No oil and gas producer trusts trimmed distributions in April. And with oil and gas prices rising this year, it’s likely we’ve seen the worst for all but the very weakest trusts.

As the experience of the past year has proven, oil and gas producer trusts’ cash flows lag energy prices, sometimes by several quarters. That’s because they sell so much of their output forward at locked-in prices. Only after a year of protracted oil and gas declines did trusts’ cash flows fall enough to take a bite out of distributions in late 2006.

Conversely, forward selling of output means it may be late 2007 before today’s rising energy prices fully impact trusts’ cash flows to the upside. The good news is the vast majority has now adjusted distributions to more-conservative policies. The new levels should hold as we wait for the higher prices to filter through.

Because energy prices are inherently volatile, I’m keeping the weaker oil and gas trusts on the Watch List below for now. Any producer trust with a first quarter payout ratio of more than 90 percent is vulnerable to a distribution cut, even if oil and gas continue to rise.

Note that all but a tiny minority in the sector have been upgraded to either holds or buys. They’re cheap and ripe for recovery, or a profitable buyout.

With first quarter drilling activity dropping 60 percent in some areas of Canada from 2006 levels, energy service trusts’ cash flows and distributions have also taken a beating. Last month, Wellco Energy Services Trust (WLL.UN, WLLUF) announced a payout cut of 22.2 percent, starting with the May 15 disbursement. The move was accompanied by the CD9.75 million purchase of Sanitherm Engineering, which will ramp up the trust’s expertise in permanent and portable water and wastewater treatment systems.

The deal looks positive from the standpoint of long-term cash generation. The lowered distribution still represents a yield of nearly 14 percent and should be protected by a payout ratio of 60 percent to 65 percent this year. Finally, after a decline of 38 percent over the past 12 months, the trust trades at just 95 percent of book value. Wellco Energy Services Trust is now a buy up to USD6.

In contrast, Fording Canadian Coal (FDG.UN, NYSE: FDG) probably isn’t finished with its recent string of distribution reductions. The trust’s first quarter profit fell 53 percent on a 26 percent dip in sales in part because of avalanches that interrupted rail shipments and the continued downtrend in the world price of metallurgical coal. Distributable cash per unit fell to just 53 cents a share, well below the actual 65 cents paid out and mandating the issuance of additional debt to make good on the difference.

These results—coupled with Dominion Bond Ratings Services’ (DBRS) placing its STA-4(middle) stability rating on watch for downgrade—indicate clearly why Fording isn’t an investment for income seekers. As the world’s biggest pure play on its highest-grade coal, however, Fording is still a good bet for speculators willing to stick around for a rebound in met coal up to USD25. Note that Westshore Terminals Income (WTE.UN, WTSHF) owns Fording’s primary shipping facility and is a buy up to USD11.

On the good news side, Superior Plus Income Fund (SPF.UN, SPIJF) comes off the Watch List this month. DBRS has confirmed the trust’s stability rating at a solid STA-3 (low) following reductions in debt and operating risk, as well as adoption of more-conservative financial policies. The ERCO Chemicals unit remains challenged by tough pulp-mill market conditions, which have cut demand for its sodium chlorate output.

And the Winroc division’s US sales are likely to stagnate. But with the distribution looking more secure than it’s been in a year, Superior Plus Income Fund ranks a solid hold.

Newport Partners Income Fund (NPF.UN, NWPIF) is a newcomer to the Watch List, as well as to Canadian Edge coverage. The risks are fairly obvious from the numbers. First, the equity owner of 18 diversified businesses turned in a first quarter payout ratio of 118 percent, not including negative cash flow of CD2.9 million from discontinued operations.

Operational underperformance at several holdings—including a recent acquisition—takes the blame, and with so many moving parts, management is severely challenged not to let it happen again. On the other hand, the units are cheap, trading at just 76 percent of book value and yielding 17 percent-plus. I’m starting Newport Partners Income Fund as a hold for speculators, pending how it does in the first half of this year.

Here’s the rest of the Watch List. I expect to remove several of these names over the next month as they announce rebounding first quarter earnings.

Advantage Energy Income Fund (AVN.UN, NYSE: AAV)
Avenir Diversified Income Trust (AVF.UN, AVNDF)
Canetic Resources (CNE.UN, NYSE: CNE)
Clean Power Income Fund (CLE.UN, CEANF)
Connors Brothers Income Fund (CBF.UN, CBICF)
Countryside Power (COU.UN, COUUF)
Daylight Resources Trust (DAY.UN, DAYYF)
Enterra Energy Trust (ENT.UN, NYSE: ENT)
Essential Energy Services Trust (ESN.UN, EEYUF)
Fairborne Energy (FEL.UN, FELNF)
Focus Energy Trust (FET.UN, FETUF)
Fording Canadian Coal (FDG.UN, NYSE: FDG)
Freehold Royalty Trust (FRU.UN, FRHLF)
Harvest Energy Trust (HTE.UN, NYSE: HTE)                          
NAL Oil & Gas Trust (NAE.UN, NOIGF)
Newport Partners Income Fund (NPF.UN, NWPIF)
Paramount Energy Trust (PMT.UN, PMGYF)
Peak Energy Services Trust (PES.UN, PKGFF)
Precision Drilling (PD.UN, NYSE: PDS)
PrimeWest Energy Trust (PWI.UN, NYSE: PWI)
Shiningbank Energy Income (SHN.UN, SBKEF)
Sound Energy Trust (SND.UN, SNDFF)
Sun Gro Horticulture Income Fund (GRO.UN, SGHRF)
Thunder Energy Trust (THY.UN, THYFF)
Tree Island Wire Income Fund (TIL.UN, TWIRF)
Trilogy Energy (TET.UN, TETFF)
True Energy Trust (TUI.UN, TUIJF)
Vault Energy (VNG.UN, VNGFF)
Westshore Terminals Income (WTE.UN, WTSHF)

Muddled In Massachusetts

Shortly after Canadian Finance Minister Jim Flaherty concluded a roadshow to promote the Conservative government’s 2007 federal budget, which included visits to New York and London, Rep. Richard Neal (D-Mass.) filed a bill in the House of Representatives, which was then referred to the Ways and Means Committee, that would revoke the existing special tax treatment on dividends from certain foreign entities, such as income trusts and real estate investment trusts (REITs).

Trust distributions are now generally taxed at a rate of 15 percent in the hands of American investors, a rate on par with taxes paid on dividends from US corporations and Canadian corporations listed in the US. Neal’s bill could jack up the tax rate on distributions to as high as 35 percent.

We’re at the start of a long process: Getting from filed bill to signed legislation will take months. And the process may or may not result in a new tax ruling.

Moreover, it won’t have much impact on prices, even if it does pass, because it won’t affect Canadian investors, IRAs or exchange-listed securities.

Non-Trust Tips

We first discussed these Canadian non-trust stocks last month. Here’s how they as part of a regular update on their prospects.

Rolling out a few new picks into a broad market rally is like the tree-sheltered, low-incline stages of a hike. It’s cool and easy now, but the trail is long and the terrain could be rough. Were investing such a leisurely activity, I’d be out of a job, but the fundamentals are similar: Bring the right tools, and know the lay of the land.

I’m not talking “bright-line connection” here, but the mid-April divergence of the S&P/TSX Index from the record-breaking US indexes is probably a function of the first-named index’s heavy energy focus; crude futures closed out the month of April with a loss of almost 3 percent. But the Loonie’s continued climb against the US dollar reflects the strength of Canada’s resource-intensive economy, and there’s nothing on the horizon to suggest the end of the long-term commodity bull run. 

Norbord (NBD.UN, NBDFF), which makes oriented strand board for construction, reported a USD16 million (USD0.11 per share) first quarter loss on weakness in the US housing market. Revenue fell 29 percent to USD261 million from USD368 million.

Declining housing starts have dragged strand board prices to their lowest levels since 2001, and Norbord’s share price already reflected the kind of numbers it eventually reported. Although Norbord faces similarly difficult US conditions into 2008, efforts in Europe are beginning to pay off. 

The story here is to ride Norbord off recent lows through a US housing rebound, collecting a decent dividend along the way, and getting back to the low single digits. Continue to buy Norbord up to CD8.50 or USD7.50.

The Bank of Nova Scotia (BNS.UN, NYSE: BNS) enjoyed a steady rise through April, interrupted only by the filing of a final prospectus for a new offering by a so-called split share corporation. The split share corporation, S Split Corp, proposes to hold a block of Scotia Bank common shares; investors in S Split Corp’s class A Shares will receive leveraged exposure to Scotia Bank’s performance, including increases or decreases in the value Scotia Bank common or decreases in the dividends paid. Investors in the S Split Corp’s preferred shares will receive monthly distributions on a fixed, cumulative and preferential basis.

Scotia Bank shares slipped the day of the prospectus-filing announcement, perhaps because of the possibility that some existing shareholders would accept S Split Corp’s offer and exchange their shares for the new, leverage-enhanced proposition.

This is just a blip but intriguing because of the at least circumstantial evidence of a connection. At any rate, Scotia Bank’s increasing exposure to emerging markets and still-solid domestic operations set it apart from other big Canadian banks. Continue to buy Bank of Nova Scotia at current prices.
 
Manitoba Telecom Services (MBT.UN, MOBAF) is up nearly 6 percent since the April CE hit the Web. MTS will report first quarter results May 8 at 4 pm ET; listen in via webcast at http://www.mtsallstream.com/. Manitoba Telecom is a buy at current prices.

Russel Metals (RUS.UN, RUSMF) has run up more than 13 percent since April 6, heading into its first quarter earnings release today, May 4. Russel is one of the largest metals processing and distribution companies in North America and also runs an international trading operation alongside its other services.

The company has benefited from a rebound in Canadian manufacturing activity. Russel also supplies energy services companies with pipe and tubing. Look for word on acquisition plans coming out of the first quarter earnings conference call.

Russel Metals remains a buy up to USD30.

Canadian Hydro Developers (KHD.UN) surged as much as 5 percent into mid-April but has settled back to breakeven.

That Al Gore’s critique of Prime Minister Stephen Harper’s carbon-emissions policy was well received north of the border is more about the long-held views of Canadians than it is about any documentary. Harper is watching his majority-rule dreams slip away and possibly any chance at the top of another minority government, as well as opposition to the Conservatives’ handling of the environment.

Canadian Hydro develops, builds and runs its renewable energy plants–and profitably so. It’ll also gain as carbon-trading schemes mature. Continue to buy Canadian Hydro Developers up to CD7.50.

Bay Street Beat

Aggressive Portfolio recommendation Vermilion Energy Trust (VET.UN, VETMF) took valedictory honors on Bay Street, scoring a perfect 5.0 average rating in Bloomberg’s regular survey of analysts.

Trinidad Energy Services Trust (TDG.UN, TDGNF) drew a 4.818 average as it continues to grind through the effects of the slowdown in energy sector activity. This one’s still relatively cheap, and in a rising-crude climate, it’s an even-more-attractive takeover target.

Yellow Pages Income Fund (YLO.UN, YLWPF), BFI Canada Income Fund (BFC.UN, BFICF), Calloway REIT (CWT.UN, CWYUF), Dundee REIT (D.UN, DUNTF), Energy Savings Income Fund (SIF.UN, ESIUF), H&R REIT (HR.UN, HRREF), Davis & Henderson Income Fund (DHF.UN, DHIFF), Crescent Point Energy Trust (CPG.UN, CPGCF), Progress Energy Trust (PGX.UN, PGXFF) and CCS Income Trust (CCR.UN, CCRUF) also made the honor roll.

TimberWest Forest Corp (TWF.UN, TWTUF) was at the low end, drawing an average rating of 2.0. TimberWest has run throughout the first half of 2007 to a point well beyond a reasonable buy target. It’s still operationally sound, and it could be on the radar screens of private equity groups. TimberWest Forest Corp is worth buying up to USD14.

Fellow Conservative Portfolio holding Algonquin Power Income Fund (APF.UN, AGQNF) also polled poorly, as did Aggressive Portfolio holding Provident Energy Trust (PVE.UN, NYSE: PVX).

Algonquin walked away with just a breakup fee for its trouble pursuing Clean Power Income Fund (CLE.UN, CEANF), but that could be a long-term victory. Clean reported a less-than-stellar fourth quarter, and any transition period had Algonquin won the bidding war with Macquarie Power & Infrastructure Income Fund (MPT.UN, MCQPF) would have been that much more difficult. Algonquin sidestepped those potential issues.

Provident Energy is set to remain a big dividend payer beyond 2011. The trust’s midstream assets provide a steady cash stream, and Provident operates the second-largest natural gas liquids (NGL) business in Canada. Cash flows from the NGL segment aren’t tied to oil and gas prices. Take a look back at April’s High Yield Of The Month for a detailed look at Provident.

Pengrowth Energy Trust (PGF.UN, NYSE: PGH), Fording Canadian Coal, Advantage Energy Income Fund (AVN.UN, NYSE: AAV), Westshore Terminals Income Fund, GMP Capital Trust (GMP.UN, GMCPF) and PrimeWest Energy Trust (PWI.UN, NYSE: PWI) rounded out the roster of CE-covered trusts getting the Bay Street beatdown.