Of the 147 trusts, corporations and closed-end mutual funds in the Canadian Edge coverage universe, 20  increased distributions last month. The only cuts came from GMP Capital Trust (TSX: GMP-U, TOC: GMCPF) highlighted in the August 7 Flash Alert, and  Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF).

On balance, the fast-food franchiser posted positive second quarter results. Same-store sales grew 1.3 percent, cash flow rose 33 percent, and distributable cash flow nearly tripled. Income from restaurant operations improved to 12.2 percent of sales from 10.6 percent a year ago.

The key difference was the trust managed to capitalize on several successful promotions, despite a tougher business environment and rising labor and commodity costs. It also managed to shave expenses by a sizeable amount and cut overall costs as a percentage of sales by 190 basis points.

Thanks to the improved performance, cash flow for the quarter after maintenance expenditures did barely cover distributions. Its payout ratio year to date, however, came in at 194.8 percent. That, plus continued uncertain business conditions, induced management to cut the monthly dividend 50 percent from 10 cents Canadian a share to just 5 cents Canadian.

Priszm’s move is a tacit admission that management’s recovery plans earlier this year were too aggressive, and the market isn’t likely to forgive its failed forecasts easily. But the new level of distribution should be easily sustainable. And coupled with targeted asset sales, the cut will mitigate the need to raise additional capital to finance operations. Interest expense, for example, rose an alarming 35.2 percent over the last 12 months, reflecting higher debt levels though growth in outstanding shares was flat.

Priszm shares sold off further in the wake of the cut, bringing their year-to-date losses to nearly 30 percent and 12-month decline to nearly 50 percent. Now yielding more than 16 percent and selling for less than book value and just 16 percent of sales, Priszm Income Fund is certified cheap and a buy for aggressive investors up to USD4.

Forestry remains a very tough business in North America. Product prices are depressed as the markets focus on near-term concerns about the economy, rather than the long-term reality of growing global scarcity of timber. The biggest use of timber is building houses, and new construction has ground to a halt in the US. As a result, many producers are holding in output, rather than selling into a weak market.

Thus far into the slump, timberland owners such as Acadian Timber Income Fund (TSX: ADN.UN, OTC: ATBUF) and TimberWest Forest Corp (TSX: TWF.UN, OTC: TWTUF) have been able to mitigate cash flow shortfalls with real estate sales. Last month, TimberWest completed the rezoning of 166 hectares of land near the Campbell River Airport on Vancouver Island. That should speed up the potential high-end development of the land, a key element of management’s plan to avoid a dividend cut for the stapled shares.

Some analysts have estimated the value of TimberWest’s properties as roughly equal to its share price, essentially pricing the timberlands value at close to zero. And the Canadian property market remains strong, with Vancouver Island a standout. Still, until timberland conditions improve, TimberWest’s shares and distribution will depend ever more on real estate values.

Both TimberWest Forest Corp and Acadian Timber Income Fund are holds for their property value alone. But they won’t truly be buys until their core business—forestry—turns up once again.

Pulp companies depend on the timber harvest for raw materials to process. Not surprising, they’re also hurting this year. Canfor Pulp (TSX: CFX.UN, OTC: CFPUF) has basically seen its sales drop 11 percent over the past year, while cash flow, operating margins and net income have fallen by half.

The culprits were a deadly combination of lower output, flat prices and rising costs, in part because of maintenance outages at facilities. The results were a bloated second quarter payout ratio of 180 percent and renewed questions about the distribution.

Encouraging, analysts and insiders remain fairly bullish. But until we see improvement in the numbers, Canfor Pulp still rates a hold for aggressive investors only.

Note I expect similarly tepid results from SFK Pulp Fund (TSX: SFK.UN, OTC: SFKUF). The trust’s distribution, however, is already at a conservative level, meaning the likely consequence is no increase. SFK Pulp Fund is also a hold.

Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF) was added to the Watch List last month because of my growing concern about the health of parent Air Canada. Since then, we’ve seen a marked downturn in North American freight traffic, and Canada’s Minister of Labor issued a decision that appears to restrict Air Canada’s ability to quickly implement layoffs of up to 2,000 employees, which were planned to offset spiking fuel costs.

Air Canada’s woes don’t immediately affect Jazz’s cash flow or distributions. In fact, they won’t unless the parent becomes unable to fulfill its obligations to the trust, which essentially involve covering all variable costs. But Jazz’s yield of nearly 19 percent is a clear warning that this is no longer as remote a possibility as it was just a few months ago.

The trust does look cheap at just 67 percent of book value and 47 percent of annual sales. But until Air Canada finds a bottom for its underlying business, Jazz Airline Income Fund is a hold for more-aggressive investors only.

I’ve been a seller of Harvest Energy Trust (NYSE: THE, TSX: HTE.UN) for some months now because of the collapsing margins of its refining business. To date, management has avoided a distribution cut, on the strength of robust results at its oil and gas production business. But the high payout ratio, coupled with elevated debt levels, has continued to be a clear, present danger for investors.

Last week, I spoke with management about these issues in detail. I still have concerns, particularly regarding capital needs and near-term results from the refining business. But combined with the recent drop in Harvest’s share price, I’m convinced the time for selling is past, and the time for buying may be approaching.

Harvest has always been an aggressively managed business by its own admission, with a focus on acquiring assets that “no one else wants.” That served the trust well earlier this decade, as it was able to acquire property in southeastern Saskatchewan for less than 2 percent of its estimated current value.

The purchase of the North Atlantic refinery in 2006 is the latest iteration of this opportunistic strategy, though, to date, it hasn’t worked out quite as well. Refining margins that averaged $40 per barrel in May 2007 have since shrunk to just $4 to $5 per barrel. As a result, despite some meaningful upgrades at the facility itself, cash flow is basically running at breakeven, not counting debt service costs.

Harvest’s woes are common to the entire refining industry. The costs of feedstock (crude oil) have vastly outrun refiners’ ability to pass them along in the price of refined products such as gasoline. The squeeze has been tightened further by depressed demand for products such as gasoline and jet fuel, as consumers have cut back usage in the face of rising prices and the weakened economy.

At this point, it’s hard to see an immediate catalyst for recovery. Crude oil prices have backed off sharply from their recent highs of near USD150 a barrel. All else equal, that would improve refining margins. In this case, however, crude prices are falling precisely because of dropping demand for refined products such as gasoline, which hurts margins.

The implication is more tough times lie ahead for this sector and for refiners such as Harvest. Longer term, however, North American refining capacity remains very tight and is likely to remain so because of difficulties in siting new facilities and expanding old ones. In this, North Atlantic is advantaged, both by its proximity to the US and Europe and opportunities for expansion and improving efficiencies.

For its part, Harvest’s goal for the facility remains the same as when it made the purchase: looking for ways to increase throughput and flexibility in an economic way. To this end, management is currently in the early stages of seeking out a financial partner to share in the profits and cover the sizeable capital costs associated with such a large project. An announcement is currently expected by the end of the year.

Harvest shares currently offer a yield of nearly 19 percent, selling for barely book value and 65 percent of sales. Given that its oil and natural gas production are very profitable, that price appears to value the refining operation at a distinctly negative number.

To be sure, management still expects to see a higher-than-average payout ratio for the rest of 2008. That’s partly due to the refining operation but also to relatively high debt-service costs and hedging of output.

On the other hand, Harvest is also enjoying strong results from enhanced oil recovery operations, which have made the vast reserves of deep pools it owns economic. The trust has paid off CAD1.1 billion in debt over the last 16 months, and older, low-priced hedges are starting to term out in favor of new, higher-prices ones.

As a result, management now states it’s comfortable maintaining the current level of distribution, in spite of the high payout ratio. If it’s able to make good, that will provide considerable downside protection from current levels and make a recovery to at least the mid-20s for the shares likely.

The upshot: I’m upgrading Harvest Energy Trust from sell to a buy below USD20 for aggressive investors. Note I’m also keeping it on the Dividend Watch List for now to underscore it’s not for conservative investors, at least until the payout ratio comes down to a more-moderate 60 to 70 percent level.

Here’s the rest of the Dividend Watch List. Note that Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF)—see High Yield of the Month—is now off the Watch List after posting solid second quarter results. Other second quarter payout ratios will be reviewed in How They Rate over the next month, as trusts report them.

Acadian Timber Income Fund (TSX: ADN.UN, OTC: ATBUF)
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 (TSX: ESN.UN, OTC: EEYUF)
Extendicare Trust (TSX: EXE.UN, OTC: EXMUF)
GMP Capital Trust (TSX: GMP-U, OTC: GMCPF)
Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN)
Jazz Airline Income Fund (TSX: JAZ.UN, OTC: JAARF)
Mullin 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)
Sun Gro Horticulture (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)

Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) has clearly benefited from skyrocketing oil and gas prices in 2008; in May the trust suspended its distribution reinvestment program because it didn’t need the cash, and distributing units rather than cash resulted in unnecessary dilution.

It’s a well-run, efficient company, and it’s unitholder-friendly. That explains why Vermilion scored a perfect 5.000 average rating in Bloomberg’s most recent survey of Bay Street analyst sentiment.

Other CE Portfolio energy holdings earning Bay Street’s esteem include: Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF), 4.750; ARC Energy Trust (TSX: AET.UN, OTC: AETUF), 4.538; and Enerplus Resources (NYSE: ERF, TSX: ERF.UN), 4.538.  

Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) has suffered this year on misperceptions about the nature of its operating environment and a lack of appreciation for its success migrating from print to the Internet. That seems to be changing, however, because Bay Street analysts gave it a 4.600 average out of a possible 5.000.

Second quarter results confirm the viability of the Yellow proposition: Net earnings were CAD135.7 million (26 cents Canadian per unit), up from CAD127.6 million (24 cents Canadian per unit) a year ago. And the fund boosted its distribution 3.5 percent to CAD1.17 annually.

Precision Drilling (NYSE: PDS, TSX: PD.UN) saw one of the biggest ratings increases, a bounce that took it near the top of the weekly poll with a 4.857 average. Precision’s effort to broaden its operational focus into the US drove a 14 percent second quarter revenue increase to CAD138.5 million. Its aggressive capital program has set it up well for a continued recovery through 2008 and into 2009.

We first recommended Canadian Hydro Developers (TSX: KHD, OTC: CHDVF) in the April 2007 issue based on management’s demonstrated ability to design, build and profitably operate renewable energy plants. 2008 is an important year for the company, as it seeks to double its installed capacity. That goal came into sharper focus with the commencement of construction on the 200-megawatt Wolfe Island wind project.

Accomplishing what you set out to accomplish plays well on Bay Street: Canadian Hydro earned a generous bump in its average analyst rating, rising 0.167 points to 4.667. Of the 12 analysts with ratings on the stock, 11 call it a buy.    

New How They Rate subjects Quebecor (TSX: QBR.B, OTC: QBRCF) and Rogers Communications (NYSE: RCI, TSX: RCI.B), discussed in this month’s Canadian Currents, also felt the love from Toronto’s equivalent of Wall Street. Quebecor’s average rating surged 0.200 points to 4.2000, while Rogers tacked 0.235 to 4.529. Both stocks gave up ground during Industry Canada’s recently concluded auction of wireless spectrum based on the perception that they were spending too much. Those fears priced into the market already, Bay Street has recognized the long-term value of the two telecoms.   

SemGroup LP, formerly a large energy trader swapping more than 500,000 barrels of oil a day and the 12th-largest privately held company in the US, filed for Chapter 11 protection July 22 after it realized a USD3.2 billion trading loss when oil futures and derivatives positions moved against it.

Given SemGroup LP’s active role in oil trading, its bankruptcy impacted oil producers and pipeline firms in the US and Canada.

The party most obviously impacted by the bankruptcy is SemGroup Energy Partners (NSDQ: SGLP), the share price of which dove from almost USD23 to just more than USD8 within two days of the revelation of its general partner’s (GP) liquidity problems. The relationship with SemGroup typically accounts for almost 90 percent of SemGroup LP’s revenues, so there will most likely be a sharp drop in profits until more third-party business can be developed.

Two of the company’s largest creditors, Manchester Securities and Alerian Capital Management, have also seized voting control because of its GP’s bankruptcy, which violates several loan agreements. The two lenders have said they will work toward negotiating new loan agreements with other creditors that will allow SemGroup LP to continue operating.

Several Canadian oil producers, including Portfolio recommendation ARC Energy Trust (TSX: AET.UN, OTC: AETUF), are listed as creditors in SemGroup’s bankruptcy filing. ARC released a statement July 22 saying that it anticipated little impact on earnings. ARC Energy is owed USD26.2 million but expects the debt to be a wash because it also owes money to SemGroup.

The chronology of events is interesting; scant details regarding the circumstances of SemGroup LP’s crash and burn have been made public, but the timing raises questions. The firm has disclosed in filings from almost day one that it used a hedge book of oil futures and other derivatives to minimize its exposure to commodity prices, but the size of the loss is totally disproportionate to its market activity.

It appears as though the company was engaged in massive speculation because, based on the timeline that can be assembled from public records and statements, the declines in oil prices of July 16 and July 17 began within hours of SemGroup unwinding substantial positions.

The bankruptcy could also add fuel to the anti-speculation fire because, although the evidence is circumstantial, it seems clear that the company’s trading activities were having a significant impact on oil prices. It will provide an excellent example for enterprising legislators to push for tighter regulations.

Canadian Edge research editor Benjamin Shepherd contributed the preceding item.