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Why you should buy a 228-year-old income trust

Little did the fur traders and voyageurs know they were creating an excellent investment opportunity for the twenty-first century.

Two centuries ago, across the vast expanses of Canada’s wilderness, two mighty companies battled for supremacy in the fur trade. And they did not disappear into the mists of history. They are still with us.

We all know where we can find the Hudson Bay Company these days (even under U.S. ownership). Its bitter rival, the North West Company, might not be quite so easily identified by many Canadians dwelling in the southern regions of the country.

But it has come down to us as an income trust. And it may be one of the best investments in the country today.

That’s the opinion of one of Canada’s best-known analysts. Writing in The Income Investor, Mr. Gordon Pape made the North West Company Fund (TSX:NWF.UN; OTC:NWTUF) his latest buy of the month.

Making history again

Founded in 1779, the North West Company is in much the same business as in the days of the fur trading posts. Headquartered in Winnipeg, it operates a chain of 130 general stores across the Canadian Arctic.

It also has a number of modern appendages, called subsidiaries. It operates 29 AC Value stores in rural Alaska, 20 Giant Tiger discount stores, two wholesale distributors and, appropriately enough, three North West Company fur marketing branches that sell native handicrafts and wild furs. Plus it is also Canada’s largest distributor of Inuit art.

The North West Company did not become an income trust during the wave of trust mania earlier in this decade. It converted back in 1997 (who wouldn’t want to try something a little different after 218 years in business?). It was, in fact, the first retailing income trust in Canada. Always making history.

The company trades on the S&P/TSX Composite Index and is also available to U.S. investors on the Over the Counter Board (also known as the “Pink Sheets”) in New York. And it trades very well on its centuries-old tradition.

A classic fit

Says Mr. Pape: “North West has all the attributes we come to associate with a top-quality income trust. Cash flow is strong and steady. Competition is virtually non-existent in many of the communities it serves. The business is almost recession-proof. Margins are strong. barriers to entry are high, and there is modest growth potential. It’s a classic fit for the trust sector.”

There’s an extra attraction as well. North West Company is seen as a logical takeover candidate as trusts enter a period of vulnerability thanks to the looming tax on distributions.

According to a recent study by RBC Capital Markets cited by Mr. Pape, an offer of $21.50 would be reasonable; the analyst, Mr. Tal Woolley, added that North West would make a “nice tuck-in acquisition for another retailer, particularly one of the larger food retailers, as there is little geographic overlap.”

Fiscal year-end results reported on March 20 showed an 11.2 per cent increase in sales (12.3 per cent when the negative impact of the stronger loonie is taken into account). Net earnings increased 25.1 per cent. The balance sheet is sound, with $22 million in cash and a low debt-to-equity ratio.

Risks, strengths and stability

There are a few risks. One appears to be resolving itself already. The move into big cities such as Winnipeg and Edmonton with Giant Tiger stores was, says Mr. Pape, “met with skepticism initially, but the junior discount stores have done well and North West continues to add to them.”

The currency risk posed by the stronger Canadian dollar persists, as of course does the tax risk for trusts. Management is working to keep the fund as tax-efficient as possible. However, adds Mr. Pape, “if there is no takeover offer it is possible that the share price will drift down as 2011 approaches.”

Here are the figures that count for the investor. Quarterly distributions stand at 22¢ for a yield of 4.67 per cent. “That ‘s very modest by trust standards,” states Mr. Pape, “which says a lot about the strength and stability of the operation.”

The trust also received a favourable tax ruling from the Canada Revenue Agency which will prompt distribution increases as long as earnings continue to rise. North West also issues special distributions from time to time; it did so in February of this year.

Mr. Pape concludes in The Income Investor that North West is “suitable for investors looking for dependable cash flow and some capital gains potential. Compared to other income trusts, the risk is low and the units are suitable for inclusion in registered plans.”

We conclude that those who understand history have an excellent chance of profiting from it.