A new breed of Canadian income trusts
America’s leading expert on Canadian markets looks at income trusts and sees a rich new harvest of dividends. He has six strong buys.
Sometimes myth wins out over facts.
That’s certainly true in stock markets, where reason often fails to keep up with emotion and rumour.
But it’s not true of Canadian income trusts, says America’s most widely consulted expert on the matter.
Mr. Roger Conrad, who follows Canadian markets closely, is happy to report that facts have triumphed in the case of trusts.
The myth of their untimely demise after the notorious “Halloween tax” has been laid to rest. “We’re witnessing the rapid and largely unnoticed birth of a new breed of Canadian stocks that pay high dividends,” he says.
Writing in Personal Finance, Mr. Conrad and his colleague Mr. David Dittman (his associate editor in a separate publication entitled Canadian Edge) tell the story. And they top it off with six buys for their U.S. readers.
Outsized dividends
The story is well known. Finance Minister Jim Flaherty stood up in Parliament on Halloween 2006 and declared that the distributions on income trusts would be taxed as of January 1, 2011.
Anger filled the air and spread to the markets. For two weeks, trusts nose-dived. Only a repeal of the act would save the trusts, many cried.
Not so, say the authors. “The Act didn’t repeal investors’ need for income, or management’s desire to keep providing it.” Nor did it turn sound companies into bad ones.
The fear mongers “under-estimated good businesses’ ability to pay outsized dividends despite new taxes and the government’s desire to make converting to tax-paying corporations as painless as possible.”
Of the 60 trusts to announce or complete corporate conversions so far, 33 are paying higher or equal dividends.
Sharply lower taxes
These experts also paint a bright picture of Canadian tax rates for the U.S. readership. Canadian corporate taxes, already the lowest of any first-world nation, are set to fall to less than half those of U.S. rates by 2012.
“Many former trusts will pay virtually no new taxes,” they proclaim.
“As for direct taxes on investors, Canadians will pay sharply lower rates after conversions.” The prognosis is good for American investors as well, they state. Those who hold them in tax-protected accounts (IRAs) will no longer pay the 15 per cent withholding tax.
That should help keep American money healthily invested in these Canadian investments.
The higher Canadian dollar also makes this “new breed of high-yielding Canadian stocks an inflation hedge as well.”
But not every trust will bear the new taxes painlessly. “Fortunately, the difference is the same as it is for every income investment,” say the authors. “A strong underlying business.” They have six to recommend.
Three for the portfolio
Three of these trusts already reside in this advisory’s Income Portfolio and get a passing but enthusiastic mention in this article.
Canadian Apartment Properties REIT (TSX-CAR.UN; OTC-CDPYF) is trading at $15.07 and yielding over 7 per cent on its $1.08 distribution.
Vermilion Energy Trust (TSX-VET.UN; OTC-VETMF) is trading at $34.45 and yields 6.6 per cent on the distribution of $2.28.
Yellow Pages Income Fund (TSX-YLO.UN; OTC-YLWPF) has seen its share price pull out of earlier doldrums to sit at $6.39. It yields a substantial 12.5 per cent on the 80-cent distribution.
The authors spend more time on the next three recommendations, one of which has already made a successful transition back to corporate status.
The same monthly dividend
The convert is Atlantic Power (TSX-ATP; OTC-ATLIF). It will list on the New York Stock Exchange later this year, which will help it raise capital and make new deals.
It pays the same monthly dividend as it did before conversion at $1.09. Although the stock has rallied more than 200 per cent off its lows in November 2008, the yield remains stout at 8.7 per cent.
Management intends to increase the payout by adding new assets, the authors tell us. These will likely be natural gas-fired power plants tied to long-term contracts. “There has never been a default on this type of contract,” they add, “and cash flows are extremely stable.”
The stock is a buy up to US$13. It trades at $12.13 in New York, $12.47 in Toronto.
Enerplus Resources Fund (TSX-ERF.UN; NYSE-ERF) intends to convert at the end of the year and will maintain its “generous dividend,” say the authors. This shows extraordinary confidence in the firm’s cash generating prospects.
The firm lowered its debt with some timely asset sales. Now it is adding assets in the Marcellus and Bakken shale “that promise to keep overall output steady and low cost for years to come.”
The company’s overall payout ratio is low, and its tax pools ensure a low tax rate well past 2011, conclude these experts. Enerplus is a buy to US$25. It trades at $22.98 in New York and $23.60 in Toronto, and yields 9 per cent on its distribution of $2.16.
Paramount Energy Trust (TSX-PMT.UN) sells for “barely half the value of its almost entirely natural gas reserves,” report the authors. It plans to maintain the current dividend when it converts later this year.
Thanks to hedging, the company has avoided the worst effects of low natural gas prices. The current payout ratio is protected.
Still, there is long-term risk thanks to uncertainty over natural gas prices. “But aggressive investors who want a long-term bet on gas prices that pays dividends will find much to like,” concludes these experts.
Buy Paramount under US$5, they say. It’s already above that in Canada, at $5.05, but trades at $4.92 in New York. The yield is a hefty 11.8 per cent on the $0.60 distribution.
The myth is that income trusts are dead. The reality is that their dividends are very much alive.
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