Holding good businesses is starting to pay off in the Canadian trust universe. I expect we’ll see even more strength in trust share prices as the first quarter numbers start to come in, on top of the recent gains from excitement about potential takeovers.

Unfortunately, when a trust’s business falters, its shares are still going to get punished. That’s what happened to Primary Energy Recycling (PRI.UN, PYGYF).

On the face of it, it should be good times for the operator of four recycled energy projects and part owner of a pulverized coal facility. Interest in such clean energy projects is growing, and power prices are in a defined uptrend. None of that, however, will help unless the facilities run by the company are operated effectively.

This week, management reported somewhat surprising news that the value of inventories at the coal facility was to be revised downward by an unexpectedly large amount. That was largely out of its control and part of a problem that’s been a drag on earnings for some time. I wasn’t happy about it, but I could live with it.

There was worse news: The company reported an outage at one of its facilities that will last at least 45 days, possibly at a substantial cost.

At this point, Primary can’t offer a definitive estimate of the lost revenue and pending repair costs and writedowns. But management did state it may have to ask its lenders for forbearance in order to continue paying distributions in the near term.

Last issue, I wrote that I was disappointed in Primary’s fourth quarter results and would be looking anxiously for improvement in the opening quarters of 2007. As it appears now, that improvement won’t be forthcoming. In fact, even in a best case, the company—which is organized as a stapled share, with a dividend part debt interest, part equity—will be paying a distribution in excess of cash flow for at least the first half of the year.

There are positives. For one thing, despite the outage, Primary’s assets are still state of the art. And the shares are now very cheap, trading at only about book value.

Based on what we’ve seen with other electric power trusts, lenders are generally willing to be lenient if they’re convinced the odds of recovery are high. And there’s also the possibility of a takeover if the price sinks too low. The latter consideration seemed to support the shares on Thursday following the news, as they closed more than 10 percent off their intraday lows.

On the other hand, it’s hard to call such a developing situation a “Conservative” holding. I added Primary to the Conservative Portfolio back in November, in large part because its distribution would be exempt from prospective taxation in 2011.

Unfortunately, no matter how tax advantaged it is, there won’t be a decent yield unless management can get a handle on its operating issues. And in view of this announcement, that doesn’t look as likely, at least in the near term.

Given the above stated positives, I wouldn’t expect much more downside in Primary’s shares at this point. For that reason, I’m going to keep Primary Energy Recycling as a hold in the model Portfolio for at least the next few days. I am, however, looking very hard at replacing it and may do so in the upcoming May issue of Canadian Edge, which you’ll receive a week from today.

Back in November, it looked like only a handful of exempt situations such as Primary’s would survive the knife of higher trust taxes. Since then, many trusts have made it perfectly clear they intend to pay big dividends as long as they remain independent. And the only way they won’t is if they’re taken over at a stiff premium. There’s no sense in holding a trust or company that has trouble running its business when there’s so much else to buy.

Note that we’ve now seen our first takeover of an oil and gas producer trust, Thunder Energy (THY.UN, THYFF). The price was still some 80 percent off its old high and well below the trust’s range of a few months below.

But it was also well off the lows for this trust, which was clearly in a death spiral. That suggests ultimate prices paid for stronger producers could be substantial indeed. The May issue Feature Article will discuss takeovers in more detail, including the most-interesting targets.