Second quarter earnings numbers are coming in fast and furious for Canadian trusts and high-yielding corporations. In the August issue that will be emailed to you imminently, I’ve reviewed results for all those reporting through the close of business, Aug. 7, 2008.

Altagas Income Trust (TSX: ALA-U, OTC: ATGFF)
ARC Energy Trust (TSX: AET-U, OTC: AETUF)
Bell Aliant Regional Communications Fund (TSX: BA-U, OTC: BLIAF)
Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)
Daylight Energy Trust (TSX: DAY-U, OTC: DAYYF)
Energy Savings Income Fund (TSX: SIF-U, OTC: ESIUF)
Enerplus Resources (TSX: ERF-U, NYSE: ERF)
GMP Capital Trust (TSX: GMP-U, OTC: GMPCF)
Newalta Income Fund (TSX: NAL-U, OTC: NALUF)
Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF)
Peyto Energy Trust (TSX: PEY-U, OTC: PEYUF)
RioCan REIT (TSX: REI-U, OTC: RIOCF)
TransForce (TSX: TFI, OTC: TFIFF)
Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)

Since the foundation of CE, I’ve repeatedly emphasized the importance of earnings in determining the underlying value of trusts. Simply, trusts backed by good businesses hold and increase their value over time. Those that don’t are always at risk to major blowups.

Businesses on both sides of the border today are threatened by a trio of challenges: slowing economic growth, particularly in the US, tight credit market conditions that make it very difficult for all but the strongest to raise capital and rising raw materials costs.

Since this bear market for stocks began more than 13 months ago, we’ve seen most trusts sell off, with even the energy sector taking a hit over the past month. That’s to be expected under these conditions. But trusts backed by good businesses have continued to hold and increase distributions, even while others have faltered.

Like most of you, I’ve lived through several bear markets. They always go on longer than you think they will and damage to share prices is frequently worse than you anticipate as well as indiscriminate, as fearful investors throw out the good with the bad. The one constant, however, is there is eventually a recovery. And when it occurs, the investments that stood up to the stress tests are off to the races.

Consequently, my goal since this bear market began has been to ensure that CE Portfolio holdings continue to operate well as businesses. To the extent that we’re successful, any red ink we’re seeing now for share prices will be temporary. Meanwhile, we’re going to continue to receive the highest dividends in the world, many of which are being steadily increased.

The 14 trusts reporting earnings so far represent roughly half the CE Portfolio. Over the next week or so, most of the rest will turn in numbers.

I’ll be reporting on this next week in a Flash Alert, and CE Associate Editor David Dittman will be updating numbers in the complementary e-zine Maple Leaf Memo as well. Note MLM also tracks results for non-Portfolio trusts and corporations tracked in CE, and past issues are stored on the CE Web site. Finally, we’ll be updating numbers for all the trusts and corporations covered in How They Rate as we have time to digest them.

The good news so far is 13 of the 14 reporting Portfolio trusts have turned in strong numbers. That’s a clear indication they’re still weathering this latest round of stress tests well. We’re going to have to watch the numbers in subsequent quarters. But management is optimistic, reflected by solid guidance, the seven dividend increases announced with earnings and insider buying. And that makes me a lot more confident to continue recommending them, despite the continuing share price volatility.

The only notable exception thus far is GMP Capital. At first glance, the trust’s second quarter numbers are a true horror show. Revenue tumbled 30 percent and distributable cash flow fell by more than half from year-earlier totals.

The results were a continuation of the trend that began late last year and was reflected in the nearly 50 percent decline in first quarter distributable cash flow from first quarter 2007 levels. And they resulted in management’s decision to trim the monthly payout by roughly 25 percent.

On the plus side, these numbers were widely expected on Bay Street. Though profits fell short of consensus forecasts, revenue actually exceeded projections. The selling of GMP shares in the wake of the news, meanwhile, has been relatively muted given the distribution cut, indicating the bad news was mostly baked in from the deep decline of the past several months.

On the minus side, these numbers paint a clear picture of a suffering company in an environment that’s very tough for its business. And there’s no minimizing the losses we’ve suffered in the shares this year, which are as much as 50 percent depending on where you got in.

The key question, of course, is whether GMP is still worth holding at these levels or if we should just take the loss and move on. Clearly, the environment remains challenging and we’re likely to continue seeing poor earnings comparisons in coming quarters. On the other hand, a lot is priced in already, and the distribution is still high even after the reduction.

What action to take depends on whether GMP is capable of staging a recovery and, more important, how likely that is. With regard to the first point, the answer is definitely yes.

Tough conditions notwithstanding, GMP is holding market share in several key areas. It remains No. 1 in block trading in Canadian markets, No. 2 in equity underwriting and No. 6 in mergers and acquisitions (M&A). Its incentive-driven employees are still at the top of their business. The trust has a number of new ventures–including a now self-sustaining European operation–that are generating strong growth, and its wealth management business has remained relatively steady.

Financially, the trust has few fixed costs and none of the overhanging liabilities that have sent many financial services firms to the bottom. That should ensure its ultimate survival, even if the North American economy and the US financial system do weaken further.

As long as it holds market share and keeps its balance sheet solid, GMP will ultimately recover. However, we won’t see it until the core driver of its business—investment banking—bounces back, and that won’t happen until market conditions improve in Canada.

At its core, GMP is a unique kind of income trust. As management showed with the special distribution paid this year, it will reward investors with cash in good times, just as it does employees with bonuses for deals well done. In tough times, investors suffer with lower distributions just as employees do with less compensation.

The sharp reversal this year from special distribution to dividend cut shows just how volatile GMP’s business can be. That’s a point I admittedly didn’t fully appreciate when recommending the trust initially, focused as I was on the trust’s successful growth initiatives. I’m still convinced these will prove to be a major boon for this forward-looking franchise. But in a storm like this one, even the strongest take on water in the near term and growth abroad isn’t enough to make up for investment banking weakness.

The good news is that GMP’s sensitivity to market conditions—and its demonstrated holding of market share—means its recovery will almost certainly be as swift and dramatic as its recent fall has been. That’s enough reason to hold on for now, with a very big caveat.

Mainly, until overall market conditions do recover, GMP’s revenue and cash flow won’t either. My view is management has set the lower distribution at a rate that can be sustained under these conditions. But there’s no guarantee things will improve in a timely fashion or that they won’t worsen further. Worse, if conditions are poor long enough, GMP may have trouble holding onto the very employees that are the foundation of its business.

Since this bear market began, I’ve consistently warned of the dangers of loading up or doubling down on a single trust, no matter how undervalued and ripe for gains it may appear. I’ve had GMP as a hold for some months and have watched its shares continue to decline, mainly because it has such a strong long-term franchise.

Now that we’ve seen the second quarter numbers, it’s clear that, at least as a franchise, it’s holding its own. But until the business numbers show some sign of turning up, it’s going to be dead money at best. And at worst, we could see still more downside.

As one trust in a diversified and balanced group of 30 Portfolio Holdings, I’m OK holding onto GMP for now. Even at the reduced rate, we’re still going to receive a big dividend every month. And as long as it holds market share, recovery is pretty much inevitable. On the other hand, I’m not going to upgrade to a buy again until hard numbers point me in that direction.