Maple Leaf Memo
Prime Minister Stephen Harper’s new budget includes the Tax Fairness Plan introduced Oct. 31, 2006, by Finance Minister Jim Flaherty.
It’s mentioned in the Themes (scroll down to “Tax Fairness Plan”) and incorporated by reference into The Budget Plan via Annex 5 Tax Measures: Supplementary Information and Notices of Ways and Means Motions (scroll all the way down to “Previously Announced Measures”).
And the Bloc Quebecois has said it will support it. Party leader Gilles Duceppe didn’t get everything, but it was enough. The Bloc Quebecois didn’t want an election but did want more money. The amount fell short of what Duceppe had demanded, but he said he was satisfied nonetheless: “It’s 80 percent of what we were asking for.”
Funny thing about this particular parliamentary system: The Bloc looked weak enough to actually lose seats in another election yet managed to coax an extra CD4 billion in federal transfer funds from Harper and Flaherty. Harper’s victory in January 2006 was made possible by a surprisingly strong showing in Quebec. But lately his numbers there have dwindled. Needing a boost, the prime minister opened the federal transfer spigot.
The federal government will boost transfers to provincial governments by a total CD6.1 billion in fiscal 2006-07, accounting for about two-thirds of the increase in spending. The increase in direct transfers for Quebec, where Harper won just 10 of 75 seats, totals more than a third of the CD6.1 billion; meanwhile, Ontario, where the prime minister underperformed in the last election, will receive a CD1.11 billion increase.
Harper’s CD233.4 billion (USD198 billion) budget also offers tax cuts for families, seniors, low-income workers, seniors, truck drivers, public transit riders and manufacturers–and sets aside CD1.5 million to promote Canadian three-down football. The plan calls for a 4.6 percent spending increase; on top of previously announced proposals–like new money for the environment and public transit–spending will increase 7.9 percent for 2005-06, the third-fastest increase in Canada in two decades.
Perhaps blind to the influence of parties three, four and five in a parliamentary system, we missed the Bloc Quebecois’ opportunity to trade some horses to boost its sagging political fortunes. The Bloc’s seats are critical to the budget’s passage. With them, the Conservatives have the support of more than 50 percent of the members of Parliament, and the budget, along with the Tax Fairness Plan, will pass.
To The Victor Goes The Surplus
The larger story for Canada is uplifting: It’s the only Group of Seven nation with a balanced budget, and its surplus for the year ending March will approach CD3 billion, all of it to be used to pay down debt. (It would have been more than CD10 billion, but the Conservatives like power.) The total surplus for the last decade exceeds CD80 billion. The government expects to reduce its debt to 30 percent of gross domestic product (GDP) by March 2009 and to 25 percent of GDP by 2013.
The Conservatives happen to be at the helm of a minority government through some pleasant seas. Rising commodities prices and record corporate profits made it easy for Flaherty to offer tax breaks to virtually everyone.
The government did cut its estimate for economic growth this year to 2.3 percent from a 2.7 percent projection in November because of declining oil prices and a strong Loonie, which hurt manufacturers. The economy expanded 2.7 percent in 2006.
The Canadian Edge Portfolios have been adjusted since Halloween 2006 with an eye on one date: Jan. 1, 2011.
The Bloc Quebecois’ acceptance of the Conservative budget exposed a blind spot in our coverage of Canadian politics–our view framed by a two-party system and hindered by a little hope. But politics being what they are, we’ve stuck to basics when it comes to making portfolio decisions: Find stable businesses paying sustainable distributions.
As we did from the beginning of the income trust tax nightmare, we’ll take the legislative proposal at face value and assume its passage. And we’ll continue to gauge its impact at the trust level. Another aspect we’ll address is the impact of some of Harper’s targeted tax changes on the businesses we cover. There’s a lot in there regarding taxation of various assets–incentives and depreciation schedules, for example–with implications for the trust universe.
Harper and Flaherty have served up a lot of giveaways and incentives–quite a far cry from what we think of conservatives–but they did it, because they could.
The Roundup
Oil & Gas Trusts
Harvest Energy Trust (HTE.UN, NYSE: HTE) reported 2006 revenue of CD1.4 billion, up from CD436.5 million in 2005, but its fourth quarter profit dropped to CD1.5 million from CD75.6 million a year ago. Revenues climbed to CD686.5 million from CD169.9 million in the fourth quarter of 2005 as production climbed 63 percent to 63,436 barrels of oil equivalent (BOE) per day. Declared distributions jumped to CD135 million from CD44.5 million, the payout ratio rose to 86 percent from 57 percent, and bank debt jumped to CD1.6 billion from CD13.9 million. Harvest reported a 30 percent year-over-year jump in profit to CD136 million from CD104.9 million in 2005.
Harvest’s annual reserve report revealed an 82 percent increase in total proved reserves and an 84 percent increase in proved plus probable reserves to 159.2 million barrels of oil equivalent (MMBOE). Internal efforts generated approximately 18.9 MMBOE of proved plus probable reserves, replacing approximately 87 percent of 2006 production. Development and exploration capital investments totaled CD363.5 million and added a net 15 MMBOE, resulting in finding and development costs including future development capital (FDC) of CD26.04 per BOE. Finding, development and acquisition (FD&A) costs including FDC were CD24.59 per BOE. Three-year average proved plus probable F&D costs were CD14.43 including FDC; three-year average proved plus probable FD&A came in at CD17.08 including FDC. Harvest’s reserve life index on a proved plus probable basis is 9.3 years. Harvest Energy Trust rates a sell.
Sound Energy Trust (SND.UN, SNDFF) reported fourth quarter net income of CD3.4 million (6 cents Canadian per unit), down from CD7.3 million (26 cents Canadian per unit) a year ago. Sound generated funds flow from operations (FFO) of CD19.0 million (33 cents Canadian per unit), down from CD21.3 million (75 cents Canadian per unit) in 2005. Production revenue before hedging decreased 3 percent to CD44.8 million from CD45.9 million last year. For 2006, the trust reported net income of CD6.5 million (17 cents Canadian per unit), down sharply from CD18.2 million (65 cents Canadian per unit) for 2005. FFO declined to CD64 million (CD1.62 per unit) from CD72.8 million (CD2.59) in 2005. Full-year production revenue before hedging was down 2 percent to CD157 million from CD161 million because of lower commodity prices in 2006. Sound Energy Trust is a hold in the wake of its 45 percent distribution cut.
True Energy Trust’s (TUI.UN, TUIJF) plan to convert back to the corporate form is meeting resistance among its unitholders. A small group of unitholders has filed a dissident proxy circular pursuant to the shareholders’ meeting to be held March 30 urging other unitholders to vote against True’s plan of arrangement and install new directors. This follows a press release issued by the current board in response to an unsolicited reorganization alternative proposal submitted by <i>Lawrence Asset Management</i>, a Toronto-based hedge fund, on March 7.
Lawrence proposes splitting the assets between the trust, operating in a “blow-down mode,” and a newly formed exploration company established through the spin-out of 1,000 BOE per day of current production and 500,000 acres of the trust’s best growth prospects. The trust’s capital program would be cut dramatically after 2007, down to CD27 million of capital expenditures in 2008 and CD7 million in 2009, resulting in increasingly declining monthly production volumes and cash flows. Lawrence’s plan is based on market assumptions the current board has described as unsubstantiated, and the board criticized the fund’s plan for a highly conditional CD40 million rights offering. Sell True Energy Trust.
Vault Energy Trust (VNG.UN, VNGFF) lost CD3.3 million in the fourth quarter as production costs jumped 35 percent and oil and gas revenue fell. The trust, which reported net income of CD4.6 million in the fourth quarter of 2005, also saw revenues slip from CD47.8 million to CD34.2 million. Production reported for the fourth quarter was higher than expected at 7,718 BOE per day. FFO was off 60 percent at CD10.7 million, down from CD26.8 million a year ago, as lower oil and gas prices and higher production costs took their toll. For the year, Vault posted FFO of CD50.84 million (CD1.26 per unit), down from CD52.5 million (CD2.16 per unit) in 2005. The net loss for the period was CD15.81 million (46 cents Canadian per unit), compared to net income of CD10.5 million (43 cents Canadian per unit). Revenue was up to CD138.8 million from CD121.12 million. Sell Vault Energy Trust.
Electric Power
Innergex Power Income Fund (IEF.UN, INRGF) reported a fourth quarter profit of CD1.5 million (6 cents Canadian per unit), down from CD3.6 million (15 cents Canadian per unit) in the year-earlier period, on flat revenue of CD8.8 million. Full-year profit, however, rose to CD11.9 million (48 cents Canadian per unit) from CD10 million (46 cents Canadian per unit) in 2005. For the year ended December 31, Innergex reported gross revenues of CD41.2 million, up from CD30 million in 2005.
Production for 2006 grew 49 percent to 641,525 megawatt hours (MWh) from 431,619 MWh mainly because of the acquisition of the Rutherford Creek generating facility in December 2005. For 2006, annual net distributable cash totaled CD26.1 million, up 27 percent from CD20.5 million in 2005. Innergex reported a payout ratio for year 2006 of 91 percent, down from 100 percent in 2005. Buy Innergex Power Income Fund up to USD12.
Business Trusts
Bell Aliant Income Fund’s (BA.UN, BLIAF) CD119 takeover offer for Amtelecom Income Fund has been rejected by trustees for the target as “inadequate.” The board reviewed the CD13 per unit offer and decided it “does not reflect the intrinsic value to unitholders.” Amtelecom controls operating divisions that provide cable, phone and Internet services in Ontario. Bell Aliant Income Fund remains a buy up to USD30.
CML Healthcare Income Fund (CLC.UN, CMHIF) reported that fourth quarter net earnings increased 25.3 percent to CD21.8 million (27 cents Canadian per unit) from CD17.4 (22 cents Canadian per unit) a year ago. Revenue rose 4.2 percent CD72 million from CD69.1 million in the fourth quarter of 2005. For the year, CML boosted earnings 16.1 percent to CD92.4 million (CD1.14 per unit) from CD79.6 million (CD1 per unit) for full year 2005. Revenue for 2006 was up 6 percent at CD288.9 million from CD272.6 million. The fund reported distributable cash of CD98.8 million and declared distributions totaling CD85.1 million for an 86.2 percent payout ratio. Hold CML Healthcare Income Fund.
Great Lakes Carbon Income Fund (GLC.UN, GLCIF) unitholders have benefited nicely from the bidding war between US-based Oxbow Carbon & Minerals Holdings</i> and Rain Commodities. Rain acquired 20 percent of the income fund last March in a deal that put the enterprise value for Great Lakes Carbon at CD656 million and had recently entered into an agreement to buy the remainder at CD11.60 per unit. But Oxbow bid CD13 per unit on March 7, forcing Rain to increase its offer to CD13.25. Oxbow countered at CD13.50. Oxbow is the world’s largest marketer of petroleum coke; Rain wanted to add to its own calcined petroleum coke capacity and even threatened a legal challenge to Great Lakes Carbon’s preliminary acceptance of the Oxbow offer. Great Lakes Carbon Income Fund is a hold.
Menu Foods Income Fund (MEW.UN, MNUFF) recalled 46 dog foods and 37 cat foods sold under various brand names following 10 animal deaths in the US. The recall will cost CD30 million to CD40 million, according to the fund. Nine cats and one dog died in connection with Menu Foods’ products made at the company’s Emporia, Kan., plant, the US Food and Drug Administration reported March 17. Menu Foods said complaints surrounding the renal health of pets eating the food coincided with the use a new ingredient, which has been discontinued. Tests failed to identify anything wrong with the items. One customer, accounting for 11 percent of the fund’s annual revenue, suspended orders. This is a horrible turn of circumstances for Menu Foods, which reported solid fourth quarter numbers and looked poised to reinstate dividends after suspending in December 2005. Hold Menu Foods.
Versacold Income Fund (ICE.UN, VCLDF) reported a net loss of CD1.73 million (4 cents Canadian per unit) for the fourth quarter, improvement from the CD3.68 million (15 cents Canadian) it reported for the same period in 2005. Revenue for the fourth quarter grew to CD178.93 million from CD70.21 million. Versacold warned of a “challenging” first quarter and lower first-half earnings. For 2006, earnings doubled to CD12.2 million (37 cents Canadian per unit) from CD5.6 million (24 cents Canadian per unit) in 2005. Annual revenue tripled to CD693.3 million from CD210.4 million. Buy Versacold Income Fund up to USD9.
Real Estate Trusts
Cominar REIT (CUF.UN, CMLEF) reported fourth quarter profit increased 17.2 percent to CD10.4 million. Net income for 2006 was CD34.1 million (99 cents Canadian per unit), up 8.8 percent from CD31.3 million (98 cents Canadian per unit) in 2005. Cominar acquired and developed 1 million square feet of space for CD67 million in 2006. Occupancy stood at 94.4 percent, down slightly from 2005 because of the bankruptcy of the sole occupant of a 275,000-square-foot facility. Cominar REIT is a buy up to USD20.
Natural Resources Trusts
Labrador Iron Ore Royalty Income Fund (LIF.UN, LBRYF) reported adjusted cash flow for the year ended Dec. 31, 2006, of CD72.9 million (CD2.28 per unit), down from CD74.6 million (CD2.33 per unit) for 2005. Iron ore sales of operating unit Iron Ore Company of Canada (IOC) amounted to 15.8 million tons, up slightly from 15 million tons in 2005. Increased sales were slightly offset by the strengthening of the Canadian dollar against the US dollar. Net income for 2006 was CD94.4 million (CD2.95 per unit), up from CD86.1 million (CD2.69 per unit). Labrador’s share of IOC’s earnings amounted to CD38.6 million, down from CD42.3 million in 2005. The increase in net income was mainly due to a CD10.5 million reduction in future income tax liabilities as a result of the 3 percent reduction in the federal corporate tax rate by 2010 and the elimination of surtax by Jan. 1, 2008. Labrador Iron Ore Royalty Income Fund is a buy up to USD24.
SFK Pulp Fund (SFK.UN, SFKUF) cut its fourth
quarter loss to CD142,000 from a year-earlier CD8.4 million as sales
revenue for the period grew to CD110.5 million from CD56.5 million a
year earlier. The fund posted a full-year profit on higher sales
revenue after key acquisitions. Sales reached CD312.4 million in 2006,
up from CD236.2 million, as two pulp mill acquisitions added CD38.7
million. Improved pulp market conditions accounted for another CD37.5
million. Profit for 2006 amounted to CD1.3 million, a turnaround from
the CD5.2 million loss posted for 2005. SFK Pulp Fund is a buy up to USD4.