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An income trust that's still writing plenty of cheques

Four years ago, this company looked like it was in a dead-end business, but it's going stronger than ever, says this analyst.

As our new century dawned, everything that was printed on paper was being consigned to history's scrap heap. The coming of the computer age meant that books, newspapers, magazines, comic books and the like would go the way of the 8-track cassette.

Not so fast, Bill Gates! While the microchip revolution has radically altered the way things are printed, it has not eliminated the demand for the printed page. It will be some time before people do all their reading on a computer screen - not that there's anything wrong with reading on a computer screen.

Other paper products also appeared to be hopelessly outdated, such as printed chequebooks (although never printed traffic tickets, alas). And therein lies the story of a successful income trust.

It is called the Davis + Henderson Income Fund (TSX-DHF.UN; OTC-DHIFF) and it 's still in the good books of Mr. Gordon Pape, as he tells us in the latest issue of the Internet Wealth Builder.

Dull is good

Davis + Henderson, says Mr. Pape, is in the "dull business" of printing chequebooks. And, despite the notion that it might fade away as more and more people paid their bills on line, it's still doing a nice business.

"True, there's not a lot of growth potential," adds the analyst, "but then that's not what we look for in an income trust." Dull is good, if it brings in a steady buck.

Mr. Pape first recommended the fund back in 2003, when the company was scarcely a household name, despite the fact that its product was found in just about every household.

The shares then traded at $12.80. The annual distribution was $1.34, for a yield of 10.4 per cent. Mr. Pape praised it for its cash flow, stability and modest growth prospects. It was ideal for conservative, income-oriented investors.

Fast forward two years, to January 2005. The shares of the fund had risen to $22.39, a cool capital gain of 75 per cent. The distribution had increased four times since the original recommendation and the shares paid $1.44. Much as he still liked the fund, Mr. Pape felt that the cheque-printing business had become too much of a good thing. Sell it, he advised, it's too expensive.

Going south on Halloween

While the shares moved a little higher thereafter, in succeeding months they proceeded to slide down into the $18-$19 range.

Then Finance Minister Flaherty made his Halloween income trust tax announcement and Davis & Henderson, like many other trusts, went south. To $13.80, to be exact.

It has recovered successfully. "In retrospect," admits Mr. Pape, "it would have been smart to buy after the shares were beaten down by the tax news." But at a time of disbelief and confusion in the trust market, the advice to purchase new trusts would probably not have been welcomed by most investors.

Six months later (yes, it's been that long), the picture is much clearer. The tax will take effect in 2011, "but the world has not come to an end." It's business as usual for many income trusts.

"In that context," says Mr. Pape, "I took a fresh look at Davis + Henderson and liked what I saw."

No more one-trick pony

Davis + Henderson still possess all the attributes that made it successful in 2003, and one more.

In May 2006, it announced that it had agreed to purchase Filogix Holding for $2.125 million. Filogix is Canada's leader in information and transaction technology for the residential mortgage and real estate markets. Its customers include mortgage brokers, residential mortgage lenders, real estate agents and boards. It supplies electronic data for each stage of the mortgage process, from underwriting to closings, and collects healthy fees based on a percentage of the amount of each mortgage.

"The acquisition was especially significant," says Mr. Pape, "because until then Davis + Henderson had been a one-trick pony and the trick (cheque printing) was getting somewhat shopworn."

The cheques still make up 78 per cent of the business, but as that market shrinks, the Filogix acquisition will loom larger. Also, the company is putting a more aggressive approach into selling chequebook upgrades and related products, such as money clips, wallets, card cases and so on.

The first quarter results for 2007 read well. Revenue increased by 26.7 per cent from the year before, 17.6 per cent of that from the inclusion of Filogix, 9.1 per cent due to organic growth.

The fund's goals are modest - 3 to 5 per cent growth per year - and are being met consistently. Following another distribution increase announced late last year, monthly payments are up to 13.2¢ a unit, or $1.584 annually, for a yield of 8.3 per cent.

The Internet Wealth Builder cites a report from Dundee Securities calling the shares of the trust undervalued, and noting that Canadian monopoly trusts like Davis + Henderson have superior margins and should therefore trade at a premium to their U.S. peers. Davis + Henderson does not. This market inefficiency, says Dundee, "creates a good entry point for investors."

Mr. Pape agrees, although he notes that in 2006, "all distributions were fully taxable in the hands of Canadian investors, so you may want to tuck this fund into the tax-sheltered safety of an RRSP or RRIF." But wherever you put it, it's a buy.

At the close of trading Friday, the shares stood at $19.30 in Toronto, and $18.09 on the Over the Counter board in New York.

Of course, they don't print share prices in many newspapers anymore. You have to look it up on the Internet. Some things are changing.