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

Canadian Edge Conservative Holdings are now up 5.9 percent year to date. Aggressive Holdings, meanwhile, are down 9.1 percent, including losses on recently sold Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) and Yellow Media Inc (TSX: YLO, OTC: YLWPF).Those numbers are considerably better than what we were looking at a month ago. And they’re thanks to an October rally that was not only largely unexpected but one of the more impressive on record.

In the October issue I urged readers to hang onto Canadian dividend-paying stocks, so long as the underlying companies remained healthy by the numbers. There are still laggards, and we were forced to discard a longtime holding that didn’t measure up, namely Perpetual. Overall, however, holding on has paid off. And with nearly two months left in the fourth quarter, the CE Portfolio is back in position to turn a hat trick–that is, to make 2011 the third consecutive year of double-digit annual returns.

Whether that happens or not depends heavily on the factors that laid the market low this summer and fall.

If we avoid the doomsday so many still expect and the market mood lightens, the massive risk premium now priced into Canadian stocks–and the Canadian dollar–will vanish. Our Holdings could well take out the late-spring highs.

On the other hand, it’s still possible Europe will fail to resolve its sovereign debt woes without a banking crisis. Should that happen, we could see a dramatic tightening of borrowing conditions and weakened global growth, with even resilient Canada sliding into recession.

That, in turn, would cause more companies to stumble, with natural resource stocks the most likely candidates for dividend cuts and worse.

The mere threat of such an event is likely to keep things churned up the rest of the year. That, unfortunately, means we’re almost certainly going to see more bad days, as investor euphoria swings to fear.

Fortunately, the key to superior returns remains the same. Keep careful tabs on the health of the companies you own. As long as your companies are healthy, growing and paying dividends, their stocks will recover any losses they suffer in the near term.

This is the lesson from the very profitable aftermath of the 2008-09 crash/credit crunch/recession, which was arguably the worst market and economic event since the Great Depression of the 1930s. And it’s certain to be the case this time, no matter how turbulent the coming months are.

Both the Aggressive and Conservative holdings are currently ahead of the typical Canadian blue-chip stock, as represented by iShares MCI Canada Index Fund (NYSE: EWC). There is, however, a wide divergence in performance this year between resource-price-sensitive Aggressive stocks and recession-resistant Conservative Holdings.

Investors are still pricing stocks perceived to be risky at huge discounts to those considered safe. The silver lining is the discounted have a very low bar of expectations to hurdle, which is all it takes to catalyze a stock price recovery.

That, in essence, is why I continue to hold a range of stocks in the Canadian Edge Portfolio, rather than focus solely on the safest in this uncertain environment. And it’s why I consider the same stocks that took the worst beating this summer to now have the greatest upside–as strong company performance forces perception to shift in a more positive direction.

Thus far we’ve seen nice recovery moves for Colabor Group Inc (TSX: GCL, OTC: COLFF), Newalta Corp (TSX: NAL, OTC: NWLTF) and Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) following the release of better-than-expected third-quarter numbers.

I anticipate the same for battered stocks like IBI Group Inc (TSX: IBG, OTC: IBIBF) and Just Energy Group Inc (TSX: JE, OTC: JSTEF) as they announce in coming weeks. I’ll be tracking them in Flash Alerts, with a full recap of all CE Portfolio and How They Rate stocks in the December issue.

The other strongly bullish factor here in late 2011 is the return to dividend growth, particularly at the strongest CE Portfolio Holdings. AltaGas Ltd’s (TSX: ALA, OTC: ATGFF) 4.5 percent boost is its first since converting to a corporation last year and will be followed by much more going forward. Meanwhile, Keyera Corp’s (TSX: KEY, OTC: KEYUF) 6.3 percent boost is another in a long line equally certain to continue.

In a volatile market like this, stocks often move dramatically for reasons that have little or nothing to do with business health. Eventually, however, prices follow dividends. And that makes the return to dividend growth the most reliable catalyst for gains by CE Portfolio stocks going forward.

For many money managers, it is fourth and long here in late 2011. And only a successful “Hail Mary” will save an otherwise dismal year, as well as year-end bonuses and probably jobs. Individual investors’ clock, however, doesn’t stop on Dec. 31, 2011. Having a good calendar year is nice. But whether we’re underwater or well in the black on any set date isn’t what’s important.

That gives us the freedom to stick with good companies, even if market opinion temporarily turns against them. Coupled with diversification to guard against the occasional stumble, that’s the key to building wealth in our favorite Canadian stocks, even as we collect what are still the world’s most generous dividends.

Portfolio Action

There’s only one change to the Canadian Edge Portfolio lineup this month. Per the Oct. 20 Flash Alert, Sell Perpetual Energy, Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) is now out of the Aggressive Holdings. If you didn’t sell on my initial signal, I now advise you to do so.

Unlike Yellow Media Inc (TSX: YLO, OTC: YLWPF), which I unloaded back in August, Perpetual has always been up front about its prospects. Unfortunately, the drop in natural gas prices from early summer to early October has made it at least temporarily impossible for the company to pay a dividend while executing its plan to boost liquids production and service its debt. We’ll know a lot more when Perpetual releases its third-quarter earnings, which should take place around Nov. 8.

In the meantime, however, there are better bets on natural gas that do pay dividends–mainly companies increasing profits either by raising production or by transporting and processing gas.

Perpetual is the second Aggressive Holding I’ve parted with this year for a sizeable loss. That, unfortunately, is the price of a portfolio that covers the risk spectrum, combining companies that rate 5 or 6 on the CE Safety Rating System with others that rate considerably lower. We’ve seen the potential upside of this strategy in October, as riskier stocks that have defied their skeptics and held dividends have vastly outperformed companies deemed to be safer.

I fully expect this kind of action in the coming months, as harder hit stocks post strong results and stage solid recoveries. But the demise of Perpetual, and Yellow Media before it, once again underscores how critical it is to follow these simple tenets: Diversify broadly to prevent the demise of a single stock from smashing your overall portfolio. Never average down in a falling stock, and don’t chase stocks on yield alone. Rather, buy only stocks that match the risks you’re willing to take.

The CE Safety Rating System, a slight revision to which I detailed in the October Portfolio Update and which I review in this month’s, is a handy guide to the risks of stocks in the Canadian Edge How They Rate universe.

High Yield of the Month

High Yield of the Month features the two best buys for November. If you’re starting a portfolio, buying the HYOTM picks each month is one good strategy, provided they meet your own risk-reward preferences.

This month’s are both from the Aggressive Holdings: Newalta Corp (TSX: NAL, OTC: NWLTF) and Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE). Both companies’ stocks have historically tracked energy prices. Penn West is a producer of oil and gas with immense reserves across Canada. Newalta specializes in cleaning up oilfield and industrial sites and recycling the waste into saleable products.

Both companies posted solid third-quarter earnings and feature tremendous growth potential. But their stocks have been hammered by investor worries about the economy. Penn West’s market value is barely half conservative valuations of its oil-weighted reserves. Newalta, meanwhile, trades at barely book value, despite growing sales 28 percent in the third quarter.

Penn West is the more attractive for yield, with a payout of about 6 percent. Newalta pays about 2.6 percent, but grew its distribution 23 percent this year. Both stocks are headed a lot higher when current economic worries subside and oil prices return to the upside. But in the meantime, both have proven their ability to take a punch as companies and are virtually immune from near-term credit pressures as well.

My buy-under target for Newalta is USD15, about 20 percent above the current price. It’s USD25 for Penn West, a level nearly 40 percent above its current price.

Both are superb bets for patient investors in search of explosive long-term total returns.

Feature Article

In the first half of 2007 some three-dozen income trusts were acquired, some at premiums as much as 50 percent above pre-deal announcement trading ranges. That boom was fueled by the combination of motivated sellers–trust managements uncertain about their futures after Jan. 1, 2011–and motivated buyers, mainly an unprecedented surplus of private capital.

Market conditions in late 2011 are far less certain and more volatile. Nonetheless, merger activity appears to be accelerating, and premiums are enormous. Last month Aggressive Holding Daylight Energy Ltd (TSX: DAY, OTC: DAYYF) got an offer of CAD10.08 per share from government-backed Super Oil China Petroleum & Chemical Corp Ltd, better known as Sinopec (NYSE: SNP), more than twice its pre-announcement price.

And the Canadian unit of Cardinal Health Inc (NYSE: CAH) offered CAD8.15 per share for Futuremed Healthcare Products Corp (TSX: FMD, OTC: FMDHF), a price a third again higher than the pre-deal trading range for the slumping maker of consumable nursing products.

Not every cheap stock will wind up fetching a good offer. That’s why my first rule buying takeover targets is to never buy anything you wouldn’t want to own if there’s no deal. But there are certainly some good candidates in the How They Rate universe that are also good companies.

I highlight the ongoing deals and my top takeover bets, including: Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV), Algonquin Power & Utilities Corp (TSX: AQN, AQUNF), Artis REIT (TSX: AX, OTC: ARESF), Avalon Rare Metals Ltd (TSX: AVL, NYSE: AVL), Cenovus Energy Inc (TSX: CVE, NYSE: CVE), CI Financial Corp (TSX: CIX, OTC: CIFAF), Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF), Newalta Corp (TSX: NAL, OTC: NWLTF), PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) and Provident Energy Ltd (TSX: PVE, NYSE: PVX).

Canadian Currents

In this month’s Canadian Currents we offer a preview of our new venture, Australian Edge, via a look at the October AE In Focus feature.

CE Associate Editor and Australian Edge Co-Editor David Dittman analyzes opportunities in resource-related companies Down Under in the aftermath of a brutal later summer/early fall selloff.

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–Three Canadian Edge How They Rate companies cut dividends last month. One was longtime Aggressive Holding Perpetual Energy Inc (TSX: PMT, OTC: PMGYF). The natural gas-weighted producer no longer pays a dividend and will face growing debt pressure unless gas prices can rebound. There are safer ways to play gas. Sell.

Daylight Energy Ltd (TSX: DAY, OTC: DAYYF) is eliminating its dividend as it waits for shareholder and regulatory approval of its takeover by China Petroleum & Chemical Corp Ltd, or Sinopec (NYSE: SNP), for CAD10.08 per share in cash. Voting “yes” on the deal is a no-brainer.

Third-quarter earnings also support the case that this company can continue as a going concern without a deal, and there’s additional potential upside of about 7 percent for US investors who hold for a few more weeks–including likely appreciation in the Canada’s loonie. Hold.

The third dividend cutter is Superior Plus Corp (TSX: SPB, OTC: SUUIF), which is reducing its payout by half to CAD0.05 per share per month beginning with the Dec. 15 payment. The reduction had been baked into the share price for a while and comes along with management guidance for adjusted operating cash flow (AOCF) of CAD1.55 to CAD1.90 per share for 2012.

AOCF is the company’s primary metric for setting dividends. That level would support the dividend and is exactly what recently affirmed guidance is for 2011. The company will use the CAD70 million to CAD75 million in saved cash to “accelerate” debt repayment. Hold.

Here’s the rest of the Watch List.  Note a few more names have joined the List in the past month, owing to the tightening of my Safety Rating System criteria.

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF)–Advice: SELL. The payout still vastly exceeds investment income. Management is covering the difference with leverage but a cut looks inevitable.

AvenEx Energy Corp (TSX: AVF, OTC: AVNDF)–Advice: Buy @ 7. Stabilizing oil prices in October are a major plus. But until we see third-quarter numbers–expected Nov. 15–this small energy producer should be viewed with caution.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–Advice: Hold. As I feared, global pulp prices softened due to Chinese de-stocking and worry about economic growth. The payout ratio moved over 108 percent, though management remains outwardly supportive of the payout.

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Advice: Hold. A settlement agreement with Spectrum LP will provide needed cash and stabilize operations. Management reduced the amount outstanding on a CAD85 million credit line to CAD49 million. That must be whittled down further, however, before the roll over Jun. 23, 2012.

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–Advice: Buy @ 5. The worry here is the health of Air Canada (TSX: AC/A, OTC: AIDIF). Numbers and management’s comments on the third quarter are due Nov. 8.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Advice: SELL. A new rate deal in Canada is a big plus. But the US operations’ health can still drag everything down under the wrong conditions. Earnings released on or about Nov. 11 will be instructive.

EnerVest Energy & Oil Sands Total Return (TSX: EOS, OTC: EOSOF)–Advice: SELL. Closed-end funds that pay dividends without receiving any from their holdings are relying on leverage, always a shaky proposition even when markets aren’t this volatile.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: Buy @ 5. This is a stock to hold quarter by quarter, as there are many questions about its transition from print to Internet. Third-quarter earnings are due Nov. 10.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Advice: Hold. The October rebound in oil prices is a plus for the fourth quarter. But the payout ratio for the third quarter (announcement Nov. 10) is likely to be higher than the second quarter’s 74 percent. The question is, how much higher?

Interrent REIT (TSX: IIP-U, OTC: IIPZF)–Advice: Hold. Third-quarter earnings due on or about Nov. 11 should show enough improvement to take the apartment owner off the Watch List.

NAL Energy Corp (TSX: NAE, OTC: NOIGF)–Advice: Hold. Speculation in the market that this company is about to cut dividends has risen in recent months. Another low payout quarter would take it off the Watch List and make it a buy. Earnings are due Nov. 8.

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–Advice: Buy @ 10. The company has great reserves, and a solid third quarter (earnings due Nov. 9) would go a long way toward proving the dividend is secure. Until then, however, it’s a speculation.

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF)–Advice: Hold. The fund’s gold and silver mining stocks should help results in the second half of the year. But this is not an income investment.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF–Advice: SELL. The Canadian dollar isn’t going to weaken enough to improve this company’s competitive position. I still expect another dividend cut in the next 12 to 18 months.

Bay Street Beat–Transports are the focus of Bay Street Beat. Associate Editor David Dittman has some surprising findings on this generally bullish sector.

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

How They Rate

CE Safety Ratings are 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 are described in the text below the How They Rate table and are as follows:

• One point if Payout ratio meets “very safe” criteria for the sector.
• One point if Payout ratio has longer-term visibility.
• One point if Debt/Assets ratio meets “very safe” criteria for the sector.
• One point if the company’s debt maturing before Jan. 1, 2013, is less than 10 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 energy producers are included here.
• Electric Power–Power generators.
• Gas/Propane–Distributors from propane to packaged ice.
• Business Trusts–A range of businesses involved principally with consumers.
• REITs–All qualified real estate investment trusts.
• 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–Canada’s banks, investment houses and other trusts and corporations feeding that business.
• 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 new additions or subtractions to the How They Rate coverage universe this month.

Advice Changes

Here are advice changes. See How They Rate for changes to “buy-under” prices.

Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV)–To Buy @ 6 from Hold. The company has CD105 million in available credit lines to cover upcoming debt maturities in a worst case, and its market value is less than half the value of its reserves.

Avalon Rare Metals Ltd (TSX: AVL, NYSE: AVL)–To Buy @ 4 from Hold. Management may be near a deal to develop a lithium reserve and secure a major development partner as well. Note that rare earths companies, particularly explorers, are highly speculative investments and can be extremely volatile. This one is for risk-takers only.

Cenovus Energy Inc (TSX: CVE, NYSE: CVE)–To Buy @ 40 from Hold. Third-quarter cash flow was up 56 percent on 14 percent production growth in oil sands properties.

Futuremed Healthcare Products Corp (TSX: FMD, OTC: FMDHF)–To SELL from Hold. The Canadian unit of Cardinal Health Inc (NYSE: CAH) has offered CAD8.15 per share for the company. The deal needs approval from regulators and two-thirds of shareholders and is expected to close in the first quarter of 2012.

That’s extremely likely. But the stock is almost fully priced to the deal value, leaving little upside. US investors will also want to be out before the deal closes to avoid any transaction mix-ups.

Pace Oil & Gas Ltd (TSX: PCE, OTC: PACEF)–To Hold from Buy @ 10. Small size and a CAD166.2 million balance on a CAD275 million credit line that matures Jun. 15, 2012, are reasons for caution.

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–To SELL from Hold. The company has eliminated its dividend in the face of pressure from falling natural gas prices. Survival still seems nearly certain, but without a dividend there’s no good reason to keep holding the stock.

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–To Buy @ 10 from Hold. The company has great reserves and a path to rising production. It’s also cheap after a recent price plunge. High debt, however, makes it a buy for the very aggressive only.

Ratings Changes

Here are Safety Rating changes, reflecting third-quarter 2011 numbers, debt maturities remaining for 2011 and 2012, and recent weakness in energy prices. Look for more next month, when all CE companies have reported third-quarter numbers.

Bell Aliant Inc (TSX: BA, OTC: BLIAF)–To 3 from 4. The third-quarter payout ratio is 99 percent of free cash flow, due to a combination of 43 percent higher capital spending and an acceleration in losses of basic local lines.

Futuremed Healthcare Products Corp (TSX: FMD, OTC: FMDHF)–To 3 from 2. The Canadian unit of Cardinal Health Inc (NYSE: CAH) has offered CAD8.15 per share for the company. That limits near-term financial pressures.

Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–To 3 from 2. The third-quarter payout ratio plunged to just 30 percent on a 20 percent boost in fuel volumes coupled with a 7.3 percent drop in costs per liter.

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF)–To 0 from 1. The summer crash in natural gas prices coupled with next year’s debt maturities forced management to eliminate the distribution.

More Information

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