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Is the road ahead safe for Canadian investors?

From a Canadian advisory for income investors comes a survey of investments that may offer a secure route through a troubled market.

If there is a recession coming, nobody in the corridors of authority seems to know quite what to do about it. Every attempt at a solution just seems to create a new problem.

It’s as though a railway bridge had gone down and nobody could figure out whether to reroute the trains or just stop them altogether until they decided what kind of bridge to build. In the meantime, everybody’s stuck where they are.

Yet as an investor you’re not really stuck. You can continue to look for investments that will endure in a befuddled market. In effect, you build your own bridges. Some will be safer, some a little riskier (that’s why you have a well-balanced portfolio, right?).

With the aid of the Money Reporter, a Canadian advisory that counsels income investors, we’ll report on some investments that can get you from here to there while the authorities haggle over what to do next.

Using a safe harbour

Are income trusts safe? That question has been gnawing at investors for over a year now. But the fact remains that the best income trusts are still delivering the goods for their unitholders. It’s just a matter of selecting the winners in a market where only the strong survive and thrive.

The Money Reporter has reports on two trusts in its latest issue. One is making dramatic moves, while the other is dull as dishwater, but reliable.

First came the federal tax on income trusts, says the advisory. “Then came the deals, with oil patch trusts joining forces while they still can. Even under the existing rules, trusts have a limited ability to expand via combinations and unit issuance. But there are still the ‘safe harbour’ provisions to be taken advantage of.”

The safe harbour provisions offer trusts a limit within which they can expand before 2011 without incurring government penalties for “undue expansion.” Under the provisions, a merger is not considered undue expansion, and thus offers a rather large loophole through which to grow. The sole condition is that they be “grandfathered” trusts, i.e., that they were trading publicly before November 2006.

Enerplus Resources Fund (TSX-ERF.UN) is the latest energy trust to drive through that loophole with its deal to take over the assets and operations of Focus Energy Trust (TSX-FET.UN).

Enerplus was already one of the biggest trusts in the oil patch with a market cap of $5 billion. That now grows to $6.6 billion. And that, says the advisory, sets up the balance sheet for still more mergers and acquisitions.

Under the safe harbour growth rules, the two trusts reckon they can issue up to $10 billion in addition equity before January 1, 2011.

Under the deal, Enerplus unitholders will own about 79 per cent of the new entity. Both boards approve the deal, although Focus unitholders must still vote on it this coming February.

Noise about further acquisitions

Enerplus alone produces 80,00 barrels of oil a day at a cost of about $9.50 a barrel. Now it should produce 100,000 barrels a day at a cost of about $8.50. No need to get out your calculator to see the advantages there. And the two trusts claim they can increase their output by 60,000 barrels over the next ten years.

They’ll also have more stuff to sell. Enerplus is involved in the oil sands, and in crude oil in Alberta and Montana, but Focus brings some high quality natural gas properties into the bargain.

“We like this combination, its diversification aspect, the potential for cost savings and the potential for an increase in production,” says the advisory. We especially like the noise about making further acquisitions. Enerplus is a buy.”

Now we’re going to go watch some paint dry.

There’s money left over

EPCOR Power L.P. (TSX-EP.UN) used to be known as TransCanada Power. It didn’t change its name from any lack of patriotism, but because EPCOR Utilities acquired TransCanada PipeLine’s interest in the company in August 2005.

Since that change in ownership, EPCOR has made several acquisitions, Frederickson Power L.P. in August 2006, and Primary Energy Ventures in November 2006. Both added a string of power facilities in the United States, and neither was cheap.

So EPCOR spent much of 2006 raising the money through a variety of preferred shares, unit offerings and a private placement of senior notes. When the final acquisition financing was done, there was money left over.

“As you can see,” says the Money Reporter, “EPCOR isn’t all that much more exciting than watching paint dry. One year it makes a couple of acquisitions. The next year it raises the money to pay for them. Now we wait for synergies to flow to the bottom line.”

The unit price has gone up and down a little, but the real proof of the trust’s strength will come in the months ahead. In the meantime, the advisory has EPCOR as a hold for distributions.

Not terribly thrilling, but safe. And safe can be pretty uplifting these days.

Like a disaster movie

Now we turn to four stocks the advisory follows regularly. Here we find a mixture of security and uncertainty, but four buys nonetheless.

The Bank of Montreal (TSX-BMO), of course, is caught up in the credit crunch like virtually every other financial institution you can name. In some ways, that’s not all bad.

The good news, says the advisory, is that the bank’s share price stopped dropping over the past three months after giving up almost $6.00 a share in the three months before that. It’s been the worst performer among the big five banks.

“In a nutshell, then, BMO may be down in price, but it’s far from cheap right now. That said, it can make up significant ground if it later joins the middle of the pack.”

It’s still a buy, but only for income.

But Canadian National Railway (TSX-CNR) is another story. Right now, it is “an even better buying opportunity in a good company that is not currently performing at its peak.”

The railway has resembled a disaster movie, with strikes, avalanches, mudslides and blockades, not to mention fewer shipments from the equally disastrous timber industry. But that’s almost a positive, says the advisory, because it is highly unlikely the same confluence of events will strike again, “which bodes well for some handsome quarterly earnings increases coming up.”

But the real gem in CN’s future is the new container terminal in Prince Rupert, B.C. It cuts days off seabound shipments from Asia, and CN has the only line running into the terminal. Another plus is acquisition of the Elgin, Joliet and Eastern Railways, which will allow CN to skirt the rail bottleneck around Chicago as it carries goods across the continent.

It’s full speed ahead on this stock (no bridges down, apparently). CN is a buy for income and gains, says the advisory.

Not the usual profile

Manitoba Telecom (TSX-MBT) doesn’t get the same sort of endorsement at the moment. It’s entering new and uncertain territory. As new regulations open up the wireless spectrum, Manitoba Tel must decide whether to throw itself into the wireless world.

It probably should, says the advisory, and it probably will. But all this will come at a price. Even when you’re using somebody else’s towers, it costs a lot to set up and maintain a full wireless network. And that could spell the end to any dividend increases for a while.

The company is a buy for income more than gains.

It’s the other way around for Jean Coutu (TSX-PJC.A), which is a buy for gains instead of income. That’s not the usual profile of a stock for conservative investors, but it is an intriguing case.

Its earnings per share are up more than 25 per cent over the past three months, yet the share price is down close to $3.00. What’s up?

Under the direction of its patriarch, the senior Mr. Coutu, the drugstore chain re-made itself by selling off its American assets and keeping only a 252-million share interest in the Rite-Aid chain.

Its Canadian operations are doing fine, but Rite-Aid missed its earnings target last quarter. “On balance,” says the advisory, “we recommend Jean Coutu as a buy for more aggressive investors looking for potential gains more than income.”

The one thread running throughout these stocks, of course, is income. Even if it stumbles temporarily, a stock is easier to live with when the dividend cheque is in the mail.

The “open-mouth” policy

Lastly, what should you be doing with the simplest investment of all, cash? The prudent policy, says the advisory, is to lengthen the term of tactical cash holdings right now.

The Bank of Canada is playing a double, “open-mouth” policy on interest rates at the moment. It may cut the Bank Rate by 25 basis points at its next meeting in January. On the other hand, the new governor of the bank takes over next month, an he may decide it’s best to take his time before bringing in a cut.

In short, there is no sure bet that rates will be cut anytime soon, but there is a clear message that rates will not be going up. That pushes the markets into taking a cautious, middling stance.

One result is that Treasury bills are paying very low rates right now, as investors stranded with asset backed commercial paper (ABCPs) rush into them as a refuge, thus inflating the demand.

“To sum up,” says the Money Reporter, “terms of 90 to 180 days are called for right now for tactical cash, and term deposits are the preferred instrument. For strategic cash, we recommend GICs with terms of three years or longer at this time.”

“In skating over thin ice, our safety is in our speed.” That’s what Ralph Waldo Emerson said. To which we add: If you wait for the powers-that-be to tell you what’s ahead, that ice is going to crack. Look for investments you like, and keep on skating.