By any measure, July was an ugly month for investment markets in general. And for the first time in a while, Canada decidedly wasn’t spared the carnage.

The catalyst has been falling energy prices. Oil and natural gas prices are still well above where they stood last year. Over the last month, however, black gold has tumbled from a peak of near $150 a barrel to less than $120 a barrel. Its cleaner cousin, meanwhile, has gone from a high in the mid-teens per million British thermal units (MMBtu) to little more than USD8 per MMBtu.



Moreover, conviction is growing in the market place that further price declines are on the way on forecasts for further plunges in US demand and a slowdown in Asia. There’s still little evidence Asia is succumbing to a US contagion. And no matter how severe it gets, bearish sentiment alone won’t bring down energy prices. In fact, the more intense the mood, the more likely an extremely powerful and sudden upward reversal is, even if Asian demand should slow down.

Severe bearish sentiment, however, does have a huge impact on prices of energy stocks, which reflect expectations rather than the current level of prices. For example, energy companies across the board, including producer trusts, have reported blockbuster second quarter earnings. And many have issued very favorable guidance for the rest of 2008 as they’ve raised output, cut costs and debt, and locked in future prices.

But none of that has prevented the massive selloff in oil and gas producer trusts of the past few weeks.

The nine in the Canadian Edge Aggressive Portfolio are still well up for the year. We’ve seen several hefty distribution increases, notably Daylight Resource’s (TSX: DAY.UN, OTC: DAYYF) 30 percent boost effective with this month’s payment and the back-to-back hikes at ARC Energy Trust (TSX: AET.UN, OTC: AETUF).  

Nonetheless, even these core trusts have been hit by considerable selling pressure and could give back more if underlying energy prices do keep falling. As the Feature Article makes clear, the downside has been more dramatic still in energy services trusts, with even the strongest, such as Trinidad Drilling (TSX: TDG, OTC: TDGCF), affected.



The Canadian dollar, or loonie, is first and foremost considered a natural resource currency, given the country’s massive exports of everything from fossil fuels and uranium to copper and potash. The bull market of recent years in raw materials is at the root of the currency’s rapid climb versus the US dollar. And the ongoing commodity selloff is having precisely the opposite impact, driving down the loonie’s value about 5 percent this year.

For most of this year, trusts outside the energy patch languished because of a lack of interest and worries about the slumping North American economy. As a result, in Canadian dollar terms, their shares have been little affected by the drop in energy prices. The loonie’s drop, however, has pushed their US dollar value down further, as well as reduced the value of their distributions to US investors.

Damage has been both widespread and indiscriminate. Even sectors such as energy infrastructure and power generation—which continue to prove their ability to withstand the current environment—have taken hits.

The Real Numbers

Those are the bad numbers. Now for the good ones: Virtually every Canadian trust to report second quarter earnings thus far—including all the CE Portfolio representatives except GMP Capital (TSX: GMP, OTC: GMCPF)—have come in with numbers ranging from solid to positively robust. Moreover, they’ve given every indication that results will be equally solid the rest of the year, just as they were in the first quarter.

Share prices ebb and flow with the market mood. This bear market for stocks is now more than 13 months old. Moreover, the North American economy is either in or close to recession, depending on how you want to measure it. Consequently, it’s no great surprise that the prevailing psychology is bearish, or that most investors are thinking sell rather than buy, no matter how earnings come out.

Energy-related Canadian trusts were huge winners in the first half of the year. The fact that they’ve come under selling pressure is part and parcel of what a bear market in stocks is all about, as even the strongest sectors are eventually ground down.

In addition, investors in bear markets pay the most attention to the dark side of earnings news, i.e., indications of weakness. The raw numbers, however, aren’t determined by the market mood but the actual conditions on the ground.

As this earnings season continues, we may yet see the kind of disturbing numbers that would indicate some trusts are succumbing to the three challenges of softening North American growth, rising raw material costs and tight credit conditions. As highlighted in yesterday’s Flash Alert, for example, GMP has been affected by a dramatic drop in Toronto market activity. It’s retained market share, which is why I continue to hold it. But it will be dead money until conditions improve. So far, however, the results on the rest are telling us loud and clear that a good many trusts and corporations are holding their own.

The market’s nasty mood may be taking them lower for now. But their underlying businesses are healthy, despite ongoing stress tests. As long as that lasts, distributions will be secure and even ripe for increase. And as long as distributions at least hold, the red ink they’re sitting in now will eventually turn black, restoring value and warding patient investors with hefty gains.  

Just as it was last quarter and the quarter before, the key to navigating the tough times is making sure your holdings are healthy. And there’s no substitute for a careful review of second quarter earnings.

Below I take a look at what we know thus far. Pembina Pipeline Income Fund’s (TSX: PIF.UN, OTC: PMBIF) powerful performance is highlighted in High Yield of the Month, along with the surprisingly strong showing of Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF).

The rest of the CE Portfolio member earnings will be reviewed in an upcoming flash alert. Raw data and commentary/analysis for all trusts and corporations tracked, including non-Portfolio members, will be updated in the How They Rate Table as soon as they can be reviewed.

Note that our three CE Portfolio closed-end mutual funds of trusts–EnerVest Diversified Income Fund (TSX: EIT.UN, OTC: EVDVF), Select 50 S-1 Income Trust (TSX: SON.UN) and Series S-1 Income Fund (TSX: SRC.UN, OTC: SRIUF)–don’t post earnings per se because they’re not strictly operating companies. Rather, I’ll be reviewing their quarterly reports, including data on holdings, fees and payout ratios based on the distributions of their holdings.

The good news is all three look set to maintain current levels of distributions, though share prices and net asset values (NAV) will vary with the market. Select 50 S-1 Income Trust has now merged with a sister fund for better economies of scale. As of yet, the fund hasn’t yet acquired a new five-letter over-the-counter (OTC) symbol for trading in the US, and it appears to have stopped trading under the old one, SFYIF.

In response, some brokerages are showing Select 50 on account statements as “delisted,” assigning it a value of zero. If that’s happened to you, the first thing to realize is the fund is still trading in Toronto under the symbol SON.UN. In fact, thanks to the merger, trading volume is higher than ever.

Second, despite the lack of an OTC symbol at the moment, Select 50 is still a very attractive holding. The fund sells at roughly a 3 percent discount to NAV and is well diversified, with Penn West Energy Trust (NYSE: PWE, TSX: PWT.UN) the only oil and gas producer in its top 10 holdings. Half the top 10 are Canadian Edge Portfolio members, and the rest are buy-rated trusts. It’s outperformed its peers this year and looks likely to keep doing so.



Select 50’s distribution amount posted in the How They Rate Table from our live quote feed still includes the 79 cents Canadian special cash dividend paid Jan. 15. The actual monthly rate is 8 cents Canadian a share, for an annual yield of around 9 percent. Note, however, that another special payment is likely at the end of the year.

Unfortunately, unless you’re one of the guys who makes OTC markets in the US, there’s not much you can do but wait for someone to either come up with a new five-letter trading symbol or go back to trading the old SFYIF. My guess is we’ll see the latter. Meanwhile, the fund is still active and paying distributions, with a payment date of the 15th of every month. Make sure your broker is crediting your account.

Note that How They Rate Table continues to post live US dollar-based quotes for Select 50. These figures are basically the latest trades on the fund’s home Toronto Stock Exchange, where virtually all volume is, expressed in US dollars. They’re the most-accurate prices available for Select 50, as well as all other Canadian trusts and common stocks.

On Solid Ground

Daylight Resources’s 30 percent distribution increase last month telegraphed a strong second quarter, and that’s just what it delivered. The gas-weighted trust’s payout ratio plunged to just 32 percent, as funds from operations (FFO) more than doubled from year-earlier levels and were up 31 percent sequentially as well. Net debt was cut to just 1.1 times cash flow, as management projected internally generated resources would cover the entire capital spending program of CAD140 million—roughly triple last year’s tally—as well as the payout.

At the root of Daylight’s blockbuster returns were two things: steady production that looks to be augmented significantly from new opportunities in coming months and much-higher realized prices of oil and, particularly, natural gas. The trust sold gas at an average price of CAD10.30 per thousand cubic feet during the quarter and its light oil at USD120.93 per barrel.

Similarly, ARC Energy enjoyed a 47.7 percent boost in second quarter FFO per share, from a 61.1 percent jump in revenues per barrel of oil equivalent before royalties. Output also rose 3.7 percent, as the conservatively run trust began to ramp up efforts at the emerging Montney region. Average realized selling prices in the second quarter, meanwhile, rose to USD118.32 per barrel for oil and USD10.41 per thousand cubic feet for natural gas.

The trust’s payout ratio fell to just 53 percent, and net debt was cut to just 0.78 times annual cash flow. That was despite a 40 percent rise in distributions and the writeoff of CAD33 million in potential losses because of the SemCanada bankruptcy.

Enerplus Resources (TSX: ERF, NYSE: ERF) came with a 53 percent jump in second quarter cash flow on solid production gains, including from the Focus acquisition. That spurred a big cut in net debt to just 40% of cash flow and triggered 12 percent dividend boost. And Peyto Energy Trust (TSX: PEY, OTC: PEYUF) saw a solid 7 percent boost in FFO, as it cut expenses and debt and upped proved reserve life.

If there’s a dark side to the numbers at Daylight and ARC, it’s that second quarter selling prices are higher than current spot prices. Moreover, that gap will widen if energy prices fall further.



The good news is all four trusts have protected themselves in advance with hedging at very strong prices. ARC had prices for more than 40 percent of its projected output locked in before the third quarter began, with lesser amounts for the rest of the year.

Perhaps more important, these trusts’ payout ratios are now extremely low, and they’ve been able to apply the cash windfall of the past quarter to improve sustainability by cutting costs, controlling debt and ramping up output. None have issued much in the way of debt or shares over the past year, relying instead on internally-generated cash flow. That’s a lot of protection, even if energy prices do fall further.

ARC Energy Trust remains a buy up to USD32 for those who don’t already own it, conservative and aggressive investors alike. Daylight Resources is a solid buy up to USD13. Enerplus is a buy up to USD50 and Peyto is a buy to USD21.

Before this earnings season, I had become deeply concerned about the prospects for TransForce (TSX: TFI, OTC: TFIFF). The transport and logistics company had converted from trust to corporation earlier this year on the premise that it needed to shepherd more cash flow to pursue its aggressive growth strategy. Management also argued that trust structure was no longer conducive to its efforts to raise capital to make acquisitions or expand its existing array of assets.

Industry conditions are still very tough for transporters. TransForce’s arrangement automatically passes through fuel costs to customers. Higher gasoline prices, coupled with a weaker US economy, however, have crimped traffic in prior quarters and, therefore, revenue and profit margins. And the expectation was it would happen again in the second quarter.

As it turned out, however, TransForce’s revenue surged 20 percent, triggering an 18 percent jump in operating cash flow and an 11 percent increase in after-tax earnings, not including onetime items. These were basically costs related to the conversion to a corporation and the termination of an incentive plan.



Once again, the key to stronger sales was successful acquisitions, as the company continued to add accretive assets and consolidate markets under its control. That’s been the strategy since TransForce’s inception. The fact that management is still executing during a severe sector slump is a clear sign of the company’s underlying strengths and should pay off in spades when conditions ultimately turn up.

Since the conversion took place this spring, TransForce’s distribution pattern has been somewhat erratic. The last regular monthly payout of 13.25 cents Canadian was made May 15. Then management dished out 6.625 per share Canadian June 13 as a “pro rata” payment to adjust to the new quarterly payment. Another pro rata payout of 5 cents Canadian will be made Aug. 15 to shareholders of record Aug. 7.

Finally, the first regular quarterly dividend will be 10 cents Canadian per share and paid Oct. 15. That will be followed by dividends on or about the 15th of January, April and July.

Given its ambitious plans for growth, the new annual dividend rate of 40 cents Canadian per share isn’t likely to be increased any time soon. On the plus side, TransForce’s payout is well protected by earnings (29.4 percent second quarter payout ratio), which affords it ample cash to fund its growth effectively without piling on debt. And the yield of nearly 5 percent is well above that of any comparable transportation corporation.

The bottom line is TransForce remains an attractive holding for long-term growth and generous income. TransForce’s shares have bounced off their lows on the earnings news but are still very cheap and a buy up to USD9.

Energy Savings Income Fund (TSX: SIF, OTC: ESIUF) is another trust I was keen to track due to its exposure to the US. As it turned out, however, US growth was strong again offsetting flat Canada results. Coupled with cost cuts and a reduction of bad debt expense the payout ratio actually fell from last year’s level and the seasonally weak quarter, and management expects further improvement. It’s still a buy for those that don’t own it up to USD18.

Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF) posted a 9.1 percent boost in distributable cash flow per share, triggering a 3.6 percent dividend boost. Online revenue grew 44 percent to 14.3 percent of overall sales, a clear sign this directory trust is dodging the fate of US rivals. Buy up to USD14.

Since the downturn began more than a year ago, the conventional wisdom has been that communications companies’ earnings would no longer prove recession resistant. Once again, Bell Aliant Regional Communications Income Fund’s (TSX: BA.UN, OTC: BLIAF) earnings show that just isn’t so.



As it has for the past several years, the company continues to lose local line connections. The rate of loss, however, was 8.5 percent lower than in the first quarter of 2008, 6.8 below the year-earlier quarter and less than half the losses from the fourth quarter of 2007. Equally important, losses were more than offset by customer gains for higher margin wireless and Internet service.

Wireless turnover, or “churn,” fell to just 1.1 percent, down from 1.7 percent for the full-year 2007. High-speed Internet customer rolls are up 13.1 percent year-over-year. The rate of growth tapered off a bit in the second quarter, but revenue per customer moved higher for the fourth consecutive quarter. And with the company’s accelerated deployment of fiber-optic connections, its network is capable of offering more data and entertainment services than ever.

Bell isn’t the picture of rapid growth Canada’s pure wireless players are. But its diversified combination of services is a study of stability in otherwise difficult times. Overall revenue growth, for example, actually accelerated from 1.1 percent in the first quarter to 2.4 percent in the second quarter. Meanwhile, distributable cash flow per share—the best measure of trusts’ profitability and ability to pay dividends—rose 16 percent over year-earlier totals.

Year-to-date, the payout ratio stands at 84 percent of distributable cash flow after capital expenditures, well below last year’s 93.1 percent. That leaves room for continued modest dividend growth, with the next bump likely coming in late 2008 or early 2009. Finances are very solid, with cash flow covering interest expense by a 7.5-to-1 margin and the balance sheet drawing midlevel investment-grade ratings from Standard & Poor’s and Dominion Bond Rating Service (DBRS).

Despite its many strengths and the stability of the dividend, Bell Aliant shares nonetheless yield nearly 11 percent and sell for just 79 percent of book value. The primary reason appears to be concern about what the new private capital owners of parent BCE will do with their still hefty stake in the trust. Speculation has ranged from a high-premium buyback of all of Bell’s outstanding shares to a sale or spinoff.

All of these outcomes should wind up being positive for Bell Aliant shareholders. But the uncertainty about what the new BCE team will do continues to weigh on the shares. The good news is insiders appear to have stepped up buying, providing a good lead for the rest of us to follow. Bell Aliant Regional Communications Income Fund remains a buy up to USD32.

RioCan REIT (TSX: REI.UN, OTC: RIOCF) has been a rock in Canada’s commercial property market for many years. Second quarter FFO ticked up 5.3 percent, as the REIT enjoyed a 97 percent overall occupancy rate boosted by gains in both the core retail center portfolio and office space.

Portfolio quality continues to be very high, concentrated in the country’s strongest areas with 82.9 percent of net leasable space rented to very secure anchor tenants (83.5 percent of annual revenue). In addition, no one customer accounts for more than 5.4 of total revenue, while leases are typically signed with duration of 10 years or more.

RioCan’s portfolio remains most focused on Ontario, with 62.8 percent of annual revenue coming from Canada’s largest and most populous province. The next largest share is from Quebec at 19 percent, with energy-dependent Alberta third at 10.2 percent. That lesser exposure to the resource patch hasn’t hurt RioCan’s steady growth to date, and it provides some downside protection should oil and gas prices really go into reverse from here.

RioCan’s greatest strength is management’s expertise at doing deals and its size as Canada’s largest REIT, which gives it the scale to execute them. In late June, RioCan’s 50-50 joint venture partnership with US retail giant Kimco bought a 10-property, 1.1-million-square-foot portfolio of new format and strip retail centers in central and eastern Canada.

RioCan sources, leases and manages the properties in the venture, while Kimco’s involvement lowers its financial commitment and risk. Overall, the REIT has properties under development equal to about 10 percent of its currently operating portfolio. That should keep cash flow and distributions rising at a reliable pace in coming quarters. The second quarter payout ratio fell to just 84.4 percent.

RioCan has long traded at a premium to other Canadian REITs because of these well-known strengths. That’s still the case, but the current yield of nearly 7 percent is now several points above those of comparable US REITs. And that’s despite operating in a much-stronger property market.

The yield advantage widens further when factoring in US taxes; RioCan’s distribution is considered a qualified dividend, while US REITs pay mostly ordinary income. Buy RioCan REIT if you haven’t already up to my continuing value-based target of USD25.

Finally, Altagas Income Fund (TSX: ALA, OTC: ATGFF) reported 8.7 percent growth in FFO, as extraction and transmission and power generation results were explosive. Offsetting weakness in the smaller energy services operation. Debt-to-capitalization was cut from 45.1 percent in March to just 36.4 percent, and management boosted the distribution by another 2.9 percent. All in all, it was confirmation of both the trust’s conservative growth strategy, and the underlying strength of energy infrastructure trusts. Buy Altagas up to USD28 if you haven’t already.