As of Thursday evening, five Canadian Edge Portfolio holdings have announced third quarter earnings: ARC Energy Trust (TSX: AET-U, OTC: AETUF), Bell Aliant Regional Communications Fund (TSX: BA-U, OTC: BLIAF), Consumers Waterheater (TSX: CWI-U, OTC: CSUWF), Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) and TransForce (TSX: TFI, OTC: TFIFF). All five reported solid results and guided toward solid fourth quarters as well.

Bell Aliant’s third quarter sales inched ahead 0.8 percent, as 13.6 percent growth in Internet revenue offset small declines in basic local and long distance revenue. That’s basically the same pattern the trust’s earnings have followed for several quarters, despite worsening economic conditions. Management also affirmed the current dividend level through 2012, which was covered by operating cash flow by nearly a 2-to-1 margin.

Consumers’ revenue rose 7.9 percent, as it enjoyed steady returns from its waterheater rental business and a boost from the recently acquired Stratacon submetering operation. Distributable cash flow rose 4.4 percent and the company brought its payout ratio, net of capital spending, down to 92.3 percent from 96.3 percent a year ago. The company also announced a new credit agreement to cover a pending January 2010 debt maturity. That was the major challenge I noted when I featured the trust in the October issue as a new Portfolio addition and a “High Yield of the Month.”

Not surprisingly, Pembina’s third quarter featured strong growth at its oil sands business, where the completion of the Horizon Pipeline increased its shipping capacity by 47.6 percent. The trust’s midstream business also recorded double-digit growth in operating income, offsetting flat results at the conventional pipelines due to a needed repair. Importantly, Pembina also announced it plans to continue to pay distributions at least at the current rate through 2013 as a high-yielding corporation. The payout ratio net of capital spending came in at 95.1 percent, and the trust expects that to come down to 90 percent for the full year.

When TransForce converted to a corporation earlier this year, management stated its intention was to ramp up its acquisitions in a weak and capital constrained environment. I didn’t like the distribution cut, but third quarter results prove the trust has been as good as its word in a very tough environment for North American transportation. Revenue rose 23 percent, cash flow surged 27 percent and pre tax earnings pushed up 31 percent, as expansion, economies of scale and cost controls paid off. As a corporation, TransForce’s payout ratio is best calculated using earnings per share. The 32.3 percent rate leaves a lot of cash available for further growth, as well as to cover the still generous distribution.

We have a lot of numbers to come for CE Portfolio recommendations. But these are very strong results for all four of these holdings, given the weak North American economy and still tight credit conditions. All four have been sold off hard in the past few weeks—in part due to the weakening and now apparently recovering Canadian dollar—and represent compelling value for income and growth.

These four companies all have one thing in common: They don’t produce energy and therefore aren’t directly impacted by changes in energy prices. That’s a commonality shared by all the Conservative Portfolio trusts, including recent sale Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF).

We won’t see Algonquin’s numbers until Friday, Nov. 7. But with Standard & Poor’s affirming its credit rating and outlook this week, it’s increasingly clear the 72 percent dividend cut announced last week was not forced, but rather was a discretionary move by management to hold onto more cash.

I still think income investors are better off holding the more conservatively structured Great Lakes Hydro (TSX: GLH-U, OTC: GLHIF). But Algonquin is the example that proves the rule: Good businesses outside the energy production business are holding cash flows steady in this the most difficult of environments in many years.

Energy is Different

Energy producer trusts present a more difficult problem. The mid-year spike in energy prices was a major plus for oil and gas trusts. Rather than ramp up distributions, most used the additional cash realized from higher energy prices to pay off debt and pursue needed capital spending.

That’s a strategy that appears to have shielded the group from the worst of what’s happened since mid-summer: a decline from nearly $150 to less than $70 a barrel in oil prices and a commensurate drop in natural gas from a price in the low teens per thousand cubic foot to the current level of barely $6.

Unfortunately, it’s becoming increasingly clear that trusts’ conservatism early this year only goes so far. ARC Energy Trust was the first to cut its payout, knocking off the second of two “top-up” distribution increases this Fall. That’s raised speculation of more to come throughout the industry.

This week, ARC made two major announcements that should answer any questions about its long-term viability and growth potential. The first was a significant increase in reserves at the trust’s Montney plays, pushing the overall gain since January to 138 percent. Recovery factor has risen to 25 percent on the estimated reserves and management now expects it to exceed 50 percent. Management concurrently announced a CAD585 million capital spending plan for 2009, including accelerated development of these lands, stating they “set the stage for a defined period of profitable growth for ARC.”

The second major announcement for ARC was third quarter earnings. The trust reported a 5.3 percent boost in daily output of barrels of oil equivalent, relatively steady operating costs of CAD10.19 per barrel of oil equivalent (BOE) and a payout ratio of 68 percent. Realized selling prices for oil and natural gas came in at USD114 per barrel and USD8.68, respectively, The payout ratio comes down to 61 percent and 58 percent year-to-date, when one-time factors are excluded from distributable cash flow calculations.

The only real negative for shareholders in the results was the anticipated roll back of the first “top-up” distribution, taking the payout back to the original 20 cents Canadian per month rate. That level will allow better funding of capital expenditures for the trust, and it’s a rate ARC has been able to maintain at lower energy prices than today’s.

Over the next week, we’ll see how our other Canadian energy producer trusts fared in the third quarter of 2008. Unfortunately, based on ARC’s moves, I think we should expect for distributions to be trimmed at most of the recommended trusts.

The good news is, with posted yields of 20 percent and higher, that’s certainly already reflected in the prices of these trusts already. Even after eliminating the two “top-up” increases, ARC’s yield is still nearly 15 percent, based on its closing price before the reduction announcement on Thursday evening.

That’s of course no guarantee ARC shares won’t sell off further in the wake of trimming its distribution, no matter how good its operating news is. That also applies to Enerplus Resources (TSX: ERF-U, NYSE: ERF), which announced a reduction in its monthly payout from 47 to 38 cents Canadian Thursday evening.

Like ARC, Enerplus’ management attempted to divvy to shareholders some of the benefit of higher oil and gas prices the first half of 2008, boosting its payout 11 percent. The reduction announced Thursday evening takes things down a little further, though it still leaves the dividend yield at 15 percent based on Thursday’s closing price.

We’ve yet to see Enerplus’ operating numbers. But I suspect they’ll be similar to ARC’s. The trust is basically maintaining a high level of capital spending for its many projects, which range from conventional natural gas development to oil sands. And I see that decision likely to prove a net positive for unitholders going forward. It’s also noteworthy that this trust, as well as ARC, continues to put a priority on holding debt to very low levels.

In my view, controlling debt is a major reason for the distribution reductions now: to ensure more cash flow to fund development without having to access still tight capital markets. And it’s one reason why reductions are likely for at least most of the other producer trusts now, as earnings numbers are released over the next week or two.

Why Hold

So why continue to hold these trusts now? For one thing, as I pointed out, their current prices more than reflect any likely or possible future distribution reductions. Again, psychology rules the market, and fear is the dominant emotion at present. But prices are certainly discounting a lot more than the distribution reductions we’ve seen.

In the Oct. 8 flash alert, I presented a table “Value Points,” which showed share prices of the CE Portfolio producer trusts at the decade lows for oil ($18.43 a barrel) and natural gas ($2.03 per million British thermal units). Here it is again:

As global stock markets were hitting their recent bottom on Oct. 10, most of these trusts were pretty close to these levels. And although they’re recovered somewhat, they’re still priced at roughly the same levels they were when oil was under $30 and gas was scraping along well under $5.

That’s despite the fact that all of them are considerably larger and more resilient trusts than they were the last time energy prices visited these levels. And it’s despite the fact that all of them have proven their ability to survive on their own resources since the Halloween 2006 announcement of the trust tax effectively restricted their access to capital.

The big reason for the recent bounce in trusts as well as other high income investments is the apparent easing of the global credit crisis. We still don’t know how tight credit conditions are going to play out on the broad economy. But the odds of seeing $30 oil again are considerably more remote now that global authorities have apparently headed off the worst on the credit front.

Barring $30 oil, the only conclusion is that these trusts are deeply undervalued. Undoubtedly, the actions by two of the most sustainable trusts—ARC and Enerplus—are a pretty clear sign that distributions are under pressure from falling energy prices and to a lesser extent from still restricted capital markets. But these are still healthy businesses and yields of 15 to 25 percent certainly already reflect the possibility of dividend cuts.

Perhaps more important, the market action of the past week shows once again just how quickly the energy market is likely to reverse to the upside, once there is some visibility on the economy. On Wednesday, for example, the price of oil surged more than 10 percent. Given the size of this market, that’s an extraordinary move. It shows once again the hair-trigger nature of the current environment and how quickly even the past weeks’ egregious losses can reverse when conditions do finally start to improve.

My long-term view remains that the two basic underpinnings of the past few years’ bull market for energy are still very strong. That’s the combination of growing demand from developing countries and the fact that cheap, conventional reserves are a thing of the past. Rather, the world is becoming steadily more dependent on non-conventional sources of energy—from oil sands and deepwater resources to shale gas—that require ever higher energy prices to be economic.

The historic events of the past several months in the credit markets have literally rendered all that moot as far as energy prices are concerned. But as the market is shored up and the worst for the economy increasingly comes into view, those forces are going to reassert themselves with a vengeance. In fact, this fall’s drop in prices ensures energy prices will ultimately go to higher highs.

Incentives for conservation, alternatives and even more drilling have gone by the wayside with oil under $70 and gas again scraping along at $6. In fact, oil sands need a conventional oil price of $90 a barrel to warrant further development, while shale gas needs at least $8 per million British thermal units (MMBtu). At today’s prices, they simply won’t be developed. And those are the only forces that can truly shift the balance of energy market power back to consumers from producers.

As I’ve pointed out many times in the past, the future of energy prices is really the future of Canadian oil and gas producer trusts. Even if they dip lower, our trusts will survive and continue to pay substantial distributions. But if they do recover as I expect, the losses we’ve suffered the past several months will be quickly erased.

In addition, as we saw this spring, trusts are certainly willing to share higher energy prices in the form of increased distributions, when conditions merit. In fact, most have made statements to the effect they’ll be able to continue current distributions after 2011 trust taxation, provided energy prices are strong. And we’ve already had a conversion—Bonterra Energy Trust (TSX: BNE-U, OTC: BNEUF)—that did go through holding the distribution at the pre-conversion level.

Last June, I titled the Portfolio article “The Case Against Oil and Gas,” stating my view that energy prices were due to pull back from then astronomical levels and advising investors to take some money off the table. As it turned out, my downside target of $90 oil and $8 natural gas proved to be far too optimistic, largely because of the severity of the credit crunch.

Had I been able to predict what would happen to the global economy, I obviously would have been far more aggressive with sell recommendations than I was. And I wouldn’t have become more aggressive with buy recommendations after prices did back off toward my targets.

All that’s water over the dam, and it’s only food for thought the next time prices surge. But I’m still thoroughly convinced the basic long-term case for energy I laid out then is still intact, and therefore we’ll see a strong recovery from these levels.

The upshot is this isn’t the time to sell. The Conservative Portfolio selections I highlighted above are obviously steadier bets against further weakness in energy prices. And I recommend them strongly for conservative income seekers as I always have. But for those who want a bet on energy prices that pays out big cash flow, these Canadian energy trusts are still the place to be.

Again, I’m not big on backing up the truck on anything. But when oil and gas prices recover, so will they. And that gives them some pretty incredible upside over the next few years, particularly for those who have the patience and risk tolerance to stick with them now.