High Yield of the Month
Those who’ve been around the block a couple of times, however, know you won’t have income without growth for long, and vice versa. Rather, the ideal combination is an investment paying a generous yield, with the wherewithal to grow its distribution methodically and robustly in time.
When I recommend a trust as High Yield of the Month, I always present a graph with two lines. The first is the market price per share of the trust, generally going back at least several years. The second tracks the 12-month rate of distributions, or what a year’s worth of income would be at the current monthly rate.
The first line is generally a good deal more volatile than the second. That’s because a lot of factors can affect the price of a trust or stock in the near-term. Long-term, however, the share price line follows pretty much in line with the dividend distribution line.
If a simple picture is worth 1,000 words as the proverb says, these graphs speak volumes. The message, however, is simple: Trust prices follow how much they pay out in distributions. If the distributions are rising, so will the share price. You literally have growth and income. Conversely, if a trust with a big yield number cuts its distribution, its share price is going to crater. You have neither growth nor income.
This month’s featured trusts pay yields in the 6 to 7 percent range. That’s on the low side for the Canadian trust universe. Their robust rates of growth, however, are as lofty as they are sure; they’re backed by some of the most solid assets in Canada. Throw in the fact that they’re in good shape to be shielded from 2011 trust taxation and you’ve got a formula for robust, long-term growth and income–and worthy candidates for my Conservative Portfolio.
One is an old friend. AltaGas Income Trust (ALA.UN, ATGUF) has been a Canadian Edge Portfolio member since January 2005, handing us a generous 50.8 percent total return. The trust is basically in the energy infrastructure business, running power plants, gathering and processing facilities and major pipelines primarily in western Canada. The company also has investments in regulated utility and other energy assets, including oil and gas production. And it runs an increasingly profitable energy services business, an offshoot of its success running its other assets.
All of those operations shone in the second quarter. Field gathering and processing–for long the core operations of the trust–scored a 60 percent jump in second quarter operating income. Fueled by new investments in wind projects, power generation income moved up 11.5 percent. Already 60 percent of total operating income, this division will become increasingly important and profitable in coming years, as new projects come on line. The trust has also entered the gas storage business in Ontario, purchasing a 50 percent interest in a facility in part to service its gas and power infrastructure business.
Overall, AltaGas reported second quarter net income of 23 cents Canadian per unit, down sharply from 54 cents the year before. That shortfall, however, was almost entirely because of a non-cash charge resulting from accounting adjustments made necessary by the Flaherty/Harper plan to tax trusts as corporations beginning in 2011. It had no impact on cash flows, which rose a steady 6.2 percent, fueled by a 14.1 percent jump in revenue.
The trust’s distribution history is one of steady increases and shareholders were treated to another last month–a 2.9 percent bump to a monthly rate of 17.5 cents Canadian. AltaGas owners will also receive one additional share of AltaGas Utility Group (TSX: AUI, CD7.73, 1.8 percent yield) as a special dividend on Sept. 17, the date of the regular distribution. Both are payable to shareholders on record Aug. 27. Those with less than 50 common shares of AltaGas Utility Group on the books will receive cash instead.
AltaGas’ business would be fully taxable beginning in 2011 under current law. The depreciable nature of its assets and their ultra-reliable cash flows–as well as management’s stated commitment to continue paying substantial distributions–argue for a big dividend well after 2011. So do the facts that actual earnings per share don’t lag distributions by much and that management has ample opportunities for further growth. There’s also the strong possibility of a takeover or other strategic move, particularly with the trust shares still selling for barely one times secure and growing sales.
In recent months, Altagas has pushed routinely above my buy target of USD26. Market volatility has temporarily shoved it under that level. But given its recent growth, I’m raising AltaGas to a buy up to USD28.
My other pick this month is a recent addition to Canadian Edge coverage, Artis REIT (AX.UN, none). As of yet, the trust doesn’t have a five-letter US over-the-counter (OTC) symbol and so will likely have to be purchased directly on the Toronto Stock Exchange. By the time it does attract enough US attention to have such an identifier, however, it will likely sell for a lot more than just 1.7 times its rapidly growing book value.
Unlike my other portfolio real estate investment trusts, Artis is a relatively new animal, operating before Feb. 15, 2007 as Westfield REIT, which itself only dated back to December 2004. It’s made the most of its relatively short life, however. Including all acquisitions in the works, Artis now runs a high quality portfolio of primarily western Canada commercial property, 64 percent of which is located in energy-rich Alberta. Properties are currently 53 percent office, 33.6 percent retail and 13.4 percent industrial.
Approximately 20.8 percent of the leasable space is in Manitoba, with the balance of holdings in Saskatchewan and British Columbia. Manitoba’s share will be greatly enlarged by the purchase of a 38 percent interest in the Commodity Exchange Tower and a retail complex in Winnipeg, which should be completed this month.
Despite the rapid pace of its purchases, Artis’ portfolio maintains excellent operating metrics. Occupancy stands at 97.2 percent, with the rest filling up rapidly as the REIT absorbs its purchases. Moreover, management estimates in place rents on average are approximately 25 percent below current (and rapidly rising) market rates. That builds in a lot of upside for rents in coming years, as well as downside protection against energy patch ups and downs.
New REITs–no matter how fast they grow–often take a while to reach profitability. That’s the case for several of those in the Canadian Edge coverage universe (see the How They Rate Table). However, that’s no longer the case for Artis.
As has been the case several times in recent quarters, the REIT’s revenue screamed ahead, growing 90.7 percent more than year earlier levels. That pushed up net operating income–profits excluding acquisitions made in the past year–by 88.1 percent. Funds from operations, the best overall measure of REIT profitability, blasted off to the tune of a 155.1 percent increase.
Of course, expansion costs money, and Artis issued 96.8 percent more shares in the past year to finance its moves. Funds from operations (FFO) per unit, however, rose 30.8 percent, a clear sign growth is more than overcoming dilution. Moreover, mortgage debt–another key source of financing–fell to just 45.8 percent of book value from 52.1 percent at the beginning of the year.
In other words, this REIT has been able to grow rapidly without taking on excessive debt or diluting its shares. That’s a sure sign of uncommon management, and that there’s a lot more growth ahead.
As for the distribution, it’s protected by a low payout ratio of 70.3 percent. Also, the REIT appears to be obeying the rules to qualify for tax-exempt status in 2011, and its strategy should ensure it continues to do so. Dividend growth has been nil during the past year, as management has instead applied the funds to cash flow-enhancing acquisitions. But the history of the trust suggests shareholders won’t have long to wait for another boost, and that when it does come it will be substantial. The last increase, for example, took place in February 2006, and took the rate to its current level of 8.75 cents Canadian per share per month, a 15-fold gain.
The next boost isn’t likely to reach that level. But with the trust’s rapid expansion likely to keep annual cash flow growth at double-digits going forward, it looks like only a matter of time before there’s a raise. And even if that happens later rather than sooner, rapid growth will give us plenty to smile about.
Aside from an acquisition-related miscalculation, the biggest risk to Artis is a possible prolonged slowdown and collapse in Canada’s oil patch. Fortunately, with oil sands becoming increasingly important to North American supplies, it’s extremely unlikely to follow the collapse of the country’s gas patch, even if environmental regulations are strengthened.
As long as they’re drilling oil sands, it will be a boon to Artis’ high quality portfolio. Meanwhile, management continues to plan against the day when energy patch conditions change for the worse, with its diversification outside the province, Alberta, that now contributes 69 percent of revenue. The most conservative will want to stick to the likes of ultra-safe RioCan REIT (REI.UN, RIOCF). But for everyone else, Artis is a strong buy up to USD18.
| AltaGas Income Fund & Artis REIT | ||
| Toronto Symbol | ALA.UN | AX.UN |
| US Symbol |
ATGFF
|
none
|
| Recent USD Price* |
25.34
|
16.58
|
| Yield |
7.7%
|
6.1%
|
| Price/Book Value |
2.93
|
1.68
|
| Market Capitalization (bil) |
CD1.573
|
CD0.464
|
| DBRS Stability Rating |
STA-3 (middle)
|
none
|
| Canadian Edge Rating |
2
|
3
|
*Recent USD Price as of 09/04/07.