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When seeing is not believing with income trusts

Look behind the numbers with income trusts, says this Canadian advisory, and you’ll find that some trusts are healthier than they look.

A good deal of the talk about income trusts over the past months has had the quality of crying over spilt milk. Since the income trust tax was proposed — it’s been almost a year, believe it or not — we’ve seen lots of news about trusts that have sagged, or slipped off the map altogether .

But the good income trusts have gotten stronger in the process. Yet even those trusts seem to have suffered a setback lately. Or have they?

Look again, says one of the leading advisories in the field, the Income Trust Guide published by the Money Reporter. During the August reporting period, when income trusts came in with their second-quarter results, a lot of unimpressive figures were released.

But those figures are misleading, says the advisory, and it all goes back to an act of Parliament.

A completely different story

In June, the income trust tax bill was passed in Parliament, putting an end to the forlorn hopes of those who still believed it might be rejected. It is now the law of the land, and that had to be reflected in the financial statements of all the companies affected.

That meant a one-time adjustment to earnings. The Income Trust Guide illustrates with one of its favourite trusts, natural gas producer AltaGas Income Trust (TSX-ALA.UN). Bear with us while we do a little math.

Over the past month, the units of AltaGas have done well, gaining 2.1 per cent. Over the past year, it has gained 4.5 per cent on top of a yield of 7.5 per cent in a market that has not always been kind to natural gas.

But the second-quarter results reflect none of this. The trust’s second-quarter net income, $13.1 million ($0.23 per unit), appears to have collapsed compared to last year’s second quarter — $29.9 million, or $0.54 per unit.

It’s all down to the one-time tax charge. That came to $14.5 million in the second quarter. On the other hand, in last year’s second quarter, AltaGas was the beneficiary of a $6.6 million tax benefit.

When you add and subtract, the figures are almost reversed: last year’s net income for the second quarter would be $23.3 million ($0.42 per unit), this year’s $27.6 ($0.48 per unit).

In short, it’s a complete different story. There are times when the numbers lie (or at least twist the truth some) and it’s worth digging a little deeper.

“In fact,” says the Income Trust Guide,” you can bet that many naive investors don’t go to this trouble, which is why they make mistakes in their buy and sell decisions. To us, AltaGas is a buy.”

Doing well by its unitholders

Further cementing its position in the advisory’s good graces, AltaGas has announced an increase in its distribution rate, plus a special distribution. Unitholders of record on August were entitled to annual cash distributions of $2.10 per unit, a three per cent increase that kicks in on September 17. That’s the fourth distribution hike since AltaGas became a trust a little over three years ago.

The special distribution consists of one common share of AltaGas Utility Group Inc. for every 100 units of the income trust held on August 27.

So AltaGas appears to be doing very well by its unitholders. But you certainly wouldn’t have anticipated such generosity if you were judging solely by the gloomy second quarter results.

The moral of the story for income trust investors: don’t let the strong trusts be lumped in with the weak on the basis on one piece of unpleasant news.

Speaking of strong trusts, the Income Trust Guide has three more recommendations in its latest issue.

An easy answer

There’s another reason to pay close attention to the numbers with income trusts. As with common stocks, good income trusts have had some value drained off by the market correction.

A case in point: Enerplus Resources Fund (TSX-ERF.UN). Its market capitalization of $5.56 billion gives it a commanding position among trusts in the oil patch. But not quite as commanding as a month ago, when it had a market cap of $5.86 billion.

“Question: did the company lose $300 million in true economic value in the past four weeks,” asks the advisory, “or did it just lose market value through no fault of its own. The answer is easy: Enerplus Resources is a buy at these prices.” The price has edged up since this issue appeared, but it is still below its market value.

Buying the units of Series S-1 Income Fund (TSX-SRC.UN) amounts to a form of theft, according to the Income Trust Guide. The units closed at $9.40 yesterday, yet it is yielding an “inordinate” 9.6 per cent, versus the 6.4 per cent of the Brompton fund, which holds many of the same income trusts in its portfolio.

“So if you need a fund to round out your trust holdings and diversify what you already hold,” suggests the advisory, “why not put a limit order in, and if you get a fill, great. If not, no loss.”

Bell Aliant Trust (TSX-BA.UN) has been granted forbearance by the CRTC, which in plain English means it now enjoys open compeition in 72 key Atlantic markets. This allows Bell Aliant “to slug it out with the cable interlopers on a level playing field for the first time,” says the Income Trust Guide. “So in the short term we see the loss of landline business tapering off, and landlines are the usual springboard for selling other services.”

And, sometime in the early months of 2008, a cool $28 billion from BCE investors will be looking to settle on a similar investment. Could Bell Aliant be the destination, wonders the advisory?

Not a normal market

We’d like to close with a look at the Money Reporter, which has some notable advice for income investors. In the wake of the credit malaise that has spread across the markets, the advisory recommends a major shift in the disposition of cash.

“Under normal market conditions,” says the advisory, “money market instruments pay a better return on our short-term cash than do term deposits and GICS. However, this is not a normal market, and a shift in strategy is called for.”

In Canada, the current liquidity crisis centres on the market for asset-backed commercial paper (ABCP). The market for commercial paper has dried up. It has gone “no bid.”

There is none for sale at any price, and won’t be until the market shakes itself out. So what do corporations and other institutional investors like pension funds do with their cash balances? The fallbacks strategy is Treasury bills.

The result, of course, is that T-bill rates have tumbled. In financial commodities, higher demand always equals lower return.

According to the Money Reporter, this means keeping terms as short as possible, “but using term deposits rather than money market instruments as your vehicle for short-term cash.

“This liquidity crisis could go on for some time, and so terms up to 90 days are indicated, with a 60-day term our top choice right now.”

We’ve looked at a lot of numbers today, only to see that they don’t always tell the truth at first. There may be “Lies, damned lies and statistics,” but only when you get to the bottom of them will the bottom line look good.