The U.S. shopping list of Canadian income trusts
These U.S. experts sing the praises of Canada’s resilient economy and have seven income trusts they believe Americans should buy in 2010.
The answer is: The best income investment for Americans in 2009.
The question: What is Canadian income trusts?
Since a Canadian has hosted Jeopardy for many years, we feel justified in pinching the format to introduce a rousing endorsement of Canada, its economy and its investments.
The praise comes from a source we know well. Mr. Roger Conrad is one of America’s foremost experts on Canadian investments. We have had occasion to quote him a number of times on the subject.
But on the threshold of a new year, he gives one of his most enthusiastic reports on the Canadian economy -— along with a substantial shopping list of Canadian income trusts for U.S. buyers.
Writing in Personal Finance, Mr. Conrad co-authors his article with Mr. David Dittman. Together, they also edit an online advisory called Canadian Edge. They just can’t get enough of the True North.
The pride of the developed world
The authors recommend a mixed bad of income trusts from different industries. “All, however, will be tremendously impacted by what happens to the Canadian economy — a very good thing in 2010,” they write.
“Exhibit A is Canada’s banking system, literally the pride of the developed world and a model for financials in other countries hit hard by the global credit crunch.”
Canadian banks did not fall into in the subprime housing trap, they tell their readers. “Rather than hustling to pay back government money, Canadian banks are eyeing opportunities to grab market share.”
Resources are the second building block in the Canadian equation, as demand rises with the prices of oil and gold. “Canada generated a surprise trade surplus on this oil-and-gold foundation in October, despite U.S. demand for manufactures remaining at near-depression levels.”
And finally, the stronger loonie is a boon for American investors — it translates into higher U.S. dollar value for dividends and share prices of Canadian investments.
Uncertainty swept away
The authors warn U.S. investors who may have missed out on the gains in income trusts in 2009 not to make the same mistake in 2010. Do not be held back, they urge, by the spectre of the upcoming trust tax.
“Most income trusts have announced they’ll convert to corporations by the end of 2010. But of the 25 that have made the move already, a dozen have elected to pay the same dividends they did as trusts.”
The Canadian government did its worst on Halloween 2006, say the authors, when it announced the distribution tax. “But since then it’s done its best to make conversions as painless as possible. Potential taxes and red tape have been eliminated and corporate taxes slashed. Many trusts expect future tax bills to be relatively insignificant.”
As dividends keep beating expectations, it has “produced windfall gains for investors, as post-2010 uncertainty has been swept away.”
So which trusts does one turn to for those windfall gains?
Straight for the oil patch
These experts head straight for the oil patch. They have no less than four energy trusts to recommend.
First is ARC Energy Trust (TSX-AET.UN; OTC-AETUF). It has covered its distribution by 2-to-1 and held debt to just 1.4 times annualized cash flow, while continuing to invest in its portfolio of new and old projects.
Its post-conversion dividend will depend on oil and gas prices, of course. “But the company has long covered its dividend by a healthy margin and boasts a track record of success on the projects it undertakes.”
The authors make it a buy up to US$20, which is just about where it is trading today. It yields 5.6 per cent on the $1.20 distribution.
Enerplus Resources Fund (TSX-ERF.UN; NYSE-ERF) is just as “battle-tested” as ARC, say the authors. “After shedding debt, cutting costs and trimming its distribution, it’s in the strongest financial shape of any company in the sector.”
Enerplus will convert late in 2010. It plans to balance the distribution level with its spending plans for growth. That would translate into a yield of about 9 per cent, say our experts. It currently yields 8.8 on the distribution of $2.16. A buy up to US$25, it is trading in New York at $23.15.
NAL Oil and Gas Trust (TSX-NAE.UN; OTC-NOIGF) kept on growing by acquisition and cost cutting even when energy prices were low.
In late 2009, it added a junior explorer with properties near its natural gas assets in Alberta. This should boost production by 28 per cent and reserves by over 30 per cent. Buy this trust up to US$20, say the authors. It’s at $13.71 today. The yield on the $1.08 distribution is 7.4 per cent.
Finally, there’s one of Mr. Conrad’s favourites. “The reliable Vermilion Energy Trust (TSX-VET.UN; OTC-VETMF) won’t have to convert because the majority of its revenue is derived outside of Canada and is already taxed.”
Most of Vermilion’s cash flow comes from outside Canada, while debt and the payout ratio are very low. Plus there’s a huge new find coming on line in 2011. The authors make the trust a buy to US$30. In fact, it has now reached $31. It yields 6.8 per cent on the distribution of $2.28.
Boring is better
These experts conclude with three trusts from different walks of life. In fact, the first has already shed its trust structure.
Atlantic Power Corp. (TSX-ATP; OTC-ATLIF) “executed a picture-perfect conversion in late 2009,” say the authors, “eliminating debt while maintaining its distribution level.” Its clean balance sheet and presence on the New York exchange will make it easier to raise money for projects.
If anything, conversion has made its yield of almost 9 per cent (on a $1.09 dividend) more secure. The buy price is US$11; it, too, has zipped past its mark, to $11.66.
Canadian Apartment Properties REIT (TSX-CAR.UN; OTC-CDPYF) is exempt from the 2011 tax as a real estate trust, the authors explain to their readers. “Its recent performance illustrates the point that boring is better when it comes to income investments,” they add. Management’s reliable approach produces modest growth with little risk to distributions or the balance sheet.
Buy it to US$15, they say. It’s at $13.71. It yields 7.4 per cent on the distribution of $1.08.
Finally, there is one trust in the group that did not have a very good year in 2009. Yellow Pages Income Fund (TSX-YLO.UN; OTC-YLWPF) cut its distribution thanks to slumping advertising rates. But now, the authors say, it can cover that distribution by a margin of better than 2-to-1, and is using the cash to cut debt.
Its online revenue is growing and it continues to dominate the market. Thus it expects to maintain the distribution rate (80¢) well past 2011.
“Nevertheless, its units are definitely pricing in another cut, yielding more than 15 per cent,” conclude the authors. “That adds up to huge potential to beat expectations.” A buy up to US$8, it trades at $5.
As far as these experts are concerned, the best Canadian trusts, operating in one of the best economies in the world, will still have the riches to reward investors after the bell tolls in 2011.
We trust Canada will live up to their high expectations.
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