Same as It Ever Was

An ominous Institute of Supply Management reading for December put an early crimp in the action, and oil and gold approached historic levels on the first day of 2008 trading. The numbers are a reminder that the housing-and-credit fog that shrouded the second half of 2007 didn’t magically lift with the turnover to 2008.

New York’s hangover stands in contrast to Toronto’s reaction. The Dow Jones Industrial Average slid 1.67 percent on Wednesday, while the S&P 500 fell 1.44 percent and the Nasdaq Composite gave back 1.61 percent. The S&P/Toronto Stock Exchange Composite Index, however, climbed 0.68 percent.

Canada is a resource economy and responded well to key markers in that space: The gold spot price was USD860.10 near yesterday’s market close, well above its previous high of USD850 set way back in 1980. Oil, meanwhile, hit USD100 during the day for the first time ever, before paring back slightly to USD99.48.

The S&P/TSX Composite was up about 6 percent in 2007, while the Dow Jones Industrial Average gained 7 percent and the Nasdaq Composite led the way at 11 percent. But all the North American indexes closed the year well off highs established before the subprime mortgage crisis hit.
 
Canada’s strong fundamentals should buoy its economy if the US founders early in 2008. A healthy labor market, a sound housing market and decent business investment mean Canada is better able to ride out upsets to the economy of its most important trading partner.

The Bank of Canada and the US Federal Reserve will make interest rate decisions later this month, and the odds favor cuts by both. A tight labor market up north and inflation concerns down here are less worrisome for central bankers than the threat of a recession, so stimulation it’s likely to be.

Higher energy costs and the negative impact this has on US consumer spending and tighter financial conditions explain some of the difficulty. But the effects of mortgage-related credit tightening, home price declines on balance sheets and adjustable-rate mortgage resets have become bigger concerns than oil prices.

Exposure to sustainable yields is one way to deal with the question of whether to hunt for overcorrected bargains or focus on strong but decelerating growth sectors. Collecting regular distribution checks is a great way to smooth out what promises to be a volatile first half of 2008.

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. The January Canadian Edge, available tomorrow, includes an in-depth look at what’s likely to be a lively year for deal-making in the income trust universe.

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.

The Roundup

Oil and Gas

Fairborne Energy Trust has completed its conversion and is now known as Fairborne Energy (TSX: FEL). Now a growth-oriented exploration and production corporation, Fairborne Energy also issued approximately 13.4 million shares to Denham Commodity Partners Fund IV LP, a US-based private equity fund, for about CAD100 million. Sell Fairborne Energy, which has also eliminated its distribution.

Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) has secured CAD4 billion of credit commitments from a syndicate of 18 banks to pay off debt taken on to acquire Canetic Resources (NYSE: CNE, TSX: CNE-U) and to increase its financial flexibility. Some of the money will also be used to retire debt associated with the CAD380 million takeover of Vault Energy Trust (TSX: VNG-U, OTC: VNGFF).

Following completion of the deals, Penn West will be Canada’s biggest conventional oil and gas trust by a wide margin, producing as much as 210,000 barrels of oil equivalent. The three-year credit facility is expected to close in early January and is conditional on the completion of the Canetic deal. Unitholders are scheduled to vote on the deals this month. Buy Penn West Energy Trust up to USD38, hold Canetic Resources, and sell Vault Energy Trust.

Electric Power

Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF) closed the sale to Fortistar LLC of six landfill gas-powered generating stations and assets owned by an affiliate for USD11.34 million. The facilities accounted for approximately 18 megawatts (MW) of installed generating capacity, which were no longer considered strategic to Algonquin’s ongoing operations.

Also, Algonquin will participate in the next phase of Manitoba Hydro’s request for proposals (RFP) from Manitoba wind-powered electrical generation facilities. Two projects totaling 165 MW have been selected for further participation in the RFP process.

The two projects consist of the 99-MW Glenwood Wind Energy Project located in the municipality of Glenwood, and a 66-MW expansion of Algonquin Power’s 99-MW St. Leon Wind Energy facility located in the municipalities of Pembina and Lorne. Further participation in the RFP could include the supply of additional technical information and supplementary information to be used in the final evaluation process.

Success in this phase will lead to negotiations between Algonquin Power and Manitoba Hydro on a power purchase arrangement. Algonquin Power Income Fund is a buy up to USD9.50.

Northland Power Income Fund (TSX: NPI-U, OTC: NPIFF) subsidiary Iroquois Falls Power Corp has reached agreement with Calpine Canada Natural Gas Partnership, an affiliate of Calpine Corp, to settle a claim brought by Iroquois as a result of Calpine’s default on Jan. 1, 2006, of a natural gas delivery contract.

Calpine will pay Iroquois USD32 million to settle the claim; Iroquois has agreed to pay USD10.5 million to one of its other long-term gas suppliers to settle Iroquois’ mitigation obligation under that supplier’s contract. The USD21.5 million aggregate proceeds will be taxable at Iroquois and won’t result in any change to the taxability of distributions to unitholders.

Northland Power expects to have net proceeds from the claim of approximately USD12.8 million after taxes payable by Iroquois and a payment for the fund manager’s gas management incentive fee under the terms of the Iroquois management agreement. Northland Power will retain these proceeds for future investment. Northland Power Income Fund is a buy up to USD14.

Peak Energy Services Trust (TSX: PES-U, OTC: PKGFF) has offered to buy Wellco Energy Services Trust (TSX: WLL-U, OTC: WLLUF) for CAD30.6 million. Under the terms of the all-stock deal, Wellco unitholders will receive nine-tenths of a Peak unit for each of their Wellco units, or CAD1.71 per unit, a 17.1 percent premium to Wellco’s CAD1.46 Dec. 19 closing price.

Wellco’s board and senior management endorsed the deal and tendered units representing 17.7 percent of those outstanding. Peak and Wellco announced in a joint statement the cessation of monthly distributions as of December 2007. Sell Peak Energy Services Trust and Wellco Energy Services Trust.

Precision Drilling (NYSE: PDS, TSX: PD.UN) plans to spend CAD370 million on its 2008 capital expenditure program, a 70 percent increase that signals the trust’s intent to speed growth. The 2008 budget includes CAD260 million for the construction of 19 super series land drilling rigs, which are slated for delivery over the next 18 months.

Precision runs about 27 percent of onshore drilling rigs in Canada and about 1 percent in the US. The trust also approved a special 2007 year-end distribution of 40 cents Canadian per unit. Precision Drilling is a buy up to USD16.

Business Trusts

CML HealthCare Income Fund (TSX: CLC-U, OTC: CMHIF) is buying American Radiology Services (ARS), a Baltimore-based diagnostic medical imaging firm, for USD151 million in cash. CML expects the purchase to contribute USD142 million in revenue in fiscal 2007.

ARS operates 15 fixed-site multi-modality and two single-modality outpatient centers in Maryland and Delaware and provides radiologist coverage to 11 hospitals in Maryland. The deal, underwritten by a CAD450 million credit facility from Toronto-Dominion Bank, is expected to close in the first quarter of 2008. Hold CML HealthCare Income Fund.
 
Connors Bros Income Fund (TSX: CBF-U, OTC: CBICF), which suspended distributions after a recall earlier this year, will pay a special distribution of between 14 cents Canadian and 17 cents Canadian per unit; the distribution will be paid in units on or before Jan. 30 to unitholders of record as of Dec. 31.

After issuing the additional units, the fund will be consolidated so that the number of units held by any unitholder will remain unchanged from the number outstanding immediately prior to the special distribution, the company said.

Connors Bros’ third quarter profit jumped 39 percent to USD14.3 million (28 cents per unit) from USD10.3 million (20 cents per unit) a year ago. Connors Bros Income Fund is a sell.

Natural Resources Trusts

PRT Forest Regeneration Income Fund (TSX: PRT-U, OTC: PFSRF) will reduce its monthly distribution to bring it in line with an anticipated reduction in PRT’s operating cash flow. The fund will reduce its expected monthly distribution from 7 cents Canadian to 4.6 cents Canadian per month effective with the January 2008 distribution.

Weaker lumber demand and lower profit margins have led to reduced timber cutting, mill closures and cash flow preservation measures. Based on early indications, PRT expects demand in its market area will decline by 10 percent to 20 percent in 2008.

PRT expects to maintain its relative market share in 2008, but prices have come under some pressure. Hold PRT Forest Regeneration Income Fund.