The past month was one of the most turbulent in memory for the financial markets. Canada’s economy and financial system are still in sturdy shape. Canadian securities, however, haven’t been spared the ups and downs. In fact, they’ve been every bit as volatile as their US counterparts, and all the more so for US investors due to the jagged moves in the Canadian dollar.

The lows we saw in early to mid-October were a scary sight to behold. Just as was the case in other markets, sellers made little or no distinction between stronger and weaker underlying businesses in their haste to liquidate. At one point, several energy producer trusts in the Aggressive Portfolio were actually trading below their late 2001 prices, when oil sold for less than $20 a barrel, gas was at $2 per million British thermal units (MMBtu) and the Loonie was at multi-year lows versus the US dollar.

My comments at the time were emailed in the Oct. 8 Flash Alert, Value Points. My view was that sellers had basically thrown value out the window and that Canadian trusts and high dividend-paying corporations were historically cheap across the board, relative to business strength and their ability to create wealth. My advice was to hang in there despite the losses.

Since then, we’ve seen some recovery. But first-rate Canadian trusts and high dividend-paying corporations are still deeply undervalued. The best course is to stick with trusts that continue to perform well as businesses.

To be sure, the macro environment is very difficult. The credit markets have calmed considerably over the past few weeks, best illustrated by the steep decline in the London Interbank Offering Rate (LIBOR) to more normal levels. Aside from a few highly-leveraged businesses, mostly debt-averse Canada is having few problems getting credit where needed. In fact, many trusts have cut their debt noticeably this year, particularly in the volatile energy sector.

The problem is the economy. We’ve yet to see just how much the recent global liquidity crisis will ultimately impact global growth. For the past year and a half, Canada has learned to live with a slowing US economy, mainly thanks to growing exports of its resource bounty to developing Asia. A real slowdown to the East, however, would erase that cushion. That’s been anticipated to some degree by falling commodity prices over the past several months, which has already taken a bite out of some businesses’ cash flows.

Earnings are where the rubber meets the road in all of this. Since this bear market began in mid-2007, the Canadian trusts and high-yielding corporations in the Canadian Edge universe have posted quarterly earnings four times. Some have stumbled. But strong businesses have grown and comfortably pay their big distributions. That’s the main reason the CE Portfolio was in the black for the bear market up to early September.

Over the past two months, of course, we’ve swung fairly deep into the red. Not only have prices nosedived in Canada, but the Canadian dollar’s fall has multiplied the paper losses for US investors. And the selling has been indiscriminate, punishing over- and underperforming businesses alike.

Now we’re in the midst of another earnings reporting season. We now know that Canada–like the US–actually shrank in the third quarter. Pressure from a slowing US remains a factor. But the more troubling trend is reduced demand growth from emerging Asia. And despite the generally solid state of the Canadian financial system, credit pressures have heightened, even as falling share prices for trusts and high-yielding corporations have made issuing equity capital more expensive.

Third quarter earnings are our first real clue of how our picks are handling these increased stress tests. As of this writing, the bulk of the numbers have yet to be released. Here again is the list of approximate reporting dates for those not highlighted below. I’ll be reviewing them in periodic flash alerts next week until the last of them are announced mid-month.

Artis REIT (TSX: AX.UN, OTC: ARESF) Nov. 13
Atlantic Power Corp (TSX: ATP.UN, OTC: ATPWF) Nov. 12
Canadian Apartment REIT (TSX: CAR.UN, OTC: CDPYF) Nov. 11
Energy Savings Income Fund (TSX: SIF.UN, OTC: ESIUF) Nov. 7
Keyera Facilities Income Fund (TSX: KEY.UN, OTC: KEYUF) Nov. 6
Macquarie Power & Infrastructure Income Fund (TSX: MPT.UN, OTC: MCQPF) Nov. 12
Northern Property REIT (TSX: NPR.UN, OTC: NPRUF) Nov. 12
Yellow Pages Income Fund (TSX: YLO.UN, OTC: YLWPF) Nov. 6

Advantage Energy Income Fund (TSX: AVN.UN, NYSE: AAV) Nov. 13
Ag Growth Income Fund (TSX: AFN.UN, OTC: AGGRF) Nov. 17
Enerplus Resources (TSX: ERF.UN, NYSE: ERF) Nov. 7
GMP Capital Trust (TSX: GMP.UN, OTC: GMCPF) Nov. 6
Paramount Energy Trust (TSX: PMT.UN, OTC: PMGYF) Nov. 10
Penn West Energy Trust (TSX: PWT.UN, NYSE: PWE) Nov. 7
Peyto Energy Trust (TSX: PEY.UN, OTC: PEYUF) Nov. 6
Provident Energy Trust (TSX: PVE.UN, NYSE: PVX) Nov. 12
Trinidad Drilling (TSX: TDG, OTC: TDGCF) Nov. 6
Vermilion Energy Trust (TSX: VET.UN, OTC: VETMF) Nov. 5

So far, however, CE Portfolio picks are handling the new stress tests, just as they did the four prior reporting periods since the bear market began. And the market has been rewarding those numbers with higher share prices.

Our trusts’ share prices are still well below their levels of early September. But market history shows good businesses do ultimately recover from bear market damage. And there’s no better indication that CE picks will other than the fact that they continue to weather their business challenges.

The big news in the Conservative Portfolio this month was the surprise distribution cut at Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF). The trust’s business of running clean energy power plants and water systems in the US and Canada was rock steady well before the bear market began. And recent accretive acquisitions of similarly strong assets seem to belie the possibility of any credit worries.

Nonetheless, in an announcement after the close Oct. 21, the trust announced a “strategic” move to shepherd cash flow for “growth,” trimming the distribution by 72 percent. Management stated it would remain a trust until 2011 for the tax advantages. The action, however, is effectively an early conversion, aligning the dividend policy with that of a corporate structure in a way that doesn’t require shareholder approval. Not surprisingly, investors didn’t take too kindly to the move. The stock opened the next day at half its previous value, a level it’s since held.

My immediate reaction was the move potentially indicated weakness either because management had concealed some risk or that there had been unforeseen developments. At this point, it’s unclear if that’s the case. Bay Street opinion is as negative as ever, with three of the five analysts covering Algonquin now rating it a sell. Standard & Poor’s has taken it off credit watch but has kept the outlook “negative” for its BBB rating.

Barring truly adverse developments, Algonquin’s dramatically lower payout ratio should provide protection for the reduced distribution, which still appears attractive at more than 8 percent. Further, the trust sells for little more than 60 percent of book value and one times annual sales. In normal times, if Algonquin demonstrates it’s not suffering from credit and economic pressures (70 percent of income is from the US), its share price is likely to tack on some gains from this washed out level.

Unfortunately, these are not normal times. In fact, the experience of this bear market has been that when a trust first shows weakness, there’s more to come. As a result, in the Oct. 21 flash alert, I recommended taking the loss in Algonquin and moving to much stronger trust Great Lakes Hydro (TSX: GLH-U, OTC: GLHIF).

As point out in High Yield of the Month, Great Lakes is uniquely positioned to handle today’s pressures, thanks to a recession-proof customer base of large utilities and governments and very low debt leverage. Management has also stated its intention to hold the current distribution rate well past 2011.

If all the stars align, a recovering Algonquin may indeed produce better returns. Selling means eating a sizeable loss and, in fact, I may recommend the trust as a buy again if its business numbers do in fact perform. At this juncture, however, Algonquin can’t hold a candle to the predictability and stability of Great Lakes Hydro, which I continue to rate a buy up to USD20.

Happily, the rest of the Conservative Portfolio entries are showing little inclination or need to follow Algonquin’s lead. And third quarter earnings we’ve seen to date portend well for their ability to put their distributions where their intentions are, even after likely trust taxation starts in 2011.

Altagas Income Trust’s (TSX: ALA-U, OTC: ATGFF) third quarter earnings were music to the ears of every shareholder. Earnings per share rise 38.9 percent to a record of 75 cents Canadian a share. And CEO David Cornhill projected fourth quarter results “stronger than fourth quarter 2007,” and forecasted “strong” results in 2009.

The key to Altagas’ continued growth is its ability to grow its portfolio of energy infrastructure assets and hedge out risk to its power and natural gas liquids production. The acquisition of the Taylor assets has proven a major plus, as have smaller organic additions to the gathering assets and carbon neutral power plants. Distributable cash flow per share came in at 79 cents per share, for a payout ratio of 68.4 percent.

As for financing, Altagas’ credit rating outlook is now “positive” according to Standard & Poor’s, which noted the successful integration of the Taylor assets and management’s conservative approach to the balance sheet. The trust’s average borrowing rate actually fell in the third quarter to 4.9 percent, versus 5.3 percent a year earlier, despite taking on more leverage with the Taylor purchase. And it continues to fund projects and distributions with internal cash flows, limiting the need for future borrowings.

These results point to continued robust growth for Altagas, despite the economic turmoil. Coupled with a yield of nearly 11 percent that was increased in the second quarter, Altagas Income Trust is a buy all the way up to USD25.

As reported in the Oct. 31 flash alert, Pembina Pipeline Income Fund (TSX: PIF-U, OTC: PMBIF) came in with very strong third quarter results, keyed by a 47.6 percent boost in contracted oil sands shipping capacity due to the midsummer completion of the Horizon Pipeline.

Conventional pipeline earnings were flat, due mainly to needed repairs to a facility. But the midstream business leveraging these assets reported double-digit growth in operating income. That enabled the trust to again cover distributions and capital expenditures internally and boost cash reserves.

The trust also announced its post-2010 plans for the first time, saying it will convert to a corporation in 2011 while maintaining the current distribution rate. That’s the icing on the cake for this extremely steady business that remains the safest way to play the growth of the oil sands region. Yielding nearly 10 percent, Pembina Pipeline Income Fund remains a buy up to USD18.

Bell Aliant Regional Communications Fund’s (TSX: BA-U, OTC: BLIAF) third quarter looked a lot like every quarter since it was spun off from giant telecom BCE. Overall sales inched ahead 0.8 percent, as 13.6 percent growth in Internet revenue offset a 4.4 percent year-over-year decline in access lines, mostly lost to cable giant Rogers. The latter is a trend that’s set to continue. But the trust’s ability to boost overall sales despite that is further affirmation of how resistant earnings are to economic pressures.

Bell did face some problems in the commercial paper market earlier this year. However, it demonstrated its strength and flexibility by being able to arrange alternate financing. Finally, management also affirmed the current dividend level at least through 2012, which it covered with operating cash flow by nearly a 2-to-1 margin. That’s a picture of stability I want for Conservative Holdings. Well off its lows and still yielding more than 11 percent, Bell Aliant Regional Communications Fund remains a buy up to USD30.

Added to the Portfolio last month, Consumers Waterheater Income Fund (TSX: CWI-U, OTC: CSUWF) has already justified my faith in its business, posting a 7.9 percent boost in third quarter revenue. The core waterheater rental business remained very solid and was augmented by the acquisition of 5,935 units from Thunder Bay Hydro Energy.

This kind of accretive deal continues to be the core of Consumers’ strategy to boost cash flow and revenue going forward. In addition, the trust’s purchase of Stratacon’s submetering operation is already paying off, accounting for 37 percent of overall revenue growth in the quarter. That was a major factor in pushing up distributable cash flow by 4.4 percent, bringing the trust’s payout ratio down to 92.3 percent from 96.3 percent a year ago.

When I recommended Consumers last month, I noted that its only real operating risk involved rolling over revolving debt at a decent rate. Last month, management announced an extension to its CAD310 million bridge financing facility to January 2010, giving it considerable flexibility to wait out today’s tight credit conditions. That should ensure healthy growth in this very stable business. Yielding over 13 percent, Consumers Waterheater Incoem Fund is a buy up to USD12 for those who haven’t taken the plunge already.

RioCan REIT (TSX: REI-U, OTC: RIOCF) is the first of our REITs to report numbers, and they’re as solid as I expected. Portfolio occupancy was stable at 97 percent, and rents grew 10.9 percent over last year. The REIT also renewed 93.9 percent of expiring leases, reported progress on several promising projects and completed the acquisition of 12 properties in central and eastern Canada at good prices.

When I first recommended RioCan in mid-2004, Canada’s property market was coming out of a protracted slump. The REIT had turned to its advantage by virtue of conservative finances and relentless attention to detail. That’s a discipline management stuck to in the recent boom times, with the result that it’s now arguably better positioned than any REIT in North America to handle the current downturn. In fact, management is gearing up to take advantage of others’ weakness to further build for long-term growth.

Unlike other Canadian trusts, REITs face no prospective 2011 taxation, assuming compliance with guidelines that have been relaxed since the tax proposals were announced Halloween 2006. That’s another reason why RioCan REIT, with a yield of nearly 8 percent, rates a buy up to USD22.

The most surprisingly bullish results thus far from the Conservative Portfolio came from TransForce (TSX: TFI-U, TFIFF), which suffered investors’ wrath earlier this year by converting to a corporation. At the time, I recommended holding on, mainly because of management’s record of executing accretive acquisitions and its promise to use saved cash from the dividend cut to rev up activity.

The share price since has been all over the map. But third quarter results are the latest evidence the company hasn’t let me down. TransForce’s revenue grew 23 percent, operating cash flow rose 27 percent and pre-items earnings per share surged 31 percent, as the company was able to make accretive acquisitions that boosted scale and profitability. That was in an environment the CEO says has presented “challenges not seen in almost 80 years.”

Admittedly, owning TransForce right now is an exercise in patience. The gains we saw following the conversion last spring have evaporated and then some, and dividend growth is obviously not the priority. On the other hand, we now have a trust yielding well more than 8 percent that’s staying highly profitable even as it builds a business for future growth in the worst possible environment. That’s why I continue to rate TransForce as a buy up to USD8.

Aggressive Portfolio: Surviving Energy’s Fall

The drop in oil and natural gas prices since midsummer has far exceeded the downside targets I set in the June Portfolio article, The Case Against Oil and Gas. For the record, prices were $90 a barrel for oil and $8 per MMBtu for natural gas.

The bigger surprise thus far, however, is how little the nearly 60 percent drop in prices of both fuels has affected underlying businesses of Aggressive Portfolio picks, most of which are leveraged to energy prices.

As noted in the Oct. 31 flash alert, ARC Energy Trust (TSX: AET-U, OTC: AETUF) has rolled back its remaining “top-up” distribution increase, initiated earlier this year to pass on the benefit of surging natural gas prices. Enerplus Resources (TSX: ERF-U, NYSE: ERF) announced a slightly deeper cut, erasing a prior 11 percent increase and a bit more.

Both trusts, however, largely affirmed development plans for the coming year, as well as their ongoing ability to finance them. ARC’s news was further cushioned by strong third quarter earnings and the announcement that it was actually ramping up the output from its Montney gas properties in British Columbia. (See High Yield of the Month).

Since then, we’ve heard from what I still consider to be a more aggressive producer, Daylight Resources Trust (TSX: DAY-U, OTC: DAYFF), which is relatively small and very reliant on natural gas production. Logically, that’s a position that should mandate a somewhat larger dividend cut than either ARC or Enerplus. However, there was no mention of any such intention from management in third quarter results.

Rather, the trust announced a near doubling of funds from operations, fueled by an 11 percent increase in output over year earlier results. Production was also 5 percent above second quarter 2008 tallies, as Daylight continued to develop its vast portfolio of reserves and land. Moreover, the payout ratio came in at just 43 percent.

Management affirmed its ability to fund both capital expenditures and the payout with internal cash flow for at least the rest of the year. And the trust managed to slash its bank debt by 27.3 percent from second quarter levels. Further, operating costs per barrel of oil equivalent were flat with year earlier levels, and the trust announced an increase in its capital budget for the coming year.

Those strong operating results are, of course, wildly at odds with the beating Daylight shares have taken the past couple of months, driving its yield up to nearly 20 percent and its price-to-book value ratio down to just 1.35. And although the third quarter realized selling prices of CAD108 for oil–37 percent of output–is nearly certain to drop in the fourth quarter, the realized selling price of CAD8.52 is well in line with current hedges.

Energy prices are the ballgame for energy trusts of all stripes. Should the economy weaken enough, trusts’ realized selling prices for oil and gas will no doubt fall further, and distributable cash flow will come down with it. But again, these trusts are conservatively run and have been well stress tested for more than two years, both in the capital markets and with energy price volatility. And with share prices now where they were when oil was less than $30 and gas under $5, they’re discounting an awful lot of bad news that simply hasn’t happened yet.

I’m still recommending ARC as a buy up to USD30, Daylight up to USD11 and Enerplus to USD40. I’ll update my recommendations in other producer trusts as earnings appear, which I’ll recap in flash alerts next week.

Three other Aggressive Portfolio trusts are worthy of comment now. GMP Capital Trust (TSX: GMP-U, OTC: GMPCF) has trimmed its distribution again, this time to 5 cents Canadian a month. The move was well priced in already for this trust, which is the true feast-or-famine play on the Toronto market. We’ve yet to see its third quarter earnings. But as long as there are no challenges to solvency—and I don’t expect any—I’ll be sticking with this one. GMP Capital Trust remains a buy up to USD8 as a speculation. I’ve cut the buy target to reflect the dividend reduction.

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF) announced very solid third quarter earnings, despite the planned outage of its wood waste power plants to conserve wood residue fuel. Revenue surged 18.7 percent and operating cash flow ticked up 3.1 percent, as strong results at the hydro and natural gas cogeneration plants offset zero September cash flow from the wood waste facilities.

Importantly, management announced it still expects to restart the woodwaste plants by the end of November and run them through the peak winter months. And it stated, Boralex was able to secure hedges for future US dollar cash flow at very favorable rates during the recent Canadian dollar volatility. The wood waste situation remains a worry. But selling for just 65 percent of book value and yielding more than 18 percent, it sure looks priced in, and these results are encouraging. Boralex Power Income Fund is still a buy for the more aggressive up to USD5.

Finally, Newalta Income Fund (TSX: NAL-U, OTC: NALUF) came in with a 29 percent increase in operating cash flow, paced by strong growth in both its eastern and western divisions. The latter’s 21.7 percent surge mainly reflects the trust’s burgeoning business in the oil sands, where its demonstrated talents recycling waste present enormous possibilities.

Throughout its challenges of the past few years, Newalta has steadfastly maintained its high dividend. These results are further vindication of management’s decision, as the payout ratio sank to just 77 percent of distributable cash flow despite a 167 percent increase in capital expenditures for growth.

As of Jan. 1, 2009, the trust has elected to take a different turn, converting to a corporation. The chief negative is it will entail a 64 percent cut in the distribution from the current rate of 18.5 cents Canadian a month to 20 cents a quarter. Management’s rationale—which it will put up to a vote on or about Dec. 17—is it can use the additional cash more effectively by expanding its business more rapidly, while limiting its need to access the capital market.

I’m no fan of distribution cuts, and I infinitely prefer conversions that don’t involve them. But given the company’s long-held strategy and its success executing it, this move makes a lot of sense. And it’s very likely the best way to lift Newalta above its currently depressed level of 73 percent of book value. As long as the business results are strong, I’m going to stick with Newalta Income Fund—which would still yield nearly 9 percent at current prices—and continue to rate it a buy for aggressive investors who don’t already own it up to a reduced target of USD13.