A baker’s dozen How They Rate denizens boosted distributions last month, versus three cuts: Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF), BFI Canada Income Fund (TSX: BFC-U, OTC: BFICF) and GMP Capital Trust (TSX: GMP-U, OTC: GMCPF).

Arctic slashed its payout 18.2 percent in a move billed by management as a “temporary” response to difficult conditions. At the root of the trust’s woes is the US Dept of Justice’s (DoJ) investigation of the packaged ice industry. When news of the probe broke earlier this year, management immediately announced it would cooperate with the DoJ and affirmed that the trust was not a target of the investigation. That remains the case today.

Unfortunately, the CAD2.1 million second quarter cost of complying with the bureaucrats appears to be somewhat above expectations. Meanwhile, soaring fuel prices have dramatically increased transportation costs, and there’s evidence of customer conservation, as sales slipped 3 percent from year-earlier levels, despite a stream of acquisitions.

To be sure, Arctic still has several big attractions for investors. The distribution should be sustainable after the recent cut and remains generous. The packaged ice business, despite feeling some impact of the US recession, remains generally stable. More than two-thirds of the trust’s cash flow is realized in the US, making it virtually immune from 2001 taxation. Management has obviously proven itself capable of handling myriad challenges and is sticking to its long-term customer-focused strategy.

On the negative side, however, this DoJ investigation doesn’t appear likely to wind up any time soon. That means an indeterminate drain on Arctic’s finances with no real idea of when it will end. It’s also possible the DoJ could wind up quashing Arctic’s expansion in the US. It’s rumored a disgruntled former employee has stated for the record that the trust did have a collusion strategy with US rivals such as Reddy Ice. And the number of lawsuits against the company—though still not joined by any significant customers—continues to grow.

Even that would be manageable, however, were it not for the higher fuel costs, conservation and the impact of the Canadian dollar’s appreciation over the past year. But together, it adds up to a company with too many question marks to be worth holding onto in this market.

In retrospect, it would have been nice to sell this spring. At this point, the next best thing is to sell and stay on the sidelines until at last some of the uncertainty is resolved.

GMP Capital Trust (TSX: GMP-U, OTC: GMCPF) chopped its distribution even more sharply last month, by 25.6 percent. Second quarter revenue fell 30 percent, triggering a more than halving of profits. The shortfall was basically due to a dramatic 43 percent decline in fees from investment banking activities, a casualty of the slowdown in mergers, public offerings and other transaction activity in the wake of the North American credit crunch. Return on equity fell to 22 percent, versus 52 percent a year ago.

As I pointed out in the August 7 Flash Alert, GMP distributions basically amount to a share of trading profits. When times are good, management has proven that it will share the bounty with unitholders, as it did through the special dividend and dividend boost made earlier this year. When times are tough, however, unitholders suffer along with the traders themselves, who are highly incentivized with profits.

In my view, that’s a good deal in the long run, provided the underlying franchise is solid. And in GMP’s case, it’s healthy as ever. The trust held onto its No. 1 position in block trading volume, the No. 2 spot on Bay Street for equity underwriting and No. 6 in mergers and acquisitions. It also reported solid expansion in investment management, as well as a venture to expand its presence in Europe.

Ultimately, these factors mean a great deal more to GMP investor returns than quarterly swings in profitability. And for that reason, I’ve elected to hold onto GMP, upgrading it to a buy up to USD14. I’m shifting it to the Aggressive Portfolio, however, to better reflect the cyclicality of cash flows, again in retrospect where it should have gone in the first place.

The good news about GMP is the dividend cut was well priced in before management acted. As a result, the shares have picked up a bit in recent weeks. I don’t look for a lot more until Canadian transaction activity revives further. As I pointed out in the In Brief article, however, that may be starting to happen, as the credit conditions in Canada at least have appeared to loosen a bit. GMP is also a perpetual takeover target, particularly at these levels.

As the Feature Article notes, the dividend cut at BFI Canada Income Fund (TSX: BFC-U, OTC: BFICF) was tactical, rather than the result of weakening cash flows. In late August, management announced that, pending unitholder approval, it would convert from an income trust to a corporation. To better facilitate its growth plans in the North American waste business, it shepherded cash flow by simultaneously slashing its distribution by 73 percent, converting a monthly payout of 15.15 cents Canadian into a quarterly one of 12.5 cents.

The market’s reaction was both swift and extremely negative, pushing down BFI’s unit price from a trading range in the low to mid-20s down below USD18. The good news is the shares have since snapped back more than 10 percent. Better, there’s clear precedent for a full recovery and very likely big gains on top of that.

Basically, BFI’s move was similar to those undertaken by three other trusts announcing early conversions this year: Groupe Aeroplan (TSX: AER, OTC: GAPFF), TransForce (TSX: TFI, OTC: TFIFF) and Trinidad Drilling (TSX: TDG, OTC: TDGCF). All three converted for the stated reason of making it easier for them to execute plans for aggressive growth in a weak economic environment. All three also slashed distributions dramatically, to free up more cash.

Like BFI, all three were initially punished in the market place, as disappointed yield-seeking investors bailed out. As I point out in the Feature Article, however, the trio has since recovered their lost ground and more. And that’s despite continuing slack conditions in the travel industry (Aeroplan), trucking (TransForce) and particularly drilling (Trinidad).

Those who dumped immediately following these tactical dividend cuts did get badly burned. But those who stuck around were able to erase the red ink, as the cloud of 2011 uncertainty disappeared and investors were able to focus more closely on the solid underlying businesses.

BFI’s plunge will likely encourage other trusts to go less aggressively on the dividend cuts when they convert. But given its very strong franchise on both sides of the border, BFI is very much a lock to recover its lost ground, once it completes its conversion. Now’s definitely not the time to throw in the towel on this great franchise, no matter how much you’re focused on income. In fact, BFI remains a buy for growth and some income up to USD25.

TimberWest Forest Corp (TSX: TWF-U, OTC: TWTUF) hasn’t specifically announced a dividend cut yet. But after posting atrocious second quarter results, management has launched a “review of distribution policy and potential capital reorganization.”

Log sales volumes fell 24 percent in the second quarter as the company generated a distributable cash loss of CAD3.2 million, after a CAD7.7 million loss from the permanent closure of its last remaining sawmill. The balance sheet remained in compliance with its debt covenants. But absolute borrowings rose by another CAD6.9 million, in part to pay the distribution.

That left total debt at CAD211.9 million and forced management to admit it “may not be able to remain in compliance with its covenants later in the year.” Further, the company issued a forecast for continuing tough conditions in the forestry industry and a projection that it wouldn’t be able to earn the current distribution level at least through 2009.

On the plus side, TimberWest is still realizing profitable sales of real estate and lumber sales to Japan have been strong. The company was also able to cut operating costs in the second quarter. That, however, may prove temporary, as problems with workers continue to fester. Meanwhile, the company is currently projecting a harvest at about 60 percent of normal levels, given weak market conditions particularly in the US.

Clearly, something has to give here. And although management is considering a wide range of options with an eye toward shareholder value, you can only squeeze so much blood from a stone. I continue to recommend holding onto TimberWest, mainly because its assets are valuable and the shares are depressed. But only hang on if you can live with the likelihood that the dividend will be eliminated completely sometime in the next six months.

Big Rock Brewery Income Trust (TSX: BR-U, OTC: BRBMF) has already slashed its payout once this year, back in May from a monthly rate of 13 cents Canadian to just 9 cents. But if second quarter earnings are any indication, there’s more bad news to come.

Sales fell 1.6 percent. But the most alarming item was selling expenses, which rose 11 percent from year earlier levels. That’s a nasty combination that augurs no good for a consumer products company in a slowing economy, particularly one with recent insider selling. Sell Big Rock Brewery Income Trust.

Extendicare Trust (TSX: EXE-U, OTC: EXMUF) suffered a shortfall in second quarter earnings due to growing cost pressures, pushing its payout ratio up to 121.2 percent. It also ran into a hornet’s nest of potential legal liability, including charges of “substandard care” and “violating the rights of residents” in a wave of lawsuits filed in the US.

The company is defending itself vigorously against the charges, which have been filed in Washington state courts on behalf of “all Washington citizens who resided in one of the company’s Washington facilities from July 1, 2004 through July 1, 2008.” As the Arctic case above demonstrates, the company may well be innocent. But that doesn’t mean it won’t have to spend heavily to defend itself, let alone the potential damage to its reputation. And that could be critical at a time when Extendicare is already stressed. Sell Extendicare Trust.

Jazz Airline Income Fund (TSX: JAZ-U, OTC: JAARF) also didn’t earn its distribution in the second quarter. Operating revenue did rise 9.2 percent as air traffic remains strong and the company’s Air Canada deal solid. But operating income plunged 27.8 percent and distributable cash flow fell 26.8 percent as operating expenses rose 13.6 percent.

That’s of course to be expected in a market like this, which has claimed the health of most airlines globally. And the share price very much reflects these challenges with a very high yield and low price-to-book value. What upped the ante for me, however, is the company’s decision to remove life vests from its airplanes to save weight and fuel.

In its defense, Jazz has pointed out that its planes don’t fly over oceans and that they’re still equipped with seat cushions that can serve as flotation devices. Management also points out that Transport Canada regulations allow planes to exclude life vests, as long as they don’t fly over water more than 50 miles from shore.

Jazz planes, however, do fly over the Great Lakes, which are quite extensive. To be sure, US airlines these days are also cutting corners. But given the other challenges faced by this trust, it begs the question of where else it’s trying to save, and that speaks of a situation that’s growing increasingly dire for the distribution. Sell Jazz Airline Income Fund.  

Here’s the rest of the Dividend Watch List. Second quarter payout ratios are now shown in How They Rate for all listed trusts and corporations. Note that Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) is now off the list, thanks to very solid second quarter profits and an increasingly profitable relationship with giant resource company Xstrata, most recently in sulphuric acid sales. Now well off its lows, Noranda Income Fund is a buy up to USD9.

Acadian Timber (TSX: AND-U, OTC: ATBUF)
Big Rock Brewery Income Trust (TSX: BR-U, OTC: BRBMF)
Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF)
Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF)
Connors Brothers Income Fund (TSX: CBF-UN, OTC: CBICF)
Essential Energy Services (TSX: ESN-U, OTC: EEYUF)
Extendicare Trust (TSX: EXE-U, OTC: EXMUF)
Harvest Energy (TSX: HTE-U, NYSE: HTE)
Jazz Airline Income Fund (TSX: JAZ-U, OTC: JAARF)
Mullin Group Fund (TSX: MTL-U, OTC: MNTZF)
Newalta Income Fund (TSX: NAL-U, OTC: NALUF)
Newport Partners Income Fund (TSX: NPF-U, OTC: NWPIF)
Precision Drilling (TSX: PD-U, NYSE: PDS)
Sun Gro Horticulture (TSX: GRO-U, OTC: SGHRF)
Swiss Water Decaf Coffee Fund (TSX: SWS-U, OTC: SWSSF)
TimberWest Forest Corp (TSX: TWF-U, OTC: TWTUF)
Tree Island Wire (TSX: TIL-U, OTC: TWIRF)

Bay Street Beat

The per-barrel price of US West Texas Intermediate crude has declined 27 percent from its July record of USD147.27 a barrel to USD108 as of the close of trading Sept. 3.

It could be that the steep drop either hasn’t filtered into Bay Street analysts’ ratings, or that the folks on Canada’s Wall Street see it as short-term pullback in the context of a continuing commodities bull run.

Oil and gas trusts reported outstanding second quarter numbers basically across the board; distributable cash flow figures were up strongly, payout ratios declined and several announced distribution increases. To top it off, the well-run, strong-balance-sheet trusts will fund capital expenditures with cash.

CE Portfolio mainstays Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) and Enerplus Resources (TSX: ERF.UN, NYSE: ERF) were among the high scorers, Vermilion notching a perfect 5.000 average and Enerplus following up with a 4.692.

Bonavista Energy Trust (TSX: BNP.UN, OTC: BNPUF) scored a 4.818, and Baytex Energy Trust (TSX: BTE.UN, NYSE: BTE) and Crescent Point Energy Trust (TSX: CPG.UN, OTC: CPGCF) each registered a 4.692.

So what separates Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF), among the lowest-rated members of the S&P/Toronto Stock Exchange Composite Index at 2.667, and Harvest Energy Trust (TSX: HTE.UN, NYSE: HTE), a 2.692?

Like the high-scoring trusts, Peyto is in position to ensure sustainability with cash; during the second quarter the trust cut expenses and debt and upped proved reserve life. And Peyto has generated a double-digit return thus far in 2008.

Harvest has always been aggressive, and recent moves on the refining side of the business haven’t paid off as anticipated. Margins have deflated significantly since May 2007 as crude prices (feedstock for a refinery) have climbed and prices for gas and other products have retreated. The trust reported a payout ratio of 75 percent, and management anticipates that number will remain relatively high through 2008.

The unit price has bounced off the 52-week low it hit around the time it announced second quarter results, though it’s still yielding more than 17 percent. We made the case for Harvest–for aggressive investors–in the August Dividend Watch List, which is based in part on a conversation with the management team.

Other CE-covered companies scoring will with Bay Street include Cineplex Galaxy Income Fund (TSX: CGX.UN, OTC: CPXGF, 5.000), Precision Drilling (TSX: PD.UN, NYSE: PDS, 4.857), Canadian Hydro Developers (TSX: KHD, OTC: CHDVF, 4.833), Inter Pipeline (TSX: IPL.UN, OTC: none, 4.750), NAL Oil & Gas (TSX: NAE.UN, OTC: NOIGF, 4.750), First Quantum Minerals (TSX: FM, OTC: FQVLF, 4.647), CML Healthcare (TSX: CLC.UN, OTC: CMHIF, 4.600) and Superior Plus Income Fund (TSX: SPF.UN, OTC: SPIJF, 4.600).

This month’s Canadian Currents focuses on Canada’s Big Six banks; one of them, Bank of Montreal (TSX: BMO, NYSE: BMO), registered a 2.467 average in Bloomberg’s survey.

“Nothing in this section affects the powers of the Governor General, including the power to dissolve Parliament at the Governor General’s discretion.”

That’s the first sentence of the law Prime Minister Stephen Harper pushed as a necessary democratic reform in May 2005. “Fixed election dates stop leaders from trying to manipulate the calendar simply for partisan political advantage,” he said.

The bottom line, however, is that the governor general can dissolve parliament at will; as a matter of Canadian custom, it only happens upon the prime minister’s request. Harper won’t break the law when he asks Governor General Michaelle Jean for a dissolution and an election, only a principle.