Dividend Watch List

The Canadian trust universe was hit with eight distribution cuts last month. Not surprising, the most represented group were small to midsized energy producers, with a weight toward natural gas.

Aggressive Portfolio holding Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV) trimmed its payout by 20 percent to a monthly rate of 12 cents Canadian. The move was in large part a result of weak natural gas prices, which had pushed up the third quarter payout ratio to an unsustainable 88 percent. However, management was also making a strategic decision to deploy more cash for development in the wake of its recent merger with Sound Energy.

The 2008 capital spending target is now CAD130 million to CAD145 million, which will be used to boost daily production to 32,000 to 34,000 barrels of oil equivalent (boe). The trust will still devote the lion’s share of its efforts toward its natural gas assets but will move 45 percent of spending toward light oil assets, its most balanced stance in some time.

Assuming natural gas prices hold about where they are now, Advantage should be able to maintain the lower distribution level. And with the Sound Energy merger now under its belt, it’s more attractive than ever as a potential takeover target. As a result, despite recent losses, Advantage Energy Income Fund remains a buy up to USD12. Note that I don’t advise averaging down on it or any other investment.

Fairborne Energy (TSX: FEL-U, OTC: FELNF) has now converted from an income trust to a corporation, completely eliminating its distribution. The move was made as part of a hookup with private equity concern Denham Commodity Partners, which gave the latter a 15.9 percent ownership interest in exchange for financial backing to fund Fairborne’s development plan.

In my view, this kind of deal is always more in the interest of management and the acquirer than ordinary shareholders, and Fairborne units have been punished accordingly. Nonetheless, the vast majority of unitholders have apparently approved the deal and, therefore, deserve their fate. Sell Fairborne Energy if you’re still unlucky enough to own it.

True Energy Trust (TSX: TUI-U, OTC: TUIJF) is cutting its distribution in half, effective with the February payment, to 4 cents Canadian per share. The reduction is part of a far-reaching strategic move that involves selling all of the trust’s Saskatchewan assets—primarily high priced oil assets—and a 50 percent increase in projected 2008 capital spending to CAD60 million, primarily on its most promising natural gas production properties. And it comes after a massive management shakeup, including the resignation of founder Paul R. Baay as chairman and CEO.

Survival for True at this point likely depends on one of two things happening: a recovery in natural gas prices that will reward its new bet on gas and/or a merger/takeover offer. These moves do make True shares more attractive to a potential buyer, in large part because they target its efforts and reduce the need for massive additions of debt. And the new payout ratio based on third quarter cash flows is again a manageable 50 to 60 percent.

But this is still a high-risk proposition, with just 9,000 boe per day in total production. Conservative investors should sell True Energy Trust.

With Canadian natural gas drilling in the dumps, conditions figure to remain very challenging for energy service trusts. That’s sparked what’s best termed as a “survival merger” between two small, vulnerable sector trusts, Peak Energy Services Trust (TSX: PES-U, OTC: PKGFF) and Wellco Energy Services Trust (TSX: WLL-U, OTC: WLLUF).

With their generally complementary businesses combined, the pair will be better able to deploy assets more cost effectively, retiring what’s losing money now and focusing on what’s working. Peak holders will own 63 percent of the post-merger trust, while Wellco owners will receive 0.9 shares of Peak per share and own 37 percent. The deal must be approved by both trusts’ unitholders and is expected to close no later than March 31.

The Peak/Wellco merger does come with one particularly bitter pill for both trusts’ shareholders: The pair has eliminated all distributions effective immediately.

Management of both trusts has billed the move as a “more efficient use of capital” to “expand current operations” and “strengthen balance sheets.” In reality, this is a pretty clear indication of just how bad things have gotten in this sector. In effect, management has telegraphed that this is something they were going to be forced into anyway.

In my view, Peak/Wellco is a much stronger trust than either alone. And given the drastic action taken with the distribution—which resulted in a wholesale meltdown of their share prices—the alternative is truly oblivion.

On the other hand, there’s still a lot of hard work to do here, and only a return to higher levels of oil and gas production activity will produce a recovery. With no distribution to reward investor patience, there’s no reason for anyone to own either trust. I’m maintaining my sell recommendations on both Peak Energy Services Trust and Wellco Energy Services Trust.

If you want a trust bet on energy services, stick to Precision Drilling (TSX: PD-U, NYSE: PDS) and Trinidad Energy Services Income Trust (TSX: TDG-U, OTC: TDGNF).

Outside the energy patch, Fording Canadian Coal (TSX: FDG-U, NYSE: FDG) has again cut its distribution, this time to a quarterly rate of 53 cents Canadian per share. That’s down from a rate of 95 cents Canadian a year ago and 60 cents Canadian in the prior quarter.

Ironically, despite cutting distributions six times in the past two years, Fording shares are trading near their highest levels in many months. The primary reason is swirling takeover speculation that appears to have been stirred by operating partner Teck-Cominco’s interest. The rumor is that Fording announced it was pursuing “strategic alternatives” in a bid to pump up its market value before a formal Teck bid is made.

Of course, it’s possible Fording will get a very lucrative bid from Teck or someone else entirely in the coming months. The long-term value of its metallurgical coal reserves is considerable, despite currently slumping met coal prices on global markets.

The risk is that market conditions aren’t currently favorable for either met coal or Fording. And if the current takeover speculation fades away, the shares are going to come down hard. Consequently, my advice is still to lock in your profit at these levels.

Newport Partners Income Fund (TSX: NPF-U, OTC: NWPIF) has slashed its distribution 35 percent. In the CEO’s words, management is responding to a “market signal” that “our current distribution policy is not the most effective use of the cash generated by the Fund’s investments.” His primary evidence cited was the 20 percent-plus yield the shares were selling for before the cut.

Buy that one if you want. But with the shares selling 45 percent off their highs, it looks to me like the market was just pricing in what it saw: a jumble of businesses that were rolling up debt and not generating the cash flow to cover distributions.

The new rate may be more sustainable for a while, but this isn’t a place I want to be. My recommendation remains to sell Newport Partners Income Fund.

Finally, PRT Forest Regeneration Income Fund (TSX: PRT-U, OTC: PFSRF) is the latest trust to get pummeled from US weakness. Management now expects a 10 to 20 percent drop in demand for its seedlings in North America, mainly because of falling lumber demand from the steep downturn in US housing starts. That’s only partly offset by higher seedling demand in British Columbia because of beetle and forest fire damage.

PRT’s payout ratio had already been running in the 100 percent range. As a result of these challenges, management is taking it back to a more sustainable 4.6 cents Canadian per month, from the prior rate of 7 cents Canadian. The 34.3 percent reduction should do the trick to keep the business on sustainable footing.

PRT Forest Regeneration Income Fund is now a hold. But no one should expect a recovery until the US economy and housing market turn the corner.

Here’s the rest of the Dividend Watch List. Note I’ve kept all of the dividend cutters noted above on the list, pending how their fourth quarter results stack up. See the How They Rate Table for buy/hold/sell advice on those not discussed above:

Acadian Timber Income Fund (TSX: ADN-U, OTC: ATBUF)
Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV)
Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)
Canfor Pulp Income Fund (TSX: CFX-U)
Chartwell Seniors Housing (TSX: CSH-U, OTC: CWSRF)
Clearwater Seafoods Income Fund (TSX: CLR-U, OTC: CWFOF)
Connors Brothers Income Fund (TSX: CBF-U, OTC: CBICF)
Daylight Resources Trust (TSX: DAY-U, OTC: DAYFF)
Essential Energy Services Trust (TSX: ESN-U, OTC: EEYUF)
Fording Canadian Coal (TSX: FDG-U, NYSE: FDG)
Freehold Royalty Trust (TSX: FRU-U, OTC: FRHLF)
Harvest Energy Trust (TSX: HTE-U, NYSE: HTE)
Mullen Group Income Fund (TSX: MTL-U, OTC: MNTZF)
Newalta Income Fund (TSX: NAL-U, OTC: NALUF)
Newport Partners Income Fund (TSX: NPF-U, OTC: NWPIF)
Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)
Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF)
Peak Energy Services Trust (TSX: PES-U, OTC: PKGFF)
Precision Drilling (TSX: PD-U, NYSE: PDS)
Primary Energy Recycling (TSX: PRI-U, OTC: PYGYF)
Priszm Income Fund (TSX: QSR-U, OTC: PSZMF)
SFK Pulp Fund (TSX: SFK-U, OTC: SKFUF)
Sun Gro Horticulture Income Fund (TSX: GRO-U, OTC: SGHRF)
Swiss Water Decaf Coffee Income Fund (TSX: SWS-U, OTC: SWSSF)
TimberWest Forest Corp (TSX: TWF-U, OTC: TWTUF)
Tree Island Wire Income Fund (TSX: TIL-U, OTC: TWIRF)
Trilogy Energy (TSX: TET-U, OTC: TETFF)
True Energy Trust (TSX: TUI-U, OTC: TUIJF)
Wellco Energy Services Trust (TSX: WLL-U, OTC: WLLUF)
Westshore Terminals Income (TSX: WTE-U, OTC: WTSHF)

Flaherty Rejects SWF

Like Norway, Kuwait, Abu Dhabi and other oil-rich nations, Canada has prospered during black gold’s long, steep climb to USD100. Demand defined by already high, sustained use in the US and rapidly growing, still-immature consumption in Asia has pushed revenues to historic levels. Many nations have used the sums generated to seed state-affiliated investment funds.

But Finance Minister Jim Flaherty said in late December that Canada had no plans to create its own sovereign wealth fund (SWF). Oil exporters such as Norway and Libya have special accounts to prevent soaring energy money from pushing up the local currency, while setting aside the bounty for future generations. Canada’s currency has risen 55 percent against the US dollar in the last five years. 

An SWF basically manages the national savings. Lately several–including Abu Dhabi’s TAQA, which bought PrimeWest Income Fund last October and Abu Dhabi Investment Co, which is getting 11 percent on the IOU it drew up with Citigroup–have introduced themselves to the public with authority.

The end of January marks the start of what’s shaping up to be a highly scrutinized reporting season. There will be more writedowns by big financials, and the need to move illiquid assets back to the books will force them to look for “infusions” of cash.

It’s safe to say there will be more deals like Citigroup. Singapore’s Temasek–“not really an SWF,” according to colleague and The Silk Road Investor Editor Yiannis Mostrous, but structured by similar authority for similar purposes–took a piece of Merrill Lynch Dec. 24 for USD6.2 billion. And Merrill is said to be in talks with Chinese and Middle Eastern SWFs that could lead to the sale of another big stake in the US bank.

New Merrill CEO John Thain is seeking even more foreign capital to bolster Merrill’s balance sheet. Analysts expect another large writedown for Merrill in the fourth quarter, with some estimating the hit will be bigger than the USD8.4 billion recorded in the third quarter.

The Kuwait Investment Authority is following its peers in the Middle East, hoping to find bargain investments in the US in the wake of the subprime mortgage crisis. The USD213 billion SWF–governed by law and subject to parliamentary oversight, rather than the wishes of the ruling family–is particularly interested in opportunities in financial services.

Abu Dhabi Investment Co’s infusion will boost Citi’s ratio of cash to debt and make the US heavyweight stronger financially. Once the equity units Abu Dhabi bought are converted into stock in 2010 and 2011, Abu Dhabi will hold a 4.9 percent stake in Citi. Until those units get converted, Citi will pay Abu Dhabi an 11 percent yield.

And there will be more deals like PrimeWest as well. TAQA’s CAD5 billion deal for PrimeWest was approved in November, as was its purchase of Canada-based Pioneer Natural Resource Co for CAD540 million. The PrimeWest purchase will be completed next month.

TAQA is looking to make more acquisitions in 2008, with a stated intention to focus on midstream or downstream assets. It plans to triple the value of its assets to USD60 billion by the end of 2012, from about USD21 billion.

Running to Stand Still

The Conservatives have a slight lead over the Liberals in horse-race polling, but Canadian Prime Minister Stephen Harper is further away from his coveted majority than at any time during his nearly two-year reign atop a minority government.

A mid-December poll by Angus Reid Strategies put support for the Tories at 33 percent, down from 36.3 percent on election day in 2006 and 39 percent last March, the party’s post-election high.

The Conservatives’ numbers are particularly disappointing in light of the ineptitude of Liberal leader Stephane Dion. The Angus Reid survey found support for the Liberals at 28 percent, followed by the New Democrats at 17 percent, and the Bloc Québécois and the Green Party, both at 10 percent. A Dec. 21 Ipsos-Reid poll showed the Tories at 35 percent and the Grits at 33 percent.

Canadians are happy with neither Harper nor Dion: 41 percent of those surveyed by Angus Reid preferred neither one for prime minister. Twenty-six percent of Canadians said the environment is their No. 1 concern, the highest-ranked issue for voters in the poll.

Bay Street Beat

Cineplex Galaxy (TSX: CGX-U, OTC: CPXGF) extended its long run as Bay Street’s most-favored trust, earning a 4.818 average rating in the most recent Bloomberg survey of analysts’ ratings for S&P/Toronto Stock Exchange (TSX) Composite Index listings.

The box office cooled during the fourth quarter, and 2008 results are forecast to be flat with 2007. But in addition to a loyalty program and a new Web-based initiative, Cineplex boasts CAD624 million in tax pools, which could reduce the fund’s effective tax rate below 10 percent well beyond 2011. 

Calloway REIT (TSX: CWT-U, OTC: CWYUF) matched Cineplex’ score. The shopping mall-focused REIT is yielding more than 6 percent, and its payout ratio is manageable at 84 percent. Calloway is paying CAD680 million for 10 Wal-Mart anchored malls, with CAD405 million due upfront and the rest in the next four years. The malls are being bought from Wal-Mart Canada Corp and SmartCentres, a private development company.

Jazz Airline Income Fund (TSX: JAZ-U, OTC: JAARF) earned a 4.667 average. Jazz boosted its distribution by more than 15 percent in the last year, and the fund was recently added to the S&P/TSX Composite Index. Canadian air traffic continued growth and the terms of its arrangement with Air Canada mean the payout is sustainable.   

Longtime CE favorite ARC Energy Trust (TSX: AET-U, OTC: AETUF) also scored well with a 4.538 average. Crescent Point Energy Trust (TSX: CPG-U, OTC: CPGCF), which notched a 4.462 average, and Progress Energy Trust (TSX: PGX-U, OTC: PGXFF), with its 4.571 average, are both takeover targets. See the Feature Article for more.

Trinidad Energy Services Trust’s (TSX: TDG-U, OTC: TDGNF) 4.455 average rating reflects its solid businesses. Trinidad has focused on the US deep drilling market, smoothing out what would have been a rough ride otherwise. Trinidad has been able to sustain its cash flow throughout the downturn in the Canadian drilling space, and the trust units could be set for a robust recovery.

Advantage Energy Income Fund (TSX: AVN-U, NYSE: AVN) was the second-lowest scoring name on the Bloomberg list with a 1.857 average. Advantage recently cut its distribution from 18 cents Canadian per unit to 15 cents Canadian, part of a plan that appears to ensure the trust will continue to operate profitably while gas prices remain low.

Algonquin Power Income Fund (TSX: APG-U, OTC: AGQNF) earned a 2.667 average score. Its St. Leon facility makes it a major player in North American wind power; output is sold to Manitoba Hydro under a lucrative contract.

Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF) earned a 2.846 average, but it did generate a double-digit gain in 2007. The fund’s fiber-to-the-node technology gives it a huge technical lead over rivals in its markets and should enable it to offer faster, cheaper services.

Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) was also among the lowest-scoring with its 3.000 average, but it’s boosted its distribution by more than 20 percent since October 2006 and has set itself up for more growth.