Maple Leaf Memo
Thomas Paine said, “That government is best which governs least.” He didn’t have corporate governance in mind.
In its latest annual report, released in advance of its June 28, 2006, annual meeting, the Canadian Coalition for Good Governance announced that it would “embark on an ambitious plan to understand, measure and enhance income trust governance.”
And the Toronto Globe and Mail, in its “Board Games 2006” report (click here to read more), concluded that, “While many large income trusts are making changes that reflect their evolution into mature business giants, (Report on Business) found that governance practices are all over the map, with a sizable proportion of trusts still operating in outdated ways rarely seen among large companies in the corporate sector.”
Let’s hope our neighbors to the north have some appreciation for the great Paine.
Until recently, regulation of corporate governance issues in Canada was undertaken by the Toronto Stock Exchange (TSX) under a model that was primarily a matter of exhortation, the only mandatory requirement of which was that issuers address their approach to corporate governance in their annual proxy circular. There was no mechanism for enforcement of this modest requirement (short of delisting) because the TSX has no functional means to require issuers to modify their annual disclosure documents filed in accordance with securities legislative requirements. Furthermore, even this modest requirement wasn’t directly applied to income trusts.
Perhaps in part because of this, there appears to be a perception that income trusts don’t do as good a job with governance as regular corporations.
If shareholders own shares in a corporation, they have rights, and the corporation has responsibilities derived from corporate statutes and their judicial interpretation over hundreds of years. In Canada, these statutory rights and responsibilities are spelled out in the Canada Business Corporations Act and the provincial Business Corporations Acts.
The key legal feature of the income trust structure is that there are no legal default terms for this organization; rather, the rules governing internal conduct at a trust are found exclusively in the trust’s Declaration of Trust (DOT).
A study commissioned by the Canadian Association of Income Funds (CAIF) and the Real Property Association of Canada and conducted by SECOR Consulting, Canada’s largest independent strategic consulting firm, revealed that income funds generally compare favorably with public corporations in complying with governance guidelines established by the Canadian Securities Administrators in National Policy 58-201: Effective Corporate Governance.
Some 88 percent of income funds are explicitly compliant with more than 75 percent of the guidelines, compared with 92 percent of public companies. Sixty-seven percent are explicitly compliant with more than 90 percent of the guidelines, compared with 71 percent of publicly traded companies.
The study looked at how many trusts and corporations had independent directors, independent chairs, a strategic planning process, job descriptions for chief executives, succession plans, audit committees made up of outside directors, and a written code of conduct and ethics, among other guidelines.
Critics argue that simply meeting these guidelines doesn’t ensure value for shareholders. Distributable cash calculations and disclosure, for example, have been contentious issues for income trusts. Just because income trusts meet these governance guidelines doesn’t mean their distributable cash will be calculated in a way that meets critics’ standards. (CAIF has organized a committee to take up this issue.)
The survey, which included 202 income trusts and 100 corporations, speculated that “much of the disparity (between them) can be attributed to the relative youth of most funds.”
Of the trusts, 74.8 percent were less than 5 years old, compared with 7 percent of the companies.
But Ronald Charbon, an analyst at Standard & Poor’s, disagreed with CAIF’s conclusion on the cause. He said he expected trusts to have better compliance records because of their youth, arguing they could have adopted the guidelines at their inception. Charbon said size is the more telling factor. Small caps tend to be less compliant, which may explain why the trusts lagged the corporations in this study.
Anita Anand and Edward Iacobucci, members of the Faculty of Law at the University of Toronto, conducted another study of the governance practices of all income trusts that completed initial public offerings on the TSX between 1996 and 2004–about 230 trusts.
Anand and Iacobucci divided provisions in the corporate statute into one of four groups: the directors and officers’ protection group (containing provisions that insure directors and officers against liability relating to their positions); the shareholder voting and meeting group (containing provisions relating to shareholders’ rights in elections or charter/bylaw amendments); the shareholder remedy group (containing provisions relating to the ability of shareholders to bring an action against the corporation, directors and officers of the corporation or otherwise to exercise a statutory right of action in the context of a fundamental change in the corporation); and the transactions group (containing provisions relating to compulsory acquisitions, arrangements, takeover bids and amalgamations/squeeze out transactions). They then reviewed the DOTs of each of the income trusts in our sample to study the extent to which the DOT mirrored the corporate statute with regard to each of the variables.
Anand and Iacobucci found that income trusts have established governance regimes that largely adopt the approach of Canadian corporate statutes. When firms have adopted unique approaches in the DOT, it’s typically been in the context of specific, clear rules (e.g., notice periods for meetings).
The RoundupEarnings news has begun to earnestly flow in. Below, we’ve recapped this week’s announcements, and we’ll continue to highlight them as they come in.
Here’s the roundup.
Oil & Gas
Avenir Diversified Income Trust (TSX: AVF.UN, OTC: AVNDF ) is spending almost CD40 million on retail buildings and leasing space and oil and gas assets in Western Canada. Avenir is buying 26 buildings and almost 187,000 leasable square feet, which includes 11 Kentucky Fried Chicken (KFC) franchise locations in Alberta and British Columbia and 15 Landmark Theatres locations. Its trust portfolio now consists of 31 separate properties with a total of about 625,000 square feet primarily in Western Canada. Avenir also announced the acquisition of oil and gas assets in east central and southern Alberta that total about CD11.4 million. Avenir‘s cash flow is split about 40 percent energy and 60 percent financial services and real estate. Hold Avenir.
Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF) revealed that Syncrude has delayed the production of a higher-quality stream of crude until the fourth quarter of 2007 because of an equipment problem. Syncrude had hoped to produce the higher-quality crude as of May 2006, after completing an expensive expansion of its oil sands production facility, and it expected to receive a higher price for its output as a result. But Canadian Oil Sands, the largest shareholder in the Syncrude consortium, said that the blend wouldn’t be produced until changes are made to some of the installed equipment. Syncrude–Canada’s largest crude production facility with a capacity of 350,000 barrels a day–will likely realize a lower price for its crude during the next 12 months than previously expected. Syncrude produces a blend of synthetic, light sweet crude called Syncrude Sweet Blend (SSB), which has historically traded roughly equal or even at a slight premium to benchmark West Texas Intermediate (WTI) light sweet crude.
The 100,000-barrel-a-day expansion to the facility, brought on stream earlier this year, increased the amount of SSB on the market, lowering prices. While SSB fetched a premium over WTI for most of 2006, it’s now trading at a discount of around USD4.50 a barrel–a figure that could widen in the long term as other Canadian firms bring more synthetic crude on stream from the oil sands. Syncrude anticipated the discount and included plans in its expansion to improve SSB by adding hydrogen to the blend. The higher quality of the new blend–Syncrude Sweet Premium (SSP)–was expected to allow existing customers to increase the amount of Syncrude output they process and potentially attract new customers, mitigating any discount resulting from the increase in supply. However, the expansion has created “unidentified hydrogen limitations,” and as a result, SSP production won’t take place until modifications have been made to the new facility, likely during turnaround maintenance in the fall of 2007. Consequently, the new blend won’t be produced until the fourth quarter of 2007. Canadian Oil Sands is a hold.
Crescent Point Energy Trust (TSX: CPG.UN; OTC: CPGCF) will hold a special meeting of shareholders Nov. 27, 2006, for a vote on the conditional approval of a reorganization of the trust and its subsidiaries. The reorganization would result in the existing business, which is currently carried on through a limited partnership (LP) and corporations, being carried on through LPs indirectly owned by the trust. The reorganization–similar to reorganizations completed by a number of other income trusts–will provide Crescent Point with a structure that should maximize the cash available for distribution. The reorganization is subject to certain regulatory and third-party approvals. For unitholders, the reorganization won’t result in a change to the number, type and ownership of outstanding units, and there will be no impact on the daily operations of the trust. Crescent Point remains a hold.
Harvest Energy Trust (TSX: HTE.UN, NYSE: HTE) has sold CD400 million worth of convertible unsecured debentures and CD100 million in trust units to an underwriting syndicate. Harvest, which produces petroleum in Newfoundland and owns a Newfoundland refinery, said the debentures carry an interest rate of 6.3 percent. The 3.15 million trust units are priced at CD31.75 each. Underwriters have the option to add 15 percent more of the debentures or the units. If they exercise that option, Harvest’s proceeds would be about CD575 million. Proceeds from the sale will be used to repay a bridge loan taken out when the trust bought its refining operation. Hold Harvest Energy.
Progress Energy Trust (TSX: PGX.UN, OTC: PGXFF) generated quarterly cash flow of CD47.2 million (54 cents Canadian per unit) for the third quarter of 2006 compared to CD53.2 million (64 cents Canadian per unit) in the third quarter of 2005. Cash distributions declared totaled CD31.6 million (42 cents Canadian per unit). Production averaged 17,667 barrels of oil equivalent per day (boe/d) during the quarter, including 85.7 million cubic feet (mcf) per day of natural gas and 3,383 barrels of light and medium oil and natural gas liquids. Third quarter production was impacted by the scheduled and previously announced Fort Nelson gas processing facility turnaround. A turbine failure at the Karr gas plant and maintenance outages at the Gold Creek gas plant also impacted quarterly production.
Progress drilled or participated in 22 gross wells (12.0 net) with a 95 percent success rate. The program yielded 17 gas wells and three oil wells. New discoveries were made at Town, Dogrib and Lily Lake in the Foothills region of northeast British Columbia and at Wapiti in the Deep Basin region of northwest Alberta. Development drilling is expected to result from these new discoveries after Progress completes its field tests. Progress added more than 15,000 net acres of land in established fairways in the Foothills and Deep Basin regions. Land acquisition will continue along mapped or seismically identified trends. In total, Progress controls nearly 450,000 net acres of undeveloped land. Progress Energy is a hold.
Electric Power
Calpine Power Income Fund’s (TSX: CF.UN, OTC: CLWIF) subsidiary, Calpine Power LP, has entered into a 20-year agreement to toll the capacity from the Calgary Energy Centre with ENMAX Energy Corp. Commencement of the agreement is subject to certain conditions, including court approval, and is scheduled to occur on Jan. 1, 2007. Sell Calpine Power Income Fund.
Gas/Propane
Duke Energy Income Fund (TSX: DET.UN; OTC: DUYIF) will be renamed Spectra Energy Income Fund. The name change comes as Duke Energy Corp spins off its natural gas unit as Spectra Energy. Duke had considered separating its gas transmission and its utility businesses before its merger with Cincinnati-based Cinergy Corp, announced in May 2005. The spinoff was delayed until after the Cinergy deal closed in April. The new company will comprise Duke Energy Gas Transmission and Duke Energy Field Services. Day-to-day operations of the income fund are not affected by the name changes or the spinoff. Buy Duke Energy Income Fund up to USD11.25.
Precision Drilling Trust (TSX: PD.UN, NYSE: PDS) reported a higher third quarter profit as lower taxes and higher rates offset a decline in new wells. Earnings from continuing operations were CD133.6 million (USD119 million), or CD1.06 a unit, for the quarter, up from CD2.4 million, or 2 cents Canadian a unit, in the year-before quarter. Precision was expected to post per-unit earnings of 99 cents Canadian, the average forecast of five analysts polled by Reuters Estimates. The profit increase came even as natural gas drilling in Western Canada, which accounts for more than two-thirds of Precision’s business, plunged as gas prices dropped. The trust drilled 1,606 wells in the quarter, 35 percent fewer than a year earlier, and its rig utilization rate fell to 53.5 percent from 59.5 percent.
Precision’s share of the Canadian market also plunged, dropping to 24 percent of wells drilled from 32 percent in the year-earlier quarter, and operating days dropped to 11,606 from 12,539. Precision said that the number of new well licenses issued in September was the lowest for that month in four years, hampered by the 40 percent drop in natural gas prices and wet weather. But Precision said weak drilling has been more than offset by higher prices charged to customers. Precision said revenue rose 16.5 percent to CD349.6 million from CD300 million, as revenue per drilling day rose 21 percent. Net income, which a year ago was inflated by the sale of a division, fell to CD139.7 million, or CD1.11 per unit, from CD1.38 billion, or CD11 per unit. Precision’s conversion last November also added to profits. The change added 32 cents Canadian a share to it earnings. Precision Drilling is a buy up to USD33.
Business Trusts
Bell Aliant Income Fund (TSX: BA.UN; OTC: BLIAF) reported net earnings of CD78.6 million (USD70.2 million) and declared cash distributions of CD77.9 million, or 0.6279 cents Canadian per unitholder. Bell Aliant commenced operations on July 7, 2006, and its quarterly report reflects operations from then until September 30. The results combine Aliant’s wireline operation in Atlantic Canada, its information technology and other former operations and Bell Canada’s former wireline operation in its regional territories in Ontario and Quebec, as well as its indirect 63.4 percent interest in Bell Nordiq.
Bell Aliant reported operating revenues of CD817.6 million and operating income of CD193 million. Local telephony revenues declined by 0.9 percent year-over-year to CD367.6 million, driven by a decline in network access services of 1.2 percent, increased local service competition, a reduction in second lines as dial-up Internet customers convert to broadband and migration to wireless; long-distance minutes declined by 2.5 percent. Data and Internet revenue was CD167.2 million, an increase of 9.6 percent, led by high-speed Internet revenue growth of 18.8 percent and customer growth of 26.4 percent. Buy Bell Aliant up to USD33.
Bell Nordiq Income Fund (TSX: BNQ.UN; OTC: BNDQF) reported a CD9.3 million profit for the third quarter and announced higher guidance for Telebec and NorthernTel, the two operating companies that are the source of its funds. For the third quarter, Telebec and NorthernTel had combined operating revenues of CD93.8 million and net earnings of CD26.9 million, up from CD92 million and CD26.8 million, respectively, a year earlier. Cash distributions declared by the two LPs totalled CD25.5 million, of which CD16.1 million went to Bell Nordiq Group, a private company within the BCE group–and CD9.3 million to the fund. The fund declared cash distributions of CD9.3 million, or 28 cents Canadian, per unit. A year earlier, in the third quarter of 2005, the fund had about CD8.7 million in net earnings and distributions of 27 cents Canadian per unit. Bell Nordiq also announced higher guidance for Telebec and NorthernTel, saying they’re now expected to generate between CD362 million and CD366 million in revenue, up from the previous estimate of CD358 million to CD362 million, due to higher-than-expected increases to their high-speed Internet and wireless subscriber bases. Bell Aliant, which assumed majority ownership of Bell Nordiq in a reorganization of BCE’s operating companies, has announced plans to take Nordiq private. Sell Bell Nordiq.
Chemtrade Logistics Income Fund (TSX: CHE.UN) reported cash available for distribution for the third quarter period was CD13.3 million, or 40 cents Canadian per unit, compared to CD13.6 million, or 48 cents Canadian per unit, a year earlier. Revenue was CD148.7 million, up from CD125.8 million, and earnings before interest, income taxes, depreciation and amortization (EBITDA) was CD16.7 million, down from CD18.4 in the third quarter of 2005. The fund reported a net loss for the third quarter of CD10.2 million compared with net earnings of CD3.2 million in the same period last year. The loss reflects a non-cash charge of CD15.6 million with respect to impairment in the net book value of property, plant and equipment used to manufacture powder SHS. The cash flows associated with these assets have been declining due to rising input costs and reduced demand and can no longer support their net book value. Chemtrade Logistics is a sell.
Consumers’ Waterheater Income Fund (TSX: CWI.UN; OTC: CSUWF) reported that total revenues in the quarter and the nine-month period ending September 30 increased by 4.8 percent compared to the same periods last year. Third quarter 2006 net earnings increased to CD7.9 million and CD40.5 million in the nine months, compared to CD5.6 million and CD15.8 million in the same periods last year. The increase in year-to-date earnings is a result of non-cash benefits arising from future corporate tax rate reductions, higher revenues and lower operating costs. The 41 percent increase in quarterly earnings resulted from higher revenues offsetting slightly higher operating costs. As of September 2006, the fund increased monthly unitholder distributions by 4.2 percent. The fund’s portfolio of installed assets continued to increase but at a lower rate due to lower new home construction completions and increased competition. Buy Consumers’ Waterheater up to USD15.
Custom Direct Income Fund (TSX: CDI.UN, OTC: CUDFF) reported that third quarter sales and operating income increased by 0.6 percent and 0.8 percent, respectively, while gross profit was USD200,000 lower compared to the third quarter of 2005. Sales for the three months ended Sept. 30, 2006, increased compared to the same period of 2005, even though the third quarter of 2006 had one less work day than the same period of 2005; this is important to note because revenues are tied to consumer-based shipments, which are impacted by the number of work days in a period. Sales increased 4.2 percent, and gross profit was up about 3.0 percent for the nine months ended Sept. 30, 2006, compared to the same period of 2005, and operating income was lower by 2.7 percent. Custom Direct management expects full-year financial performance will continue to be consistent with historical levels. Sell Custom Direct.
Oceanex Income Fund (TSX: OAX.UN, OTC: OCNXF) revealed that its third quarter net income was CD2.9 million, or 33 cents Canadian per unit, compared to CD2.8 million, or 32 cents Canadian, in the year-ago quarter. Revenue rose to CD33.7 million from CD32.6 million. For the year-to-date period, Oceanex reported net income of CD6.2 million, or 71 cents Canadian per unit, against CD6.6 million, or 75 cents Canadian per unit, in the year-ago period. Revenue was CD92.2 million, up 6.2 percent from CD86.9 million. Buy Oceanex up to USD13.
Sleep Country Canada Income Fund (TSX:Z.UN) is accelerating the expansion of its Dormez-vous banner in Quebec with plans to open 10 more mattress stores during this year and next. The 117-store trust made the announcement Friday, October 27, a day after reporting a 52 percent rise in third quarter sales, partly due to its acquisition of Dormez-vous Sleep Centers this year. During the third quarter, Dormez-vous opened four new stores, bringing the current store count to 15. It’s planning to open two additional stores before the end of the year. Next year, Dormez-vous expects to open eight stores, for a total of 25 by the end of 2007.
The fund ended its latest quarter with CD24.7 million in cash and cash equivalents, compared with CD11.6 million on June 30. Growth also continues at the fund’s Sleep America unit in Arizona, which opened one store in the third quarter and is planning an additional store before the end of 2006. The core Sleep Country unit will open five more stores in the fourth quarter. The fund estimates that the mattress industry has a long-term growth rate of about 5 to 6 percent in North America. In Canada, the industry has typically grown at rates of 4 to 6 percent annually, supporting higher same-store sales despite recent softness in the country’s real estate market. Economists say that Canada’s housing market continues to fare better than its US counterpart, with housing starts dipping 6.6 percent year-over-year in the third quarter versus a much steeper 20 percent drop in the US. The fund’s higher third quarter earnings of CD9.7 million reflect sales growth in all regions in Canada, led by Alberta. Earnings amounted to 69 cents Canadian per unit versus profits of CD7.6 million, or 54 cents Canadian a unit, in the year-ago quarter. Total sales increased to CD97.8 million from CD64.5 million, while same-store sales increased 12.9 percent. The fund also increased its monthly distribution to 11.67 cents Canadian a unit from 11.25 cents. Hold Sleep Country.
The Keg Royalties Income Fund (TSX: KEG.UN, OTC: KRIUF) reported sales for the third quarter of CD98 million compared to CD87.6 million for the year-ago period, an increase of 11.9 percent. The Keg’s same-store sales (sales of restaurants that operated during the entire period of both the current and prior years) increased by 8.9 percent in Canada and by 7.1 percent in the US for the quarter. After translating the sales of the US restaurants into their Canadian dollar equivalent, consolidated same-store sales increased by 7.3 percent for the period and 6.4 percent for the nine months ended October 1, in spite of the continuing negative effect of the exchange rate between Canadian and US dollars. Hold The Keg.
Pipeline Trusts
Enbridge Income Fund (TSX: ENF.UN, OTC: EBGUF) reported a rise in third quarter profits and said it would increase its monthly distributions 4.5 percent. Net earnings for the three months ended September 30 amounted to CD5.8 million, or 17 cents Canadian per unit, up from CD5 million, or 15 cents Canadian per unit, in the same period a year ago. Enbridge attributed the increase primarily to a higher income tax allowance in Alliance Canada due to loss carry-forwards used in the prior-year quarter. Transportation revenue in the quarter fell to CD60.8 million from CD63.3 million in 2005.
The fund is increasing its monthly distribution to 8 cents Canadian per unit from 7.66 cents per unit, effective December 15. Enbridge’s assets include a 50 percent interest in the Canadian segment of the Alliance Pipeline, a full interest in the various pipelines comprising the Saskatchewan System, a 50 percent interest in NRGreen and interests in three wind power projects in Western Canada. Enbridge is a buy up to USD12.
Pembina Pipeline (TSX: PIF.UN, OTC: PMBIF) posted a record quarter as combined throughput of its oil sands and conventional pipes hit a record and the newly acquired energy midstream operations continue to perform well, with a 143 percent jump in net operating income. Overall, revenue rose 16.7 percent while net operating income surged 15.5 percent. Important, the pipeline-owning Canadian income trust continues to invest in new projects that will boost future cash flows, both inside and outside of the oil sands region. The trust increased its distribution reserve by CD4.5 million in the quarter, after investing in new projects and its existing network. That’s the sign of a very healthy trust indeed, particularly because dividends are 12.4 percent higher now than a year ago. Buy Pembina up to USD16.
Real Estate Trusts
Calloway REIT(TSX: CWT.UN, OTC: CWYUF) will pay USD1 billion for 16 SmartCentre-owned shopping properties, most anchored by Wal-Mart stores in Ontario, Quebec and New Brunswick. Most of Calloway’s 122 retail properties are anchored by Wal-Mart stores. As part of the deal, Calloway will also acquire part of the SmartCentres property-management business that runs Calloway-owned shopping centers. An initial payment of USD440 million will be made, with the remaining balance paid as construction of properties is completed. The deal is expected to close in December, subject to due diligence and certain approvals and conditions. The deal should increase Calloway’s cash flow, but that the real estate investment trust (REIT) hasn’t indicated that it would increase distributions at this time; Calloway has raised its distribution five times in the last two-and-a-half years. Hold Calloway REIT.
Natural Resource Trusts
TimberWest (TSX: TWF.UN, OTC: TWFIF) generated CD9.3 million of distributable cash for the third quarter, or 12 cents Canadian per unit, down from CD13.3 million, or 17 cents Canadian per unit, for the corresponding 2005 period. Despite the weaker quarter, on a year-to-date basis, Timberwest generated revenue of CD76.3 million, or 98 cents Canadian per unit. In the third quarter of 2005, Timberwest reported revenue of CD52.6 million, or 68 cents Canadian per unit. The trust satisfied 91 percent of its annual distributable cash requirement in the first nine months of 2006. Buy TimberWest up to USD13.50.