Tight credit markets and weakening global growth sent energy prices and the Canadian dollar plummeting in the second half of 2008. That took a big bite out of Canadian trusts. And even those that continued to post strong growth in cash flows and distributions weren’t spared.

My bet for 2009 is we’ll see many of those negative factors reverse. Oil at USD50 a barrel is well below reserve replacement costs of at least USD80 to USD90 a barrel. New shale-based natural gas supplies counted on to meet future US demand won’t materialize at USD6 per million British thermal units, and very likely need at least USD8.

Global growth has noticeably slowed since summer. But governments the world over are pumping up the money supply and embarking on huge fiscal spending plans, having committed to doing whatever it takes to catch the economy’s fall.

Not everything they’re doing is going to work. But sooner or later something will.

Recovery

Energy prices are down this year solely on macroeconomic fears. We haven’t seen the kind of permanent demand destruction, movement to alternatives or new conventional supplies come on stream of the magnitude that ended the 1970s energy bull market. In fact, those forces have likely been set back months, if not years.

As a result, energy is set to be among the very first markets to respond. And the one-day surges of 10 to 15 percent in the prices of producer stocks we’ve seen periodically in recent months are pretty good indications of how explosive the recovery may become.

Since I began writing Canadian Edge, I’ve urged readers to consider dividing their investment between trusts and companies that produce energy and those that don’t. The latter I’ve set up in the Conservative Portfolio, the former in the Aggressive Portfolio.

Both groups have been hit hard since mid-summer. The Aggressive Portfolio energy trusts have taken the biggest hits, largely because falling energy prices have made distribution reductions more likely. But despite little exposure to energy prices, few credit risks and stable-to-rising distributions, Conservative holdings’ prices have also come off.

That’s mainly because the Canadian dollar has followed oil down, hitting the US dollar value of all Canadian securities and their distributions. But it’s also because of a general fear of investors for all equities, the same emotional forces that took down prices of even recession-resistant regulated US utilities in September and October.

As one subscriber rightly pointed out to me, a loss is a loss, even if it’s not related to a problem at the underlying business. My rejoinder, however, is there’s a big difference when it comes to recovery.

Market history has shown time and again that stocks and trusts backed by strong businesses recover when macro conditions inevitably improve. As long as the businesses keep weathering the underlying stress tests of the bear market, patient investors make their money back and then some.

As I pointed out in a late November Flash Alert, I’ve never seen a market where companies yielding 20 percent and more are actually raising distributions. But that’s what Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) did last month. Meanwhile, every one of our Conservative holdings and all but GMP Capital Trust (TSX: GMP-U, OTC: GMCPF) in the Aggressive holdings posted solid third quarter 2008 earnings, just as they did in the second and first.

All of the Conservative holdings also guided toward solid results for the fourth quarter and beyond. Aggressive holdings don’t have the luxury of doing that, as commodity prices set cash flows. But the general picture is still one of stability: management anticipating the worst case and ensuring trust sustainability in the face of it.

And contrary to the charges of some bears, debt control has been a priority for some time, and it’s showing up in a lack of credit problems even in this tight environment. (See November’s Feature Article.)

Below, I review results for the trusts that reported third quarter earnings after the November issue was published. All were also briefly highlighted in last month’s Flash Alerts and Maple Leaf Memos.

The bottom line on all of them is their underlying businesses are still strong. That’s more than two years into increasingly intensifying stress tests that have forced them to rely ever-more on their own resources under increasingly challenging conditions. Despite the losses in their share prices, they’ve truly proved themselves to be a hearty bunch.

The only real questions we need to ask now: Are they the best candidates to continue weathering the market storm and ride the expected recovery? Or is there something else we should be swapping into that’s a better bet?

In years past, I’ve used the December issue of CE as an opportunity to do a little housecleaning. I’ve continued to cover the sold trusts in How They Rate, and often they’ve reverted to buys in subsequent issues. But I’ve been able to add new names I’ve come to like more.

At present, there are 32 total holdings in the Canadian Edge Portfolio. This month, I’m adding three trusts, all to the Conservative Portfolio. Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) and CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF) are highlighted in the High Yield of the Month section. The other–Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF)–is discussed in the Feature Article.

All of these trusts have proven their ability to weather the weakening of the Canadian economy this year. That should continue to be the case going forward, thanks to a favorable combination of blue chip clients and products and services that remain in demand no matter what the economy is doing. Yielding an average of more than 10 percent (paid monthly), distributions are secure and likely to rise over the next few years. All three are the cheapest they’ve been in years.

My quandary is what should be sold to make room for them. It’s always tough to sell anything you’ve stuck with throughout a selloff like this one. But I’ve settled on what I consider to be the weakest links–the trusts that could suffer the worst if Canadian economic conditions fail to improve by mid-2009. They are: Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF), GMP Capital Trust and EnerVest Diversified Income Trust (TSX: EIT-U, OTC: EVDVF).

I’ve stuck with Boralex this year largely because management did anticipate the worst case for the supply situation at its wood waste plants. As a result, the dividend hasn’t been cut again. The wood waste power plants are apparently on track to produce energy this winter, despite abysmal conditions in the forestry industry and, therefore, the shortage of wood residue as fuel. And that should help the trust maintain its huge distribution at least for the fourth quarter.

Boralex, however, is simply not the trust its replacement Innergex is, with its growing portfolio of well-run hydro and wind plants. And with the latter now priced at barely book value and yielding more than 10 percent–with the potential for increases–the swap makes sense. I’ll continue to cover Boralex in How They Rate and it remains a decent speculation. But it’s now sold from the Portfolio. Sell Boralex Power Income Fund.

GMP Capital Trust has punished me all year for not following my rule of always selling non-energy producing trusts that cut distributions. Last month, the trust cut its payout again and worse than expected third quarter results are a warning that things just might get worse still.

I still believe GMP will make it. Third quarter results also showed that it’s holding market share as Canada’s premier transaction-based investment house. And management has announced a buyback for up to 10 percent of its shares, a sign that it has adequate cash flow. A revival of the Toronto market will quickly spur a recovery, and management has shown it will share the wealth with unitholders, demonstrated by the special distribution paid out earlier this year in happier times.

Again, this is one I intend to keep my eyes on and it remains a worthy speculation. But it’s now out of the Portfolio. Sell GMP Capital Trust.

Incidentally, Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF) continues to provide a cautionary tale to investors about what can happen when you stick around weaker fare too long. The trust has now been named a target in the US Dept of Justice investigation of the packaged ice industry.

Even if it’s ultimately proclaimed innocent, Arctic Glacier will almost certainly have to spend a lot more to defend itself, putting further pressure on the sizeable debt load. The share price has now broken a buck. Sell Arctic Glacier Income Fund if you haven’t already.

The third sell recommendation this month–closed-end fund EnerVest Diversified Income Trust–stems from the latter’s inability to resolve its problem with leverage. Admittedly, much of what’s happened to the fund hasn’t been its fault. Unlike most of the scores of closed-end funds holding Canadian trusts that sprouted up mid-decade, EnerVest’s management has historically kept a tight leash on its borrowing, which is employed by funds to boost yield. But with the Toronto market plunging, it’s nonetheless run up against limits, which are based on the ratio of debt to the net asset value of the portfolio. That’s forced the fund to liquidate assets.

This fall, management distributed warrants to unitholders to induce the sale of additional shares for cash, which in turn would be used to right the leverage imbalance. Unfortunately, this offer has now been pulled for lack of investor interest. Ironically, EnerVest shares rallied on the news, likely because of the dilution a successful share sale would have caused. But the result is the fund is still being challenged, and will be until the Toronto market can bounce back.

That’s exactly what I expect it to do in the coming months as the global economy stabilizes. Canada remains relatively healthy, as are EnerVest’s holdings. And at this point, EnerVest’s management has pledged to continue to monthly dividend of CAD0.07, just as it has the past three years. EnerVest shares currently sell at a discount of nearly 30 percent to net asset value. That’s mainly because of the leverage challenge, and it points to outstanding upside when the fund overcomes it. That will happen either when it’s sold enough assets or the Canadian market bounces back.

Until that happens, however, EnerVest is going to be an underperformer relative to closed-end funds that didn’t employ so much leverage. Sell EnerVest Diversified Income Trust.

Both of the other funds in the CE Portfolio fit that description, and both trade at discounts to NAV under 10 percent because of it.

Series S-1 Income Fund (TSX: SRC-U, OTC: SRIUF) actually comes very close to covering its full distribution solely with the distributions paid by its holdings. Buy Series S-1 Income Fund  up to USD10.

Select 50 S-1 Income Trust (TSX: SON-U, OTC: SFYIF) does manage the trick and then some. Note that the yield quoted from our live feed is inflated by the inclusion of a special annual dividend, but the regular yield is still comfortably in double-digits. Buy Select 50 S-1 Income Trust up to USD11.

Rounding Up the Results

Starting with the Conservative Portfolio results, Artis REIT (TSX: AX-U, OTC: ARESF) shares have been beaten down on the perception that Canada’s energy patch is ready to fall off a cliff. There’s been some retrenchment in the wake of falling energy prices. But Artis’s property markets remain strong.

The third quarter payout ratio sank to just 64.3 percent as the company saw a 10.5 percent jump in distributable income per share on a 35.1 percent increase in revenue. Occupancy surged to 97.3 percent.

Artis also has another ace in the hole: The contracted rents on its properties are 80 percent below current market rents and 30 percent below very conservative projections for the early part of next decade. That points to rent growth even if the market slows a lot. It’s also likely a big reason why insiders are buying. Buy Artis REIT up to USD10.

Atlantic Power Corp’s focus on long-term power sales contracts to US utilities continues to ensure revenue stability, since no regulated utility has ever defaulted on an independent power contract. Third quarter results confused some, as distributable cash flow didn’t cover the dividend in the period. All the plants ran well, however, as did the Path 15 Powerline. And the trust soon announced the closing of the previously announced acquisition of the Auburndale power plant in Florida.

The 155 megawatt natural gas-fired cogeneration unit is expected to add USD20 to USD23 million to cash flow in 2009 and USD8 to USD10 million a year from 2010 to 2013. Coupled with conservative financing and management’s timely hedging of currency and commodity price exposure, the move extended Atlantic’s cash flow visibility for the dividend to 2015. That spurred the company to boost its dividend by another 8 percent. Buy Atlantic Power Corp up to USD10.

Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) came in with another strong quarter, as revenue rose 8.8 percent and distributable income surged 11.4 percent on rising rents, successful acquisitions and stellar occupancy of 98.3 percent. The trust also cut operating expenses to 42.6 percent of revenue, down from 43.3 percent the prior year.

Canada’s residential real estate market has cooled off noticeably the past several months, but prices have remained steady in most markets. Moreover, tighter credit conditions are playing into the hands of apartment REITs, as they make renting more attractive. The trust’s distribution is solid and the shares are cheap at less than 1.7 times book value. Buy Canadian Apartment Properties REIT up to USD15.

Energy Savings Income Fund (TSX: SIF-U, OTC: ESIUF) affirmed its distribution and business stability in a press release dated Nov. 19, stating that the economic turmoil in the US and Canada wasn’t threatening its payout in any way. The trust also announced a plan to buy back up to 10 percent of its shares.

Third quarter results continued the strength of prior quarters, a very good thing for Energy Savings. The trust continues to add customers on both sides of the border, despite a higher attrition rate in the US. That’s likely one reason insiders are buying, and it’s why management expects the current dividend to be sustainable well past 2011.

The third quarter payout ratio exceeded 100 percent including all marketing costs. But the key metrics are healthy, and this one is pricing in some pretty bad news that hasn’t happened yet. Energy Savings Income Fund is a buy up to USD10.

Energy infrastructure business Keyera Facilities Income Fund (TSX: KEY-U, OTC: KEYUF) had another blockbuster quarter, boosting third quarter earnings 132 percent as it added new infrastructure. The trust’s assets weathered the huge drop in natural gas prices in 2006-07, largely because they’re in places where drilling activity remained robust. That’s still the case today, even as the trust adds more “tuck in” acquisitions to boost cash flow.

The payout ratio is down to 78 percent, making another increase likely in the coming months. Meanwhile, the shares are very cheap yielding more than 10 percent. Keyera Facilities Income Fund is a buy up to USD20.

Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF) continues to stick to its mission of providing high distributions from a recession-resistant portfolio of solid assets. Third quarter cash flows didn’t disappoint, as distributable cash flow per share rose 9.4 percent. The seasonally weak payout ratio came in at 133 percent, but management affirmed its expectation it will fall to 100 percent for the year, including capital spending.

The trust is segregated from the troubles of its parent Macquarie Group, which itself showed some real signs of turning around over the past month. CEO Gregory Smith stated, “The fund’s portfolio is continuing to deliver strong performance, which reflects the stability of our regulated and contractually-defined infrastructure assets throughout the economic cycle.” Macquarie is still a buy up to USD10.

Northern Property REIT (TSX: NPR-U, OTC: NPRUF) thrived the last time the Canadian property market hit a rough patch. And it looks set to do so again. Distributable income per share rose 12 percent in the third quarter, thanks to a 15 percent boost in revenue on property buys, rising rents and solid occupancy.

Northern operates in many areas where there’s no other alternative to its facilities, and its clients are basically very strong companies and governments. That formula points to strong growth for many years to come.

The payout ratio of 65.6 percent also points to dividend growth, while strongly bullish Bay Street and insider buying point to extreme value for this strong REIT. Buy Northern Property REIT up to USD20.

Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF) demonstrated once again why it’s in a fundamentally stronger position for this downturn than either its US rivals such as Idearc (OTC: IDAR) or its Internet partners such as Google (NSDQ: GOOG).

The trust posted an 8.8 percent boost in distributable cash flow per share for the third quarter. The results included both higher sales and operating margins, which rose to 60.5 percent of revenue. The key was continued robust growth in Internet revenue, which surged 38.4 percent even without counting acquisitions and other expansion. Yellow Pages Income Fund is a buy for those who don’t already own it up to USD10.

The big surprise in the Aggressive Portfolio is how few distribution cuts have been made thus far, despite a more than two-thirds haircut for energy prices. Note Provident Energy Trust (TSX: PVE-U, NYSE: PVX) is reviewed in the Dividend Watch List.

Last month, I reported Daylight Energy Trust’s (TSX: DAY-U, OTC: DAYYF) stellar numbers. Those were followed by very strong results for the other two leveraged natural gas plays in the CE Portfolio: Advantage Energy Trust (TSX: AVN-U, NYSE: AAV) and Paramount Energy Trust (TSX: PMT-U, OTC: PMGYF).

Advantage came in with a payout ratio of just 54.5 percent, as it reported strong 17 percent output growth and cashed in on higher energy prices. Interestingly, though, its realized natural gas prices for the quarter were still just CAD7.55, in roughly the same ballpark as current spot rates. That suggests little dropoff in gas revenue going forward (63 percent of output), though realized oil prices are likely to be lower than the CAD100 third quarter average. Advantage also shaved 4 percent from interest expense per barrel of oil equivalent (boe).

Paramount, meanwhile, hacked back its debt by 7.8 percent en route to posting a 44 percent payout ratio. Output fell slightly, but the trust’s realized price of CAD8.78 for its gas (100 percent of production).

Looking ahead, this trust is even more heavily hedged than Advantage, and management continues to say the current dividend rate is sustainable. Realized selling prices are likely to come down, barring a jump in gas prices. But massive insider buying is a pretty good sign management is confident in its plans of balancing new production with debt reduction and paying steady distributions, even in this tough environment.

Make no mistake: Both of these trusts are aggressively leveraged to natural gas prices. But both are also selling at their lowest valuations this decade and yield well over 20 percent. That’s a pretty good risk/reward, and it’s why I recommend both Advantage Energy Income Fund and Paramount Energy Trust up to USD10.

If we do get a real rally in gas in early 2009, they could easily best the 60 percent-plus gains they scored in the first half of 2008.

Ag Growth Income Fund (TSX: AFN-U, OTC: AGGRF) was the last of my Portfolio trusts to report third quarter earnings, and it was worth waiting on. Sales rose nearly 50 percent and earnings surged by more than 10 percent. The company enjoyed the benefits of strong demand–particularly in the US–and the improvements at the Westfield facility, which were a drag last year. The dividend payout ratio was just 55 percent, providing sound backing for the increase earlier this year.

Strong sales of portable grain handling and aeration equipment, which account for approximately two-thirds of the Fund’s total sales, have resulted in low inventory levels throughout the Fund’s distribution network. In addition, demand in the Fund’s segment of the agricultural space remains strong due to an increase in on-farm storage and successive large corn harvests. As a result, fourth quarter demand for portable grain handling and aeration equipment is expected to significantly exceed historical levels. Management anticipates that strong demand for portable grain handling and aeration equipment will continue into 2009.

Again, this is very positive guidance. Agricultural product prices have come down hard in the second half of this year, raising questions about equipment companies as well as producers. Note the trust’s ability to weather tough times is partly due to the ethanol industry’s reliance on its products. Buy Ag Growth Income Fund up to USD25 if you haven’t already.

Last month, I reported Enerplus Resources’ (TSX: ERF-U, NYSE: ERF) distribution cut to CAD0.38 from a prior monthly rate of CAD0.47. This month, the trust reported solid third quarter earnings and a payout ratio of just 59 percent on the prior rate, along with a reduction in debt to just 0.4 times cash flow. The payout ratio, including capital spending, came in at 102 percent, as the trust continued to develop its Kirby oil sands project and its Baaken light oil play, neither of which yet produce much in the way of current cash flow.

The need to continue development of these lands and hold down debt in a weakening price environment explains the dividend cut. The numbers and management’s conservative actions are also a measure of comfort for the current dividend level, as well as this trust’s ability to withstand mighty blows to its industry as it has for more than 20 years. Buy Enerplus Resources up to USD30 if you haven’t already.

In contrast to Enerplus, Penn West Energy Trust (TSX: PWT-U, NYSE: PWE) didn’t trim its dividend when it announced third quarter results. The trust’s payout ratio was also 59 percent, but the hard numbers disappointed some analysts, mainly because of the negative impact on production from unplanned well and pipeline activity. The “turnarounds” are the almost inevitable result of the trust’s recent major acquisitions and will moderate in coming quarters.

Like all energy trusts, Penn West’s biggest challenge going forward will be falling realized prices for the oil and gas it sells. The big hedges that conveyed so many mark-to-market losses in the second quarter reversed with a vengeance in the third. But lower prices will take their toll if they endure.

That said, the 20 percent-plus yield prices in that risk and then some. Penn West Energy Trust is a buy up to USD20 for those without a position.

Peyto Energy Trust’s (TSX: PEY-U, OTC: PEYUF) third quarter payout ratio was 64 percent, as higher realized selling prices and cost controls offset weaker overall output. The trust’s 84 percent reliance on natural gas sales should insulate it from the drop in oil prices to a great extent. So will its very low operating costs of just CAD2.54 per barrel of oil equivalent and its clean balance sheet.

Realized selling prices for gas in the fourth quarter will stay high due to hedging. That should protect the distribution, barring a plunge in gas to USD4 or less. But the point with Peyto is it’s set up for long-term sustainability. That’s why its insiders continue to buy. And that’s why I continue to recommend Peyto Energy Trust up to USD15 for those who don’t already own it.

Trinidad Drilling (TSX: TDG, OTC: TDGCF) is in the one industry that’s fared worse than energy producers in the share market. But the trust continues to execute on its strategy of developing advanced rigs and contracting them out long term to creditworthy producers.

Third quarter revenue rose 18.2 percent, and cash flow surged as utilization rates remained strong in both the US and Canada. Trinidad Drilling remains a great play for aggressive income investors looking for a play on drilling up to USD8.

Last but certainly not least, Vermilion Energy Trust (TSX: VET-U, OTC: VETMF) is still the industry blue chip, with virtually no debt, a solid, growing and diversified production profile, and a distribution that’s every bit as protected as a Super Oil’s. The third quarter payout ratio came in again at 30 percent, just 68 percent including all capital spending.

Exposure to markets in Australia and Europe as well as North America reduces exposure to price swings in a single market. And its 42 percent stake in developmental company Verenex Energy (TSX: VNX, OTC: VRNXF) provides both upside in production and a way to pay off all remaining debt.

Management is buying back shares, Bay Street is bullish (12 buys, two holds), and insiders have been buyers at much higher prices. If you didn’t get a chance to buy Vermilion the last time it was this cheap, don’t pass it up again. Vermilion Energy Trust is a solid buy even for conservative investors up to USD30.