The rising Canadian dollar was a major plus for US investors in trusts last year, boosting the US dollar value of both distributions and share prices by more than 14 percent. And it’s likely to be a plus this year as well.

Just as in 2007, however, it will be critical to stick with trusts whose businesses are helped rather than hurt by a strong loonie. Two that fit the bill are this month’s High Yields of the Month: RioCan REIT (TSX: REI-U, OTC: RIOCF) and Provident Energy Trust (NYSE: PVX, TSX: PVE-U).

The key is cross-border investment. Before the Halloween 2006 tax announcement, retail center-focused RioCan was planning a sizeable strategic investment in US properties. Management put these designs on hold following the announcement of the so-called Tax Fairness Act, largely because it included a provision ending the favorable tax status of REITs drawing more than a tiny portion of income from outside Canada.

Last month, however, the Canadian government rolled back this restriction, which some projected would have made most in-country REITs fully taxable in 2011. Moreover, it removed for the first time the distinction between income drawn from foreign and Canadian properties, putting Canadian REITs on the same investment footing as international rivals.

To date, RioCan management hasn’t announced a resumption of its efforts abroad. But as the industry leader in size, financial strength and management experience, it’s by far the most likely beneficiary of the rule change.

The REIT’s market capitalization of CAD4.4 billion is the largest of any Canadian REIT. So is its stability rating of STA-2 (low) from the Dominion Bond Rating Service (DBRS). DBRS expects “continued cash flow stability” as well as “reasonable growth in cash flow through modest same-store growth in net operating income (NOI) and a greater focus on new developments.” The agency also cites the REIT’s conservative capital structure, which will protect it from the risk of rising interest rates as well as tightening credit conditions.

Over the past several years, RioCan has held distribution growth to relatively modest levels, largely because of the demands of capital investment and its desire to keep new share and debt issuances to conservative levels. That could change as early as the second half of 2008, as management services income rises and several new developments come on line, bringing down the payout ratio. In addition, the trust’s rents are generally below market, and leases on some 2 million square feet of space expire through the end of 2009, leaving a lot of room for rent growth.

Retail center owners are exposed to the economic cycle as shopping patterns wax and wane. RioCan, however, is very well protected from ups and downs, with first-tier tenants making up more than 80 percent of cash flow, extraordinary diversification both by renter and geographically and consistently high occupancy levels of more than 97 percent. The average age of leases is a solid 12.5 years.

Current plans call for RioCan to boost its property portfolio by 10 percent through the end of 2008 on projects under development in Canada alone, with a commensurate boost to the bottom line. That’s not including the impact of likely acquisitions on either side of the border.

In retrospect, Canadian government restrictions on overseas REIT investments came at a good time for RioCan. Investments made in the past year, for example, would have already been severely challenged by deteriorating property market conditions, tightening credit and a drop in the Canadian dollar value of US property and cash flows.

Similarly, removal of those restrictions now is also timely. RioCan will be able to get a far better read on which projects are best stress tested against economic turmoil than it would have a year ago. And because of the rise in the Canadian dollar over the past year to parity with the US, its purchasing power will go a lot further as well.

All in all, I expect RioCan to accelerate growth in cash flow available for distributions over the next couple years and ultimately distribution growth. That’s an added kicker for owning this very strong REIT, which continues to yield around 3 percentage points more than US REITs of similar high quality. That yield advantage is further widened by the fact that the distributions are considered qualified for tax purposes in the US, as posted on the trust’s Web site, in stark contrast to the ordinary income dividends paid by most US REITs.

We’ve already realized strong gains in RioCan since my original recommendation in July 2004. I expect even more in the next three and a half years. And the trust remains a takeover target in its own right for any entity seeking a highly profitable stake in Canada’s still hot real estate market. Buy RioCan REIT up to USD25.

Provident Energy Trust’s south-of-the-border investment is even more important to its US investors’ long-term returns for two reasons. First, it provides valuable geographical diversification from its core Canadian markets, which remain depressed. Second, foreign-based income will be exempt from trust taxation in 2011 and beyond. The more Provident grows its operations here, the lower its ultimate tax bill and the higher its post-2010 distributions will be.

Now at roughly a quarter of overall cash flows, US operations are primarily held under BreitBurn Energy Partners. Despite generally weak conditions for raising capital as a trust, Provident was been able to dramatically accelerate its growth in the US by taking advantage of the public’s mid-2007 infatuation with limited partnerships.

The initial public offering of BreitBurn shares in October 2006 was a major success, with Provident realizing more cash for growth than expected. That was followed up by the September 2007 announcement of the acquisition of all of the natural gas, oil and midstream assets in Michigan, Indiana and Kentucky owned by Quicksilver Resources. The terms of the USD1.4 billion deal called for BreitBurn to spend USD750 million in cash and mint 21.348 million more common units.

When the deal closes early this year, Provident’s stake in BreitBurn will shrink to 23 percent of the common units. It will, however, continue to completely control BreitBurn by owning 100 percent of the general partner interest. And the acquisition will boost BreitBurn’s cash flows and distributions and, therefore, cash flow to the parent Provident.

The Quicksilver Resources’ asset purchase also better aligns the BreitBurn operation with the rest of Provident in another very important respect. Mainly, it includes midstream assets in addition to the long-life, gas-weighted reserves (19 years reserve life). That translates into steadier, as well as richer, revenue.

Midstream operations are, of course, already a big part of Provident’s business mix. The focus is processing and storage for natural gas liquids. Margins in this business have been wide in recent quarters, as the price of the primary input (natural gas) has lagged the selling price of gas liquids, which tend to mirror oil prices.

Midstream profits haven’t completely offset the impact of weak natural gas prices in recent quarters or the depressing impact of a rising loonie on the Canadian dollar value of oil sales. The trust’s payout ratio, for example, pushed up to 89 percent of distributable cash flow in the third quarter of 2007. And it’s likely to remain on the high side in the fourth quarter as well, though higher oil prices may lift cash flow considerably.

The trust sold its oil in the third quarter for an average price of just USD64.59 per barrel, or roughly USD30 per barrel below the prevailing spot market price for most of the period. That figure is bound to rise, pushing up oil-based cash flow.

Looking ahead, Provident’s unique upstream/midstream focus appears best positioned for remaining independent, rather than being taken over by another trust. On the other hand, it’s a strong candidate for continuing to make acquisitions, snapping up two valuable properties in Canada in the second half of 2007 that will add to output growth in 2008. Those purchases also further diversify operations outside of Alberta, whose royalties are slated to rise beginning in 2009.

Reflecting Provident’s rapid growth, management has announced an ambitious capital spending plan for 2008, both for Canada and the US. Some CAD43 million is targeted for midstream asset growth, including a CAD18 million investment in new underground storage caverns and another CAD10 million for railyard development. That will further increase the trust’s income base from steadier sources, providing an even larger platform on which to expand growth in North American oil and gas output.

Priced at just 1.51 times book value, 95 percent of sales and a yield of more than 14 percent, it’s obvious Provident shares are discounting a great deal of risk at these levels. Some have cited its debt load of 30 percent of assets as a danger point, particularly given the 23 percent increase in debt over the past year to finance growth.

Higher debt always brings higher risk, particularly in an already tight environment for credit. Given the trust’s mix of steady and more volatile businesses, however, the real burden is actually much lower than it looks at first glance. So is the third quarter payout ratio, which is too high to be sustainable for a pure producer but moderate for an infrastructure company.

In sum, there’s no reason to doubt management’s recent affirmation of “Provident’s strong financial position” and that, despite “recent market volatility,” shareholders will “continue to benefit from the stable, predictable, cash-generating assets in [the trust’s] diverse energy portfolio.” Despite the recent drop in the trust’s shares—in large part because of investors’ tendency to sell major acquirers of assets while transactions are in progress—Provident Energy Trust is a strong buy up to USD14.

For more information on both trusts, visit the How They Rate Table. Click on the “.UN” symbol to go to the Web site of our Canadian partner MPL Communications for press releases, charts and other data.

These are substantial companies, so any broker should be able to buy them, either with their Toronto or New York Stock Exchange/over-the-counter symbols. Ask which way is cheapest.

Note that both trusts pay qualified dividends in the US, and 15 percent of distributions are withheld at the Canadian border. Tax filing information is listed on the Canadian Edge Web site under Income Trust Tax Guide. Canadian withholding can be recovered by filing a Form 1116 with your US income taxes.

RioCan REIT & Provident Energy Trust
Toronto Symbol	REI.UN	PVE.UN
US Symbol	RIOCF	NYSE: PVX
Recent USD Price*	21.80	10.39
Yield	6.4%	14.0%
Price/Book Value	2.69	1.56
Market Capitalization (bil)	CAD4.457	CAD2.591
DBRS Stability Rating	STA-2 (low)	none
Canadian Edge Rating	1	4

_{*Recent USD Price as of 01/02/08.}