US investors’ actual returns are more than twice that, thanks to the explosion in the Canadian dollar. In recent months, the value of the loony has risen from around 85 US cents to more than 94 US cents. That’s automatically lifted the US dollar value of trusts’ share prices and distributions by more than 10 percent. Better still, the loony shows every sign of rising for several more years, giving Americans’ trust returns a further boost.

Canada is fundamentally a natural resource economy. Rising commodity prices lift the value of Canadian exports, spur economic growth and whet foreigners’ appetites to buy good businesses. All lift demand for the loony and, hence, its value in US dollars.

Not surprising, the last time the loony beat up on the greenback this badly was during the 1970s, the most-recent resource bull market. That time around, the loony moved to parity with the US dollar, faltering only when the resource bull faded. Today, the world is still a long way from real conservation, alternative energies, new conventional reserve finds or even a recession. As a result, the resource bull shows no sign of faltering and the loony rally should go well beyond parity before it does.

Sustained appreciation in the Canadian dollar will cause problems for some trusts, particularly those that compete for sales overseas. That applies to business trusts such as Clearwater Seafoods Income Fund (CLR.UN, CWFOF) and Menu Foods Income Fund (MEW.UN, MNUFF), which is dogged by lawsuits regarding the safety of its wet pet food products.

Canadian government currency intervention to protect such businesses may stall the loony’s rise temporarily. Ultimately, however, the rally will resume, boosting US investors’ returns in trusts.

Of course, the real difference-maker for trust returns is the health of underlying businesses. Highlighting those is the primary focus of Canadian Edge, rather than forecasting the Canadian dollar, Ottawa’s actions on trust taxation or potential takeovers.

Favorable developments remain possible on all three of these fronts. By sticking with strong businesses, we’ll reap the benefits and are in good shape even if nothing happens. In short, now’s the time to buy the recommendations in this issue, which remain among the very few income payers anywhere in the world selling at anything close to bargain levels.

Portfolio Action

Conservative Portfolio and Aggressive Portfolio holdings had another strong month. I’m adding High Yield Of The Month Advantage Energy Income Fund (AVN.UN, NYSE: AAV) to the Aggressive Portfolio. I’ve also raised some buy targets again to reflect strong first quarter results and the prospect of further prosperity ahead.

High Yields Of The Month

The June Conservative High Yield Of The Month is closed-end trust mutual fund EnerVest Diversified Income Fund (EIT.UN, EVDVF), which sells for a little less than 88 cents per dollar of assets and yields more than 12 percent. It’s a rare recommendation in an asset group with few standouts. The Aggressive Portfolio High Yield Of The Month is new addition Advantage Energy Income Fund, which is very cheap and poised to profit from higher natural gas prices. It also has tax pools that would fully shield its current income stream from prospective corporate income taxes for 18 quarters-plus.

How They Rate

I’m adding three selections to How They Rate coverage this month: Restaurant royalty stream PDM Royalties (PDM.UN, PDMRF), diversified midstream energy asset manager Inter Pipeline Income Fund (IPL.UN, IPLLF) and closed-end mutual fund Strategic Energy Income Fund (SEF.UN). The latter made an unsolicited offer for shares of some 65 different trusts last month, with the result that it was able to expand its asset base substantially at a very good price. Hopefully, everyone ignored their offer, per my advice in the May 21 Flash Alert.

Here are advice changes. See the How They Rate or the Portfolio tables for changes in buy targets. Price and yield information is updated every 15 minutes on both tables. Also note this issue includes first quarter earnings and payout ratio information.

• Advantage Energy Income Fund—From hold to buy up to USD14. For more, see High Yield Of The Month.
• Avenir Diversified Income Trust (AVF.UN, AVNDF)—From hold to buy up to USD8. More than 70 percent of its income is from outside energy production.
• Canetic Resources (CNE.UN, NYSE: CNE)—From sell to hold. First quarter earnings came in better than I expected, but aggressive acquisitions made last year at higher energy prices are still a risk.
• Crescent Point Energy Trust (CPG.UN, CPGCF)—From sell to hold. First quarter earnings were better than expected, particularly for production. But there could be more fallout from recent acquisitions.
• Clean Power Income Fund (CLE.UN, CEANF)—From tender to sell. Macquarie Power & Infrastructure (MPT.UN, MCQPF) isn’t offering US investors the option to take stock in this deal. Rather, Clean shares will be sold on the open market and proceeds will be distributed. That’s hardly worth hanging around for, as I explained in the May 30 Flash Alert.
• Custom Direct Income Fund (CDI.UN, CSIUF)—From tender to sell. The Edgestone Capital unit of GMP Capital is offering CD10.20 per share in cash for the trust. The share price is very close to the tender price, so there’s no point waiting around if you haven’t already tendered your shares.
• NAL Oil and Gas (NAE.UN, NOIGF)—From sell to hold. First quarter earnings were a remarkable improvement, but I still have concerns about a smallish trust trying to operate in this environment.
• Versacold Income Fund (ICE.UN, VCLDF)—From buy up to USD10 to hold. The cold storage trust looks good for acquirer Eimskep, but it would have looked better staying in the Canadian Edge Portfolios. A counterbid is unlikely but possible because of the low price of this trust, which was featured as a recommended potential takeover target in the May Feature Article.

Feature Article

Tax pools are the next great frontier of value in the Canadian trust universe. I look at what they are, what they’re good for and who has the most of them. In my view, tax pools—which are basically dollar-for-dollar exemptions from trusts’ potential corporate tax liability—aren’t yet reflected in share prices. That means upside for those that have them, including High Yield Of The Month Advantage Energy. I also examine the other great tax exemption for trusts: foreign-based income.

Canadian Currents

Last month, the Conservative Party government announced its version of a plan to combat global warming by controlling carbon emissions. One of the sectors most potentially impacted is oil sands production, which emits huge amounts of carbon both from the mining process and the electricity needed to run it. Fortunately for oil sands producers, the government’s new standards have a lot more bark than bite. Note that the complementary Maple Leaf Memo covers major issues like this on a weekly basis.

Tips On Trusts

This section taps our take on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide Subscriber Tips section.

Dividend Watch List—For the second month in a row, the oil and gas production sector avoided distribution cuts. I’ve moved a number off the Watch List in light of strong first quarter earnings, as well as my expectation that natural gas prices bottomed earlier this year. There was one distribution cut in the energy service sector, Aggressive Portfolio holding Precision Drilling (PD.UN, NYSE: PDS), which is poised for a major rebound as prices tick up and Canadian oil and gas activity bounces back. The only other dividend cut was former Portfolio holding Primary Energy (PRI.UN, PYGYF), which continues to have problems with several projects.

Prorogue Elephant—The opposition Liberal Party is now a staunch opponent to the conservatives’ plan to tax trusts as corporations beginning in 2011. Finance Minister Flaherty and Prime Minister Harper, however, have dug in and appear to have the votes to pass their budget, which contains taxation. The parties are now jockeying for positions in what looks like an inevitable election later this year, which may decide the trust tax issue once and for all.

The good news is we get a windfall if the Liberal position wins. But even if the Conservative position holds, it’s already well reflected in trust prices. More important, it’s increasingly irrelevant to trust returns—compared to the health of underlying businesses—and even to the impact of 2011 taxation, as our Feature Article explains.

Bay Street Beat—We cover how the Canadian analyst community views trusts and how to use that information.

Following Up—We continue coverage of high dividend-paying Canadian corporations. Several picks turned in strong first quarter results.

More Information

The following is a regular repeat from prior issues.

Use our live quote feed on the How They Rate Table for US dollar prices of trusts intra-day. For other information, go directly to a trust’s Web site by clicking on its name in the table. Clicking on the Toronto symbol (suffix “.UN”) will take you to the Web site of our Canadian partner Toronto-based MPL Communications (133 Richmond St. West, Toronto M5H 3M8) , which has price charts and access to press trust releases. For questions and comments, drop us a line at canadianedge@kci-com.com.

Check out the Toronto Stock Exchange Web site for a range of information on income and royalty trusts. The Web site is an online library of documents filed by trusts with the Canadian equivalent of our Securities and Exchange Commission. The Toronto Globe & Mail features the “Globe Investor” section with all the latest news on trusts. Dominion Bond Rating Service is the pre-eminent credit rater for trusts. The Bank of Canada Web site features a handy currency converter for Canadian dollars and US dollars into 50 other currencies around the world, and it’s a great source of free information on the Canadian economy.

Roger Conrad
Editor, Canadian Edge