Tips on Trusts
Dividend Watch List
Essential Energy Services Trust (TSX: ESN.UN, OTC: EEYUF) was the only entry in the Canadian Edge universe to trim distributions last month. A haircut was anticipated, but the magnitude (70 percent) was above expectations, resulting in a further decline in the share price. The move was made in conjunction with the sale of Essential’s transport division to Mullen Group Income Fund (TSX: MTL.UN, OTC: MNTZF), which is likely to exit the Watch List after the release of its second quarter earnings.
Essential will receive cash proceeds of CAD135 million for the operation, which contributed approximately 38 percent of its overall cash flow. The sale is expected to close in early July and includes transport operations for fluid hauling, rig relocation, pipe hauling and oilfield hauling equipment. A large chunk of the proceeds will go toward reducing Essential’s debt, with most of the rest to be reinvested in the trust’s rigs and downhole tools and rentals divisions. The trust is currently the sixth-largest rig operator in Canada and should benefit as that sector continues to cycle out of its recent weakness.
Overall, the sale and distribution cut have been viewed positively on Bay Street, with two of the three analysts covering the trust now rating it a buy, up from zero last month. That, plus recent insider buying, are encouraging signs, though I want to see how second quarter earnings shape up before upgrading Essential to a buy. Hold Essential Energy Services Trust.
The former Aeroplan Income Fund is now Aeroplan Group (TSX: AER, OTC: GAPFF). Shareholders should by now have received a share of the post-conversion corporation for every one of the trust they formerly owned. As we pointed out last month, the switch from trust to corporation comes with a distribution cut of about 40.5 percent. It leaves a healthier company better able to handle the challenges of a worsening market for flyer miles and other consumer benefits.
But with the next dividend not payable until Nov. 17 (to shareholders of record Sept. 30), there’s not a lot of appeal for income investors here. We’re still covering Aeroplan Group in the How They Rate Table, but it remains a sell.
Keystone North America (TSX: KNA.UN, OTC: KYSNF) has completed the conversion of 91 percent of its former income participating securities (IPS) to common shares. The IPS still trades on the Toronto Stock Exchange, though management cryptically states “there can be no assurance the listing will continue.”
As pointed out last issue, management accomplished the conversion through a rights offering that effectively exchanged the bond portion of the IPS for five ordinary shares of stock in Keystone. The result was the 91 percent of IPS holders accepted the rights wound up with six ordinary shares of stock. Management has now consolidated these into one share of common stock. Consequently, shareholders who accepted the rights and held on through the consolidation now have one ordinary share of Keystone for every IPS they formerly held.
Keystone’s move was apparently made because of debt covenants that may have been nearing violation, in large part because of the weakness of the US dollar. With its facilities located in this country, Keystone’s receivables are essentially in US dollars, while a good chunk of payables—i.e., IPS dividends—are paid in Canadian dollars. That works to its benefit when the US dollar is rising against the loonie and against it when the US dollar drops.
The good news is the conversion has eliminated this risk, and left Keystone’s generally recession-resistant funeral facility business in much better shape. Those who converted have generally come out whole, though with a 23.8 percent dividend cut. Investors who acted on our buy recommendation last month are already up around 20 percent.
Unfortunately, those who didn’t convert and still hold the IPSes have suffered both a dividend cut and a 20 percent dilution of their ownership interest. The shares have continued to plunge and were suspended from trading on the Toronto Stock Exchange June 30.
My advice remains the same as it’s been the past two months. If you own Keystone IPS securities, sell at the first opportunity. Note, however, that you shouldn’t accept less than 20 percent below the price of the common share, which represents the 20 percent dilution of the IPSes. The current differential is about 25 percent, but my feeling is that should narrow. Meanwhile, Keystone North America common shares are now a buy up to USD7.
Two trusts go on the Watch List this month: Long-term care REIT Extendicare Trust (TSX: EXE.UN, OTC: EXMUF) and Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF). Both trusts have seen cash flows lag distributions over the past year, with Extendicare not earning its payout in the first quarter. But there are additional complications that could make matters more dire going forward.
In the words of several analysts, Extendicare “blindsided” investors with a decision to raise CAD126.6 million in new equity, after providing little or no indication of the need to raise capital in first quarter financial statements. Some CAD92 million of the offering was in the form of a 7.25 percent convertible bond, with ordinary trust units comprising most of the rest.
Potential uses of this capital include paying down the trust’s debt, as well as funding ongoing expansion projects. But it will also potentially dilute cash flow, putting additional pressure on the distribution. And the apparent sale by the former chairman of all his holdings is also disturbing. Whatever the case, there are too many unknowns here. Sell Extendicare Trust.
To date, regional air transport trust Jazz has been insulated from rising fuel costs and the weakening North American economy by its relationship to Air Canada. The latter essentially rents all of its planes and absorbs virtually all costs. In addition, traffic along its major routes has remained robust, despite the slowdown in most of North America. However, airline industry conditions overall continue to worsen, reflected by the more than halving in the value of Air Canada A shares since late 2007.
Now selling at a yield of more than 17 percent, 75 percent of book value and half annual sales, Jazz is cheaper than it’s been at any time since its Feb. 2, 2006, inception as a trust. Concerns about the trust’s dependence on Air Canada to contract its planes appear to be why the shares have dropped so sharply over the past two months. The risk is now well priced in. But as long as Air Canada looks challenged, Jazz Airline Income Fund rates a hold only for more aggressive investors.
Here’s the rest of the Dividend Watch List. Note that first quarter payout ratios are will be reviewed in the How They Rate Table as trusts report them.
Acadian Timber Income Fund (TSX: ADN.UN, OTC: ATBUF)
Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF)
Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF)
Canfor Pulp (TSX: CFX.UN, OTC: CFPUF)
Connors Brothers Income Fund (TSX: CBF.UN, OTC: CBICF)
Essential Energy Services Trust (TSX: ESN.UN, OTC: EEYUF)
Extendicare Trust (TSX: EXE.UN, OTC: EXMUF)
Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN)
Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF)
Mullen Group Income Fund (TSX: MTL.UN, OTC: MNTZF)
Newalta Income Fund (TSX: NAL.UN, OTC: NALUF)
Newport Partners Income Fund (TSX: NPF.UN, OTC: NWPIF)
Noranda Income Fund (TSX: NIF.UN, OTC: NNDIF)
Precision Drilling (NYSE: PDS, TSX: PD.UN)
Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF)
Sun Gro Horticulture Income Fund (TSX: GRO.UN, OTC: SGHRF)
Swiss Water Decaf Coffee Fund (TSX: SWS.UN, OTC: SWSSF)
TimberWest Forest Corp (TSX: TWF.UN, OTC: TWTUF)
Tree Island Wire Income Fund (TSX: TIL.UN, OTC: TWIRF)
Bay Street Beat
We’re narrowing our Bay Street focus this month to concentrate on a particular long-term CE favorite that’s taken its lumps in 2008.
Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) scored an impressive 0.400-point increase in its average, boosting its average, compiled by Bloomberg based on its survey of Bay Street analysts, to 4.600 out of a possible 5.000.
Eight of the 10 Bay Street analysts covering the stock now rate it a buy; none recommend selling.
Its US peers have suffered, justly, amid declining advertising revenue and the continuing weakness of the US economy. But Yellow has declined nearly 40 percent this year, unjustifiably, because it’s in a much stronger relative position than its US counterparts.
First, it dominates the market up north. It’s the sole owner of Yellow Pages directories in Canada and faces little competition. Second, it generates significant free cash flow. Third, Yellow is already successfully transitioning to the Internet, shifting to a multiproduct, multi-platform business model. What’s now a print business will eventually be Web-based, but in the meantime, Yellow will benefit from its dominant role in auto and real estate advertising.
Yellow reported a 12.9 percent increase in distributable cash flow (DCF) per share on a 7.8 percent increase in overall revenue for the first quarter; DCF actually accelerated from 10 percent growth in the fourth quarter. And consolidated online revenue increased by 47.7 percent. Those numbers directly refute contrarian Bay Street analysts who predicted both print and Internet advertising would suffer amid the deteriorating North American economy.
There’s a reason Yellow Pages Income Fund was the June High Yield of the Month: It’s a compelling value at these levels, yielding more than 12 percent.
The Telecom Story
Non-Trust recommendation Shaw Communications (NYSE: SJR, TSX: SJR.B), Canada’s No. 2 cable and satellite TV company, reported a 39 percent increase in earnings for its fiscal third quarter last week. Shaw also announced an 11 percent dividend increase.
Shaw earned CAD128 million (30 cents Canadian per share) during the three months ended May 31, 2008, up from CAD92 million (21 cents Canadian per share) a year ago. Revenue grew 13 percent to CAD792 million.
Attention now turns to Shaw’s wireless strategy. The company has bid CAD206.7 million for 23 licenses in western Canada in Industry Canada’s spectrum auction. The company has secured enough spectrum to cover its entire cable footprint and set itself up to be a services-bundling superstar.
One analyst estimates that Shaw will generate CAD1.35 billion of free cash flow between 2008 and 2012 and could spend up to CAD600 million during the same time frame on a wireless initiative, including spectrum, network infrastructure and start-up losses. That suggests Shaw has enough flexibility to roll out a wireless service and still grow its dividend.
Shaw isn’t going to compete with BCE (NYSE: BCE, TSX: BCE), Telus (NYSE: TU, TSX: T) and Rogers Communications (NYSE: RCI, TSX: RCI.B) on a national level. That role may be left to upstart Globalive Communications. Privately held Globalive has bid CAD443 million for 25 licenses that span nearly the entire country. Quebecor leads all newcomers with CAD556.5 million across 17 licenses but is focused on its home province of Quebec.
Industry Canada set aside 40 percent of the spectrum available in the current auction for new wireless participants. The auction, which won’t end until there are two consecutive rounds with no bidding, has raised CAD4.18 billion so far, with mainstay Rogers leading all participants with CAD928.9 million worth of bids on 52 licenses. Telus has bid CAD855.3 million on 56 licenses, and BCE has 54 licenses worth CAD719 million.
We’ll take a deeper look at the spectrum auction and what it means for Canada’s telecommunications industry, and we’ll attempt to untangle the mess that’s become the BCE takeunder in the August Canadian Currents.
Essential Energy Services Trust (TSX: ESN.UN, OTC: EEYUF) was the only entry in the Canadian Edge universe to trim distributions last month. A haircut was anticipated, but the magnitude (70 percent) was above expectations, resulting in a further decline in the share price. The move was made in conjunction with the sale of Essential’s transport division to Mullen Group Income Fund (TSX: MTL.UN, OTC: MNTZF), which is likely to exit the Watch List after the release of its second quarter earnings.
Essential will receive cash proceeds of CAD135 million for the operation, which contributed approximately 38 percent of its overall cash flow. The sale is expected to close in early July and includes transport operations for fluid hauling, rig relocation, pipe hauling and oilfield hauling equipment. A large chunk of the proceeds will go toward reducing Essential’s debt, with most of the rest to be reinvested in the trust’s rigs and downhole tools and rentals divisions. The trust is currently the sixth-largest rig operator in Canada and should benefit as that sector continues to cycle out of its recent weakness.
Overall, the sale and distribution cut have been viewed positively on Bay Street, with two of the three analysts covering the trust now rating it a buy, up from zero last month. That, plus recent insider buying, are encouraging signs, though I want to see how second quarter earnings shape up before upgrading Essential to a buy. Hold Essential Energy Services Trust.
The former Aeroplan Income Fund is now Aeroplan Group (TSX: AER, OTC: GAPFF). Shareholders should by now have received a share of the post-conversion corporation for every one of the trust they formerly owned. As we pointed out last month, the switch from trust to corporation comes with a distribution cut of about 40.5 percent. It leaves a healthier company better able to handle the challenges of a worsening market for flyer miles and other consumer benefits.
But with the next dividend not payable until Nov. 17 (to shareholders of record Sept. 30), there’s not a lot of appeal for income investors here. We’re still covering Aeroplan Group in the How They Rate Table, but it remains a sell.
Keystone North America (TSX: KNA.UN, OTC: KYSNF) has completed the conversion of 91 percent of its former income participating securities (IPS) to common shares. The IPS still trades on the Toronto Stock Exchange, though management cryptically states “there can be no assurance the listing will continue.”
As pointed out last issue, management accomplished the conversion through a rights offering that effectively exchanged the bond portion of the IPS for five ordinary shares of stock in Keystone. The result was the 91 percent of IPS holders accepted the rights wound up with six ordinary shares of stock. Management has now consolidated these into one share of common stock. Consequently, shareholders who accepted the rights and held on through the consolidation now have one ordinary share of Keystone for every IPS they formerly held.
Keystone’s move was apparently made because of debt covenants that may have been nearing violation, in large part because of the weakness of the US dollar. With its facilities located in this country, Keystone’s receivables are essentially in US dollars, while a good chunk of payables—i.e., IPS dividends—are paid in Canadian dollars. That works to its benefit when the US dollar is rising against the loonie and against it when the US dollar drops.
The good news is the conversion has eliminated this risk, and left Keystone’s generally recession-resistant funeral facility business in much better shape. Those who converted have generally come out whole, though with a 23.8 percent dividend cut. Investors who acted on our buy recommendation last month are already up around 20 percent.
Unfortunately, those who didn’t convert and still hold the IPSes have suffered both a dividend cut and a 20 percent dilution of their ownership interest. The shares have continued to plunge and were suspended from trading on the Toronto Stock Exchange June 30.
My advice remains the same as it’s been the past two months. If you own Keystone IPS securities, sell at the first opportunity. Note, however, that you shouldn’t accept less than 20 percent below the price of the common share, which represents the 20 percent dilution of the IPSes. The current differential is about 25 percent, but my feeling is that should narrow. Meanwhile, Keystone North America common shares are now a buy up to USD7.
Two trusts go on the Watch List this month: Long-term care REIT Extendicare Trust (TSX: EXE.UN, OTC: EXMUF) and Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF). Both trusts have seen cash flows lag distributions over the past year, with Extendicare not earning its payout in the first quarter. But there are additional complications that could make matters more dire going forward.
In the words of several analysts, Extendicare “blindsided” investors with a decision to raise CAD126.6 million in new equity, after providing little or no indication of the need to raise capital in first quarter financial statements. Some CAD92 million of the offering was in the form of a 7.25 percent convertible bond, with ordinary trust units comprising most of the rest.
Potential uses of this capital include paying down the trust’s debt, as well as funding ongoing expansion projects. But it will also potentially dilute cash flow, putting additional pressure on the distribution. And the apparent sale by the former chairman of all his holdings is also disturbing. Whatever the case, there are too many unknowns here. Sell Extendicare Trust.
To date, regional air transport trust Jazz has been insulated from rising fuel costs and the weakening North American economy by its relationship to Air Canada. The latter essentially rents all of its planes and absorbs virtually all costs. In addition, traffic along its major routes has remained robust, despite the slowdown in most of North America. However, airline industry conditions overall continue to worsen, reflected by the more than halving in the value of Air Canada A shares since late 2007.
Now selling at a yield of more than 17 percent, 75 percent of book value and half annual sales, Jazz is cheaper than it’s been at any time since its Feb. 2, 2006, inception as a trust. Concerns about the trust’s dependence on Air Canada to contract its planes appear to be why the shares have dropped so sharply over the past two months. The risk is now well priced in. But as long as Air Canada looks challenged, Jazz Airline Income Fund rates a hold only for more aggressive investors.
Here’s the rest of the Dividend Watch List. Note that first quarter payout ratios are will be reviewed in the How They Rate Table as trusts report them.
Acadian Timber Income Fund (TSX: ADN.UN, OTC: ATBUF)
Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF)
Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF)
Canfor Pulp (TSX: CFX.UN, OTC: CFPUF)
Connors Brothers Income Fund (TSX: CBF.UN, OTC: CBICF)
Essential Energy Services Trust (TSX: ESN.UN, OTC: EEYUF)
Extendicare Trust (TSX: EXE.UN, OTC: EXMUF)
Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN)
Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF)
Mullen Group Income Fund (TSX: MTL.UN, OTC: MNTZF)
Newalta Income Fund (TSX: NAL.UN, OTC: NALUF)
Newport Partners Income Fund (TSX: NPF.UN, OTC: NWPIF)
Noranda Income Fund (TSX: NIF.UN, OTC: NNDIF)
Precision Drilling (NYSE: PDS, TSX: PD.UN)
Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF)
Sun Gro Horticulture Income Fund (TSX: GRO.UN, OTC: SGHRF)
Swiss Water Decaf Coffee Fund (TSX: SWS.UN, OTC: SWSSF)
TimberWest Forest Corp (TSX: TWF.UN, OTC: TWTUF)
Tree Island Wire Income Fund (TSX: TIL.UN, OTC: TWIRF)
Bay Street Beat
We’re narrowing our Bay Street focus this month to concentrate on a particular long-term CE favorite that’s taken its lumps in 2008.
Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) scored an impressive 0.400-point increase in its average, boosting its average, compiled by Bloomberg based on its survey of Bay Street analysts, to 4.600 out of a possible 5.000.
Eight of the 10 Bay Street analysts covering the stock now rate it a buy; none recommend selling.
Its US peers have suffered, justly, amid declining advertising revenue and the continuing weakness of the US economy. But Yellow has declined nearly 40 percent this year, unjustifiably, because it’s in a much stronger relative position than its US counterparts.
First, it dominates the market up north. It’s the sole owner of Yellow Pages directories in Canada and faces little competition. Second, it generates significant free cash flow. Third, Yellow is already successfully transitioning to the Internet, shifting to a multiproduct, multi-platform business model. What’s now a print business will eventually be Web-based, but in the meantime, Yellow will benefit from its dominant role in auto and real estate advertising.
Yellow reported a 12.9 percent increase in distributable cash flow (DCF) per share on a 7.8 percent increase in overall revenue for the first quarter; DCF actually accelerated from 10 percent growth in the fourth quarter. And consolidated online revenue increased by 47.7 percent. Those numbers directly refute contrarian Bay Street analysts who predicted both print and Internet advertising would suffer amid the deteriorating North American economy.
There’s a reason Yellow Pages Income Fund was the June High Yield of the Month: It’s a compelling value at these levels, yielding more than 12 percent.
The Telecom Story
Non-Trust recommendation Shaw Communications (NYSE: SJR, TSX: SJR.B), Canada’s No. 2 cable and satellite TV company, reported a 39 percent increase in earnings for its fiscal third quarter last week. Shaw also announced an 11 percent dividend increase.
Shaw earned CAD128 million (30 cents Canadian per share) during the three months ended May 31, 2008, up from CAD92 million (21 cents Canadian per share) a year ago. Revenue grew 13 percent to CAD792 million.
Attention now turns to Shaw’s wireless strategy. The company has bid CAD206.7 million for 23 licenses in western Canada in Industry Canada’s spectrum auction. The company has secured enough spectrum to cover its entire cable footprint and set itself up to be a services-bundling superstar.
One analyst estimates that Shaw will generate CAD1.35 billion of free cash flow between 2008 and 2012 and could spend up to CAD600 million during the same time frame on a wireless initiative, including spectrum, network infrastructure and start-up losses. That suggests Shaw has enough flexibility to roll out a wireless service and still grow its dividend.
Shaw isn’t going to compete with BCE (NYSE: BCE, TSX: BCE), Telus (NYSE: TU, TSX: T) and Rogers Communications (NYSE: RCI, TSX: RCI.B) on a national level. That role may be left to upstart Globalive Communications. Privately held Globalive has bid CAD443 million for 25 licenses that span nearly the entire country. Quebecor leads all newcomers with CAD556.5 million across 17 licenses but is focused on its home province of Quebec.
Industry Canada set aside 40 percent of the spectrum available in the current auction for new wireless participants. The auction, which won’t end until there are two consecutive rounds with no bidding, has raised CAD4.18 billion so far, with mainstay Rogers leading all participants with CAD928.9 million worth of bids on 52 licenses. Telus has bid CAD855.3 million on 56 licenses, and BCE has 54 licenses worth CAD719 million.
We’ll take a deeper look at the spectrum auction and what it means for Canada’s telecommunications industry, and we’ll attempt to untangle the mess that’s become the BCE takeunder in the August Canadian Currents.
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