Editor’s Note: In Brief is the executive summary of the August 2011 issue of Canadian Edge. Please use it as a guide to points of interest. — RC

Canada’s 30-year government bond yields touched 3.16 percent this week, the lowest level since the Bank of Canada (BoC) started keeping records in 1970.

To be sure, it’s a pretty unattractive return. But it does make two developments crystal clear for investors.

First, the Canadian dollar is no longer just a petrocurrency, doomed to bust and boom along with volatile oil prices. Rather, the loonie is increasingly being viewed globally as a safe haven, backed by one of the world’s strongest banking systems, a federal government with at least nearly balanced books and a generally healthy economy that’s by no means overleveraged.

It’s a bit early to declare full decoupling. But, for the most part, the Canadian dollar has held its own while the world’s economic anxiety has grown, remaining comfortably above parity with the US dollar. Meanwhile, oil prices, as measured by near-term NYMEX (New York Mercantile Exchange) Division light sweet crude contract, have skidded all the way down into the mid-80s.

That’s not something that has happened often, if ever. And the loonie’s resilience means Canadian stocks are much more likely to avoid the kind of double-whammy they suffered during the 2008-09 crash, when US investors’ stock market losses were magnified by currency losses.

Second, such low benchmark bond rates make a Canadian credit crunch less likely than ever. In fact, Canadian companies are likely to enjoy low borrowing costs for the rest of the year, even if the Bank of Canada does lift interest rates as many expect.

Low interest rates have emerged as a major catalyst for Canadian companies’ growth. That’s confirmed by the robust expansion of Canadian Edge Portfolio companies reporting second-quarter results. And several–including new Aggressive Holding Student Transportation Inc (TSX: STB, OTC: STUXF)–have been able to use the enhanced purchasing power of the loonie as well to expand abroad, particularly in the much larger US market.

Such strategies do carry risks, not the least of which is managing further appreciation by the loonie. The agreement that raised the federal debt limit almost certainly did head off a market panic. But the US still faces a yawning government deficit, coupled with a stubbornly high unemployment rate and no agreement among policymakers about how to deal with either–other than relentless finger-pointing.

The more a Canadian company invests here, the more vulnerable it is to this country’s problems. On the other hand, companies like Student Transportation are also getting high-quality assets cheap. And while die-hard pessimists and rabid financial television watchers may think otherwise, history shows the US will bounce back eventually–richly rewarding those who patiently place their bets.

Of course, at this point in time most investors are focusing on preservation rather than growth. That’s understandable with the US economy weak, the European sovereign debt crisis threatening to engulf Italy and Spain, and even emerging Asia not reporting particularly good news lately.

Moreover, when macro conditions worsen, some stocks blow up. That, unfortunately, has happened to longtime Portfolio Holding Yellow Media Inc (TSX: YLO, OTC: YLWPF), and there are plenty of candidates to follow it into the mire. Each that falls will cast aspersions on other companies deemed similar, igniting more selling and pushing prices lower, even for stocks of companies that are thriving as businesses.

That’s what always happens when stocks sell off, and we’re definitely in the middle of a slide, with the S&P 500 off some 170 points (12.4 percent) from the post-2008 crash high set back in May. Yellow’s collapse is a clear warning that we’re going to have to vigilant and willing to prune stocks whose underlying businesses are weakening.

On the other hand, there’s also a definite silver lining here. A large number of Canadian Edge recommendations have lost considerable ground over the past couple months, particularly the last couple weeks. And that’s despite reporting robust second-quarter earnings.

The most important lesson from the 2008 crash is this: So long as companies stay on track as businesses, they will recover even the most severe stock market losses, and then some. That means those who buy when others are bailing out are in effect locking in hefty capital gains as well as high income streams.

As I write this, I’m counting at least a Baker’s dozen CE Portfolio companies with yields of 8 percent or more. And by the time this selloff is over, we could see as many yielding upwards of 10 percent. That adds up to one of the best opportunities to buy Canada that we’ve seen in some time.

Invest carefully, but by all means do invest as bargains emerge. You may not get a better crack at many of these stocks.

Portfolio Action

I’m making two changes to the Canadian Edge Portfolios this month. First, I’m selling Yellow Media Inc (TSX: YLO, OTC: YLWPF) from the Aggressive Holdings and replacing it with Student Transportation Inc (TSX: STB, OTC: STUXF). Second, I’m raising Colabor Group Inc (TSX: GCL, OTC: COLFF) back from hold to buy, with an entry target of below USD10.

Starting with Colabor, I had downgraded the stock to a hold following what were troubling first-quarter results. At that time, management projected a sharp improvement in second-quarter numbers and affirmed the safety of the dividend. As it turned out, that’s exactly what we saw in second-quarter earnings. With second-half results likely to be even better thanks to increased revenue from mergers and cost cutting, the stock is a worthy buy again. Colabor Group is a buy under USD10.

In contrast, Yellow Media laid an egg with its second-quarter numbers, posting an alarming drop in revenue and cash flows and slashing its dividend for the third time in three years, by 77 percent. Much worse, however, was the fact that for the first time the numbers backed up the contentions of the company’s critics, rather than management. That removed the only premise under which I was still holding the stock.

Yellow’s move set off another drop in the stock that’s likely to be at least partly reversed in the coming days. And exiting now does mean locking in a large percentage loss. But again, this is only one stock–we didn’t double down on it as it dropped–and there’s no longer a reason to expect a real recovery, hence to hold it. Sell Yellow Media.

In Yellow’s place, I’m putting High Yield of the Month Student Transportation. This company is in prime position to profit from state and local governments’ need to cut costs in an era of high unemployment, weak housing prices and still-to-come federal budget cuts. That’s because these entities still operate two-thirds of school bus fleets in the US–and they can cut costs by either selling them outright to Student Transportation or hiring the company under contract to run them.

The company has targeted long-term annual revenue growth of 11 percent, a figure it’s routinely beat even while paying a yield of more than 9.4 percent. As an added bonus, it’s applied for a listing on the Nasdaq, a move that both affirms the safety of its dividend and will provide access to capital that will spark growth, just as it has for CE Portfolio Holding Atlantic Power Corp (TSX: ATP, NYSE: AT). When the listing is granted, the US over-the-counter (OTC) traded shares will automatically list on the Nasdaq, just as Atlantic’s did when it hit the New York Stock Exchange (NYSE). Buy Student Transportation up to USD7.

High Yield of the Month

High Yield of the Month features the two best buys for August. This month I’ve highlighted a new addition to the Aggressive Holdings and a current Conservative Holding that’s taken a spill. The first is Student Transportation Inc (TSX: STB, OTC: STUXF), highlighted above. The other is Extendicare REIT (TSX: EXE-U, OTC: EXETF).

An owner of nursing homes and provider of advanced care services in Canada and the US, Extendicare’s share price was hit hard this week by a decision by Medicare to reduce payments to nursing homes by 11.1 percent. The move whacked other sector stocks a lot harder and has left Extendicare’s yield pushing toward 11 percent, a level that generally means dividend risk. We should know more when the company announces its second-quarter earnings, scheduled for Aug. 9.

But because Medicare was previously contemplating an 11.3 percent cut, it’s highly unlikely this has come as a real surprise for the company, despite management’s professed shock and harsh words. Moreover, it comes as the company has completed a series of debt refinancings and repayments that will shave USD14 million from interest costs. As a result, though the stock is pricing in at least a modest dividend cut, it’s far from certain there will be one. That’s a good risk-return tradeoff even in this highly uncertain market. Extendicare REIT is a buy up to USD12 for those who don’t already own it.

Feature Article

With oil prices backing off under USD90 a barrel and natural gas prices slumping, stocks of dividend-paying Canadian energy producers have also slid in recent weeks. As these companies proved during the 2008-09 crash and again when they converted to corporations in 2010-11, they’re perfectly capable of weathering even the toughest environment. And we’re not likely to repeat either scenario anytime soon, either.

The result is an emerging opportunity to buy first-rate, dividend-paying Canadian producers. The industry’s cheapest stocks are the long-suffering natural gas producers. Although gas prices are likely to stay depressed–due to a glut of shale gas and the lack of infrastructure to export it out of North America–gas producers are rapidly ramping up profit by pumping out natural gas liquids (NGLs).

In fact, companies like ARC Resources Ltd (TSX: ARX, OTC: AETUF) are finding it profitable to dramatically boost their gas output, just do they can get to the NGLs. In this article, I explore Canada’s emerging NGL bounty and the producers that are shaping up to be major players–and therefore major bargains.

Canadian Currents

CE Associate Editor David Dittman takes a look at a country often compared to Canada because of its resource wealth, Australia, with an emphasis on the banking sector.

Tips on Trusts

This section features short bits on a wide range of topics. For more evergreen and tutorial items, see the Subscribers Guide.

Dividend Watch List—Yellow Media Inc (TSX: YLO, OTC: YLWPF) was the only CE How They Rate company to trim its dividend last month. As I wrote in the “Portfolio Action” section above, the 77 percent cut is the last straw for my long-held position in the stock, and I now rate it a sell despite the losses sustained. I explore Yellow’s numbers and my decision to exit in Dividend Watch List.

The bad news is that Yellow’s blow up isn’t likely to be the last of this downturn. Worsening conditions always bring out the worst in companies, and investors must be vigilant in pruning their portfolio when conditions require it. That said, here’s the current list, along with my current advice, when to expect the next round of earnings and what makes their payouts at risk.

Brompton Stable Income Fund (TSX: VIP-U, OTC: BVPIF)–Fund, no report. Advice: SELL. This closed-end mutual fund can maintain its dividend as long as management can keep paying from other sources besides dividends of its holdings. But sooner or later, it will have to adjust to reflect post-conversion dividend cuts.

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Aug. 12 (confirmed) Advice: Hold. The company doesn’t see “a material effect” form the cut in Medicare payments to nursing facilities, as none of its properties are apparently affected. That’s a big plus, but the dividend remains very thinly covered.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Aug. 11 (confirmed). Advice: SELL. The stock has stabilized after the management shakeup but with the US uncertain and dividend coverage light, the dividend is still definitely at risk.

FP Newspapers Inc (TSX: FPI, OTC: FPNUF)–Aug. 10 (confirmed). Advice: Hold. With the demise of Yellow Media (see above), all print-to-Internet businesses should be considered suspect. This one is still performing on its numbers, however. Until it doesn’t, it’s OK for risk takers.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Aug. 11 (estimate). Advice: Hold. Thin dividend coverage in the first quarter may improve in the second. But this company depends on others to drill its lands and is walking on eggshells in this environment.

InterRent REIT (TSX: IIP-U, OTC: IIPZF)–Aug. 12 (estimate). Advice: SELL. Based on recent results and what appears to be emerging Bay Street bullishness, this apartment REIT may indeed be making it back. The 5.7 percent yield, however, is less than several REITs of higher quality, begging the question, why own it?

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–Aug. 10 (estimate). Advice: Buy @ 5. This one is all about natural gas prices. If you’re not willing to make that bet, don’t come near it.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF)–Aug. 5 (confirmed). Advice: SELL. This company routinely doesn’t cover its payout and faces some severe competitive pressures.

Yellow Media Inc (TSX: YLO, OTC: YLWPF)–Aug. 4 (see above). Advice: SELL. Dividends have been cut back to the bone. But with management missing its targets in the numbers for the first time, no one should count on the new level to hold either.

Bay Street Beat–How the Canadian analyst community views trusts, including our favorite trusts.

Tips on DRIPs–Reinvest your dividends paid by NYSE-listed Canadian companies–in some cases at a discount and without paying commissions.

How They Rate

The CE Safety Rating System is based on six operating and financial criteria. Companies meeting all six criteria are rated my highest rating of “6.” “0” is the lowest rating, indicating companies that meet no safety criteria. Safety criteria, described in the text below the How They Rate table, are as follows:

• One point if the payout ratio meets “Very Safe” criteria for the sector.
• One point if the payout ratio is not “At Risk” based on the criteria for its sector.
• One point if debt-to-assets ratio meets “Very Safe” criteria for the sector.
• One point if the company’s debt maturing before Jan. 1, 2013, is less than 20 percent of its market capitalization.
• One point if the company’s primary business is recession resistant. Qualifying varies from company to company, though virtually all Electric Power and Energy Infrastructure companies qualify, while no Energy Services companies do.
• One point if the company has not cut its distribution over the preceding five years.

I list trusts and high-yielding corporations by the following sectors:

• Oil and Gas–All producer trusts are included here.
• Electric Power–Power generators.
• Gas/Propane–Distributors from propane to package ice.
• Business Trusts–A range of businesses involved principally with consumers.
• Real Estate Trusts–All qualified Canadian REITs and real-estate related corporations.
• Trust Mutual Funds–Closed-end funds holding portfolios of individual trusts.
• Natural Resources–Trusts and corporations that produce resources and raw materials other than oil and gas.
• Energy Services–Trusts and corporations whose main business is providing drilling, environmental or other services to energy producers.
• Energy Infrastructure–Trusts and corporations that own primarily pipelines, processing facilities, and other fee-generating assets.
• Information Technology–Trusts and corporations that provide communications, newspaper, directory, and other information services.
• Financial Services–Canadian banks, investment houses, and other trusts and corporations providing support to these businesses.
• Food and Hospitality–Trusts and corporations that franchise restaurants, own and operate hotels and manufacture, and distribute food and beverages.
• Health Care–Trusts and corporations involved in the medical care and/or supply business.
• Transports–These trusts and corporations ship freight and move passengers by bus, truck, rail or air.

Coverage Changes

There are no additions to How They Rate this month. Note that Peak Energy Services Ltd and TimberWest Forest Corp have now been dropped from coverage. Again, Peak has now been acquired for CAD0.95 in cash, while TimberWest was purchased for CAD6.16. All cash should now be in investors’ accounts.

Advice Changes

Here are advice changes. See How They Rate for changes to buy targets. Rating system criteria are shown at the bottom of the document.

BCE Inc (TSX: BCE, NYSE: BCE)–Buy @ 40 from Hold. Earnings per share and revenue both rose at a double-digit rate, even as the stock has become cheaper.

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–Buy @ 32 from Hold. Strong second-quarter numbers accompanied by heavy selling have put this high-quality NGLs play back on the bargain counter.

EnerVest Diversified Income Fund (TSX: EIT-U, OTC: ENDTF)–Buy @ 14 from Hold. The crazy action in this closed-end fund’s units has little or nothing to do with the value of its portfolio. It has taken the price down towards my buy target, however.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–SELL from Hold. Weakening natural gas prices and the recent drop in oil will further pressure the thinly covered dividend.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–Buy @ 12 from Hold. Second-quarter earnings were strong, with distribution coverage rising to more than 2-to-1, and the stock has backed off.

Yellow Media Inc (TSX: YLO, OTC: YLWPF)–SELL from Hold. Abysmal second-quarter numbers and a 77 percent dividend cut prove the company’s critics were right and management wrong about its prospects. I bet wrong, there’s no longer a reason to hold and I will take my lumps.

Ratings Changes

Here are CE Safety Rating changes.

AltaGas Ltd (TSX: ALA, OTC: ATGFF)–6 from 5. Second-quarter earnings were very solid and showed the value of owning a range of power and gas assets.

Fortis Inc (TSX: FTS, OTC: FRTSF)–3 from 4. The company’s payout ratio moved higher. On the plus side, management didn’t follow Gas Metro into a bidding war for Central Vermont Public Service Corp (NYSE: CV) but will bide its time.

Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–2 from 1. Second-quarter results are one more step on the road back to paying a distribution again. The company has also settled its refinancing needs at a reasonable cost.

The Keg Royalties Inc (TSX: KEG, OTC: KRIUF)–2 from 3. A second quarter of a payout ratio over 100 percent and flat sales don’t necessarily mean a dividend cut, but they deserve a lower Safety Rating.

TransAlta Corp (TSX: TA, OTC: TAC)–4 from 5. The company’s earnings were stronger in the second quarter than a year ago, but the payout ratio nonetheless climbed a bit.

Yellow Media Inc (TSX: YLO, OTC: YLWPF)–0 from 3. The magnitude of management’s miss from prior guidance shocked even the company’s worst critics. The company would normally get a point for payout ratio after the 77 percent cut. But until management reestablishes some credibility, I give that no credence.

For More

How They Rate has automatically updated US dollar unit/share prices, dividend payment rates in US dollars, yields, most recent dividend dates, dividend frequency and debt-to-capital ratios. Note that our quote service sometimes includes special annual distributions along with the regular monthly payments. How They Rate also includes several free links. Clicking on the Toronto Stock Exchange (TSX) symbol will now take you directly to the Google Finance page for every company in the How They Rate coverage universe.

Clicking on the US symbol of a company takes you to a chronological listing of every Canadian Edge and CE Weekly article in which that trust has been featured. You can also use that page to access articles on other trusts by typing in the relevant exchange and symbol in the “Search Query” box at the top of the page.

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 dividend paying equities. The Web site www.sedar.com 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. Dominion Bond Rating Service is the pre-eminent credit rater in Canada. The Bank of Canada has 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.

How They Rate can now be accessed several places on the Home Page. The Income Trust Tax Guide has backup to file distributions as “qualified dividends.”

Roger Conrad
Editor, Canadian Edge