. That makes investing in this basic infrastructure a rare, high-percentage bet for these volatile times.

Over the next two decades, the world will spend tens of trillions of dollars on new infrastructure, and Canada will be in the thick of the fray. Best of all, unlike many nations, it has the balance sheet to easily cover the tab.

That adds up to an incredible opportunity for Canadian income trusts whose business is building, owning and operating infrastructure. Below, I highlight the best bets, including new addition to Canadian Edge coverage Bird Construction Income Fund (TSX: BDT.UN, OTC: BIRDF) and several high-yielding Portfolio stalwarts.

Still Strong

As we reported in the February CE Feature Article, The Big Picture, Canada continues to weather the US credit crunch and economic slowdown well. As the Bank of Canada (BoC) had anticipated, the nation’s overall economic growth rate has slowed in recent quarters, in large part because of fewer exports to the US. In its April 24 report, the BoC actually reduced its forecast for US growth, as well as for Canadian exports to this country.

Canadian growth, however, remains very much within the expectations laid out by the BoC earlier this year and last, coming in at 1 percent for the first quarter 2008. That was up from 0.8 percent in the fourth quarter 2007. And the BoC expects further recovery in US exports and Canadian growth to begin in the second half.

Left almost unsaid is the fact that Canada is less dependent than ever on exports to the US, thanks to surging exports of its natural resource bounty to Asia. Basically, as long as Asia is importing, Canada will be exporting, and its economy will remain resilient.

The report also states, “The relatively strong capitalization of Canadian financial institutions should mean that credit availability will remain more robust in Canada than in other major markets.” That’s a stark contrast with the weakened condition of US banks. In fact, the only Canadian banks to suffer thus far during this credit crunch were those with the greatest exposure to the US financial system, largely from investing in US securitized mortgages.

Credit spreads have widened over the past two years. But the spread between yields on investment-grade corporates and government paper is still under 200 basis points in Canada. That’s an amazing 80 to 90 basis points below spreads in the US, and it translates into steady credit conditions for Canadian companies, particularly income trusts that historically rely heavily on bank credit lines.

Another contrast with the US is that Canadian wages and employment remain robust, while Consumer Price Inflation is very well behaved, coming in at just 1.8 percent in the first quarter 2008 and down from 2.4 percent in the fourth quarter 2007. Core inflation, which excludes food and energy prices, came in at just 1.4 percent for February and March, the most recent months available.

Unlike Washington, the Canadian federal government continues to run a huge surplus. Interest charges on the national debt have fallen substantially over the past few years and are on track for further declines.

As a result, the ruling Conservative Party has had the flexibility to cut taxes to spur growth, enacting a CAD60 billion package last year. As noted here, that included a cut in ordinary corporate tax rates to just 15 percent by 2012 and a reduction in the prospective tax on income trusts to 28 percent, both major benefits to investors.

Canadian housing prices have continued to rise. That’s a radical difference with the US, where prices nationwide fell at an average annual rate of nearly 13 percent in February. The BoC expects home prices to moderate over the next year. But with subprime less than 5 percent of overall Canadian mortgages before the crunch began last year, there’s no chance of a repeat of the turmoil affecting the US, particularly with employment near full capacity.

The Economist Intelligence Unit now rates Canada the best major country in which to do business for the next five years because of infrastructure quality, market opportunities, moderate taxes, and a lack of restrictions on trade and foreign exchange. And in a KPMG study last month, the country placed second only to Mexico as the most cost-effective place to do business.

Two Challenges

Canada does face two challenges in coming years. The first is the rising loonie, which has gone from a deep discount to parity with the US dollar in just a few short years.

That’s been a benefit for US investors in Canadian trusts and other stocks, as the value of their shares and distributions in US dollars has risen with the exchange rate. That was a major reason the CE Portfolio was able to show an 11.4 percent total return last year, an otherwise stress-tested one for trusts.

As I’ve pointed out in CE, however, the surging loonie does present a stiff challenge to Canadian corporations and trusts, particularly those reliant on exports to the US. The situation became particularly acute in late 2007, as the loonie moved well past parity to a significant premium.

The loonie’s rise mirrors a similar climb during the 1970s. Then, as now, higher commodity prices (particularly for oil) pushed the currency to new heights against the US dollar, as rising exports pushed up global demand for Canadian dollars.

That’s essentially the same dynamic pushing the loonie higher now, and the Canadian government is anxious to control it. The recent 50-basis-point cut in Canada’s equivalent of the US federal funds rate was couched as a way to cushion the economy from deeper shocks because of the slowing US economy.

It also was almost surely done with the idea to help moderate the loonie’s rise, because falling rates make the currency less attractive. And to that effect, the BoC has been reasonably successful this year: Despite oil prices’ upward lurch to more than $120 a barrel, the loonie/US dollar exchange rate has remained right around parity. And with the country running a strong trade and federal budget surplus and domestic inflation remaining low, the BoC has a lot of room to maneuver, particularly compared with the US Federal Reserve.

The greater challenge is, ironically, infrastructure. According to several studies—most recently one from investment bank Canaccord Adams—the country is facing an “infrastructure deficit” of some USD238 billion, the result of alleged underinvesting for the past four decades.

Needs are myriad. Energy development, transport and support infrastructure—from roads and buildings to power plants and water mains—remains gravely stretched in rapidly growing Alberta. Neighboring British Columbia and Saskatchewan have similar needs. Meanwhile, numerous facilities in more populous eastern Canada are in dire need of repair and modernization.

Spending is already starting to accelerate. Across Canada, nonresidential construction spending surged 10.8 percent in 2007, a sizeable jump from the already impressive five-year average growth rate of 7.9 percent. Alberta and British Columbia accounted for some 80 percent of the increase—not surprising, considering their burgeoning energy sectors.



But other provinces—including the largest, Ontario—are starting to pick up. The compound annual growth rate (CAGR) of utilities sector spending, for example, was 17.3 percent in Ontario over the past five years. And overall spending CAGR was nearly 5 percent, a very big number considering the province’s size.

Further, the federal government alone has already committed some USD33 billion to infrastructure projects, and provincial entities have earmarked even more. That official backing speeds the regulatory and environmental permitting for projects, thereby limiting the potential for cost overruns because of delays. It also increases the assurance companies doing the work will get paid. And it helps hold down overall financing costs, which are the potential bane of any significant infrastructure project.



Accelerated spending by the government and in the private sector is a clear sign funding infrastructure is a priority in Canada and will be for years to come. Coupled with the country’s solid economy and its tie-in to the long-term natural resources bull market, that makes it ripe for investing in infrastructure-based trusts.

A Direct Play

The most direct bet on the growth of Canadian infrastructure spending in the trust sector is Bird Construction Income. I first reviewed this as a new trust a couple years ago, with the idea to wait for it to build a track record operating as a flow-through entity.

Since then, it’s passed all tests. I’m adding Bird Construction Income Fund to How They Rate coverage under Business Trusts as a buy up to USD40.

Bird is a general contracting company on major, nonresidential infrastructure projects. About 35 percent of its sales come from institutional development, comprising government buildings from hospitals, correctional facilities and schools to military projects. This is obviously the most secure segment of revenue in any market, and the trust has numerous strong relationships—always the key to getting more government business.

The largest slice of revenue—approximately 45 percent—is from industrial projects. This is also the highest potential segment because it features projects in the fast-growing petrochemical sector, including several emerging deals in Alberta’s oil sands region. These include actual energy development projects, as well as much-needed water reclamation and building construction.



Statistics Canada projects the country’s investment in oil and gas extraction will increase 23 percent in 2008 to CAD19.7 billion. Further, there are more than CAD66.3 billion in ongoing or approved Alberta oil sands projects and an additional CAD89.3 billion on the drawing board.

Super Oil Total announced a major new oil sands investment last month, and even BP is making a move. As these projects unfold, from all indications, Bird is well-positioned to grab more than its fair share of the business.
 
The balance of Bird’s revenue is roughly evenly divided (10 percent each) between retail and commercial/residential projects. Retail includes construction of shopping malls, shopping plazas and grocery stores coast to coast for major clients like Wal-Mart. The commercial/residential operation builds office buildings, hotels, casinos and multifamily buildings, ranging from condominiums to long-term care facilities.

With its reach extending to every area of Canada’s infrastructure boom, it’s no wonder Bird’s overall business is thriving. Full-year 2007 net income surged 50 percent, while fourth quarter earnings-per-unit growth actually accelerated to 58.8 percent. Construction revenue rose 42.2 percent for the year and 52.2 percent in the quarter.



First quarter 2008 results were better still, with revenue rising 65.5 percent. Order backlog—or orders booked and in the pipeline—stands at nearly CAD1.2 billion. That was up 24.6 percent from last year. Bird won another CAD123 million in projects in Alberta (a concrete foundation for an oil sands plant) and British Columbia (a mixed-use retail and residential development project in Vancouver).

Last year’s purchase and integration of Rideau Construction and Rideau Management Services gave the company a major presence in Atlantic Canada for the first time, a region with considerable infrastructure needs and a history of government supporting them. Overall backlog is now more than twice year-end 2006 levels and three times the 2004 tally.

As for the balance sheet, cash and securities on hand continue to exceed total debt by more than CAD100 million. In other words, Bird could retire all its existing debt with cash in the bank and have plenty left to spare. Maintaining a high level of cash is a requirement of doing business in construction and provides a great deal of surety about the trust’s financial strength.

The only real negative about Bird is its relatively low yield. Dividend growth, however, has matched its robust business growth. The payout was increased 25 percent with the Dec. 31 payment, in addition to a special cash distribution of 5.8 cents Canadian per share.

In addition, the first quarter payout ratio was only 55 percent and looks set to keep falling toward 50 percent over the next two years at least, a good sign that strong dividend growth will continue. Management has also indicated it will pay another special distribution this year.

Bird shares have tacked on strong gains during the past couple years. The units, however, sell for just 65 percent of sales.

Management hasn’t indicated what it will do in 2011 when trusts are slated to be taxed. Earnings per unit, however, already mirror distributable cash per share, and the payout ratio should fall further by 2011. New taxation may limit special distributions after 2011, but it should have little impact on the current distribution or on Bird’s ability to continue regular increases.

Note that Canadian Hydro Developers (TSX: KHD), a non-trust developer, owner and operator of 20 power generation facilities, is discussed in this issue’s Canadian Currents section and is now tracked in the How They Rate Table. The company has net interests in 364 megawatts (MW) of operating power plant capacity in water, wind and biomass and has an additional 471 MW under or nearing construction.

Operating in British Columbia, Alberta, Ontario and Quebec, Canadian Hydro Developers is a buy for aggressive investors up to USD5.88.

Vital Resources

Another way to cash in on Canada’s infrastructure boom is to buy producers of raw materials. My favorite resource pick—Russel Metals (TSX: RUS, OTC: RUSMF)—is featured in this month’s Canadian Currents article, as well as in April 29 Maple Leaf Memo. Note that I’ve added Russel and other non-trusts to How They Rate coverage.

Zinc and iron ore are essential elements in construction. Noranda Income Fund (TSX: NIF.UN, OTC: NNDIF) is basically a royalty stream from one of the largest zinc processing facilities in North America. The facility is operated by global metals giant Xstrata, which provides considerable financial surety and expertise.

Like an energy refiner, Noranda’s cash flow depends on the price of finished products staying ahead of raw materials. That’s recently become squeezed by economic weakness in the US.

But the yield of more than 11 percent is discounting much of the risk already. Accordingly, Noranda Income Fund is a buy up to USD9 for more aggressive investors.

The trust with the play on iron ore—the key element for producing steel—is Labrador Iron Ore Royalty Trust (TSX: LIF.UN, OTC: LBRYF). It’s a royalty stream from the Iron Ore Co of Canada (IOC), the country’s largest manufacturer of iron ore pellets. IOC operates a mine, concentrator and a pelletizing plant in Labrador City, Newfoundland and Labrador, as well as port facilities in Quebec and a 418-kilometer railroad connecting the mine to the port.



That kind of integration is a major plus when it comes to controlling costs and maintaining margins at IOC. Another plus: IOC’s ultimate owner is global mining giant Rio Tinto, a major global player in iron ore.

Business has been booming over the past few years. And with Rio and other iron ore producers negotiating big price increases with global steel makers, it should continue to for several years. The only drawback is Labrador units aren’t cheap and yield just 3.6 percent—including special distributions. But Labrador Iron Ore Royalty Trust would be a solid buy on a dip to USD50 or lower for the next leg up.

Power, Wires and Pipes

For safety, high income and steady growth, you can’t beat trusts that own and operate infrastructure assets. These trusts’ cash flows basically grow as they build or buy assets. And that cash is systematically passed on to unitholders in the form of steadily rising distributions.

Infrastructure trusts form the backbone of the Canadian Edge Conservative Portfolio. Share prices have been volatile at times over the past several months. But my picks have continued to find ways to grow assets and cash flow, despite tightening credit conditions this year. And they’ve continued to reward us with high, rising distributions—a sure-fire formula for higher share prices long term.

AltaGas Income Fund (TSX: ALA.UN, OTC: ATGFF) has two basic business segments. The gas gathering and processing division is one of the largest in Canada and includes natural gas gathering and processing facilities, extraction plants and transmission pipelines. The division took a quantum leap forward earlier this year as the trust closed on the acquisition of Taylor Natural Gas Liquids Limited Partnership. The deal increased AltaGas’ asset base by 65 percent and doubled its natural gas liquids production.

Immediately accretive to cash flow, the Taylor deal also boosted the scale of AltaGas’ other key business—renewable energy—adding several hydro projects to the mix that also includes a major wind power complex. Meanwhile, the trust continues to execute smaller purchases and construction projects, announcing in late April a CAD55 million expansion to increase efficiency and capacity at an Alberta processing facility.

First quarter earnings were again stellar, with power production and the Taylor assets major contributors. Buy AltaGas Income Fund up to USD28.



Keyera Facilities Income Fund (TSX: KEY.UN, OTC: KEYUF) is also a major player in natural gas processing infrastructure. The trust continues to expand its asset base of processing, storage, transport and marketing assets, closing on the purchase of a 35.6 percent ownership interest in the ATCO West Pembina gas plant for CAD26 million last month.

In March, the trust purchased a distribution terminal in the Edmonton/Fort Saskatchewan energy hub for CAD32 million as part of a CAD50 million growth initiative. The facility, to be known as the Alberta Diluent Terminal (ADT), represents a major expansion of Keyera’s presence in the growth of the oil sands. Diluent is a critical item in processing bitumen, the essential product from oil sands.

The trust’s growth strategy is to add assets that are complementary to those it already owns. That reduces risk and keeps Keyera focused on where it already has expertise.

The shares have surged recently but still yield nearly 8 percent, and management has affirmed its commitment to paying a big dividend to 2011 and beyond. Buy Keyera Facilities Income Fund up to USD22.

Pembina Pipeline Income Fund (TSX: PIF.UN, OTC: PMBIF) remains my favorite way to play the growth of the oil sands region. The trust continues to build out the transport network of the Syncrude partnership, for which it holds an exclusive arrangement.

It’s also nearing completion of the CAD400 million Horizon Pipeline, on target for a July 1 startup. The new pipeline is expected to double the trust’s income from oil sands operations, which earn fees from usage and capacity contracts.

First quarter earnings were again strong, as distributable cash flow per share ticked up 7 percent. That enabled the payout ratio to fall to 81 percent from 90 percent in the year-ago first quarter, despite a 9.1 percent increase in the distribution. I expect another sizeable increase once Horizon comes on stream.

Meanwhile, the trust’s conventional pipelines and other midstream assets continue to run well. Now trading back in the mid-teens, Pembina Pipeline Income Fund is a strong buy up to USD18.

The CE Portfolio lists four power generation trusts: Algonquin Power Income Fund (TSX: APF.UN, OTC: AGQNF), Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF), Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF) and Macquarie Power & Infrastructure (TSX: MPT.UN, OTC: MCQPF).

Macquarie—which also owns a stake in a senior housing company—has its assets entirely within Canada. But Algonquin, which also operates water treatment facilities, holds most of its power plant assets in the US. Not an operating company, Atlantic holds virtually all of its power plant and power line investments in the US. And Boralex derives a sizeable chunk of its income stream from US plants.

As a result, this quartet is also a bet on the electricity infrastructure boom ongoing in the US. According to a study recently commissioned by the Edison Foundation, the power industry in this country will have to spend USD1.5 trillion by the year 2030 to simultaneously upgrade aging facilities and meet a projected 30 percent jump in electricity demand, while sharply reducing emissions of carbon dioxide.

As primarily producers of renewable energy—particularly hydro, wind and biomass—Algonquin and Macquarie have considerable opportunities to expand assets in coming years. Atlantic, meanwhile, continues to look for new assets that meet its strict investment criteria.

In contrast, Boralex Power Income Fund is effectively an income stream from certain assets operated by parent Boralex. That makes it unlikely to grow.

Rather, the play is that it will come to be valued at more than just 94 percent of book value, possibly as part of a sale. The reduced distribution appears secure. Boralex Power Income Fund is again a buy up to USD6 after reporting in-line first quarter earnings numbers.

Algonquin Power Income Fund is a buy up to USD9.50. Atlantic Power Corp and Macquarie Power & Infrastructure are buys up to USD12. Macquarie had a solid first quarter, demonstrating its successful integration of the Clean Power assets and pointing the way toward more dividend growth.

Last but not least, Bell Aliant Regional Communications Income Fund (TSX: BA.UN, OTC: BLIAF) is still a very solid play on rural Canada’s switch to broadband communications. Solid first quarter earnings reflect the trust’s ongoing successful executive of its strategy to upsell copper-wire customers to its broadband Internet and television offerings, which in turn has spurred steady growth in the distribution.

Bell also faces less competition than US rural telephone companies, another major plus. Buy Bell Aliant Regional Communications Income Fund up to USD33.