Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) is up 23 percent year to date. Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF), meanwhile, has lost 23 percent. Noranda is also the owner of a lower payout ratio, with its roughly 8.7 percent yield covered with distributable cash flow by almost a 5-to-1 margin. Davis + Henderson’s 8.4 percent yield is comfortably protected by a 70 percent payout ratio.

Ironically, of December’s High Yields of the Month, Davis is by far the lower-risk bet. Meanwhile, Noranda is a high-potential play for aggressive investors only.

Despite its drop this year, Conservative Holding Davis + Henderson’s numbers have been a picture of growth and reliability. The diversified niche provider of services and products to the banking industry saw third-quarter revenue rise 13.4 percent, following a 10.8 percent year-over-year gain in the second quarter, an 8.8 percent boost in the first quarter and a 5.9 percent rise in the fourth quarter of 2010.

Cash flow was up 27.8 percent in the third quarter year over year, reflecting strong margin growth. That followed 9.9 percent growth in the second quarter, a slip of 0.5 percent in the first quarter and a 3.8 percent increase excluding one-time items in the fourth quarter of 2010.

That’s a clear pattern of accelerating growth for both revenue and cash flow, thanks to successful acquisitions and growth of existing operations. Davis + Henderson’s offerings now include check supplies (41 percent of revenue), student loan servicing (19 percent), secured loan services/registration (21 percent) and lending technology solutions to the mortgage market (13 percent), with the remainder from outsourcing activities performed for key customers.

The primary market is Canada, but the April 2011 acquisition of Mortgagebot extended operations to the US as well. Mortgagebot derives about 65 to 75 percent of revenue based on transaction fees from Canadian mortgage origination, a market that never saw the boom and bust of the US and is therefore very steady.

Like most companies converting from trusts to corporations this year, Davis trimmed its dividend in January, going from a monthly rate of CAD0.1533 to a quarterly payout of CAD0.30. That was a roughly 35 percent haircut. The company announced both the amount of the cut and the conversion on Mar. 2, 2010, 10 months before making its move. And since then the guidance on which it based post-conversion dividends has proven conservative.

That’s 3 to 5 percent annual revenue growth and commensurate cash flow and profit growth, for a target payout ratio of 72 to 75 percent based on distributable cash flow. As a result the company was able to boost its dividend by 3.3 percent beginning with the Sept. 30 payment and still maintain a payout ratio of just 70 percent based on third-quarter profits and the higher rate.

Looking ahead, newly installed CEO Gerrard Schmid stated during the company’s third-quarter conference call that the primary objective is “organic growth initiatives” such as boosting the “installed base of Mortgagebot customers and expanding enhancement services to credit card and checking accounts, all value added services for its customers. The company is also working to cut expenses and improve efficiencies. No corporate taxes are due until 2013.

Capital spending is ramping up to an annual rate of CAD35 million to CAD40 million in 2012 from CAD32 million to CAD35 million in 2011. That’s primarily to fund new growth initiatives at existing operations that will continue to feed the top line. Next year’s cash flow will also get CAD3 million to CAD4 million in projected benefits from intense integration activities completed this year.

All that should keep Davis’ top and bottom line beating management’s modest target of 3 to 5 percent growth. That in turn ensures solid annual dividend growth going forward, augmenting the 8 percent-plus yield and triggering a share price recovery as markets settle down. Davis + Henderson Income Corp is a solid, high-yielding value up to USD20.

Noranda, in contrast, is best thought of as a calculated risk with huge upside. The company’s primary asset is a royalty interest on the second-largest zinc processing facility in North America, which is also the largest on the eastern seaboard, located in Salaberry-de-Valleyfield in Quebec. The facility is currently owned and operated by Canadian Electrolytic Zinc Ltd. It’s supplied by mining giant Xstrata Plc (London: XTA, OTC: XSRAF) under an agreement slated to last until 2017.

In late 2010 Noranda unitholders successfully fended off a takeover effort by Xstrata Canada Corp for CAD3.90 per unit in cash. That revolt was aided by the efforts of an independent committee, which stuck to its guns that the Xstrata offer was too low, even in the face of pressure from a pending debt maturity.

Since then the company has been able to refinance at good rates and extend maturities to 2016 as well as sell CAD90 million in five-year notes at a rate of just 6.875 percent. As a result, it no longer faces credit pressures, though management has stuck to a program of paying off at least CAD15 million per quarter–with some CAD59.4 million in debt retired since the beginning of 2011.

Business has turned up decidedly as well this year. Cash flow from operations rose 11.8 percent as a 4 percent dip in processing volumes was more than offset by higher processing fees, zinc metal premiums and better sales of byproducts like sulfuric acid. The market for the latter remains particularly strong globally, with the price per ton rising from USD40 a year ago to USD78. Stable demand in the US Gulf of Mexico region is a particularly hopeful sign that 2012 will be as solid as 2011.

With the company facing no financial or operating pressures and quickly slashing debt, the focus is now on what will happen in 2016, when the zinc supply contract with Xstrata expires. During management’s third-quarter conference call an analyst essentially charged Canadian Electrolytic–which is owned by Xstrata–with what amounts to self-dealing, i.e. paying itself a dividend in prior years rather than paying down debt.

He went on to say that Noranda isn’t paying out a high enough percentage of available cash in distributions, a charge echoed by other analysts during the call. According to management, available cash flow was effectively CAD9.6 million even factoring in one-time costs, versus just CAD1.6 million paid out during the quarter.

The result is the establishment of an independent committee charged simply with determining “the availability of funds for future distributions.” The bet for Noranda buyers is that the amount determined will be appreciably higher than the current monthly rate of CAD0.04167, triggering further unit price gains as well as an improved income stream.

How likely is that? Noranda unitholders’ ability to fight off Xstrata’s takeover effort–which actually did have support from the board at one point–is as impressive as it is a good sign for higher prospective dividends. One of the company’s biggest equity holders, Clearwater Capital Management, immediately issued a press release following the announcement of the committee’s formation. Clearwater President Roland Keiper stated, “Clearwater fully supports use of an independent committee, receiving independent advice, to make determinations concerning unitholder distributions…and help address the conflicts of interest arising from the multiple roles and interests of Xstrata Canada.”

Mr. Keiper went on to assert he expects “the review will confirm the long-term viability of the Fund’s processing facility” and that “a bona fide independent effort to locate zinc concentrate supply will be successful in coming years as new mines are developed and existing mines expanded.” That, he believes, would obviate the need to build reserves to cover the costs of a potential shutdown, as management has stated might be necessary. His demand is in effect for a boost to a monthly rate of CAD0.08333, the level established at Noranda’s initial public offering in May 2002.

That’s effectively twice the rate currently paid to unitholders. And with Noranda yielding nearly 9 percent, it’s not hard to imagine the unit price doubling if that happens.

That’s certainly no guarantee it will. But trading at book value and with debt declining rapidly, increasingly profitable Noranda looks like a value even if the dividend rate stays the same. This is certainly not a Conservative Holding, but the possibilities make the units a worthy buy for aggressive investors up to USD6.

What can go wrong at Davis + Henderson and Noranda? In the former’s case, the primary worry seems to be that European banking woes will hurt the Canadian banks, which are the company’s primary customers.

A European banking crisis that spreads to these shores would also likely slow North American economic growth, which would in turn reduce activity in the Canadian financial services industry and therefore weaken Davis + Henderson’s revenue.

The company has built relationships with community banks, however, which are generally sheltered from industry ups and downs.

Davis + Henderson has very limited exposure to the credit markets, with no maturities until a CAD355 million credit line (CAD243 million drawn) comes due on Apr. 12, 2016. Debt repayments of CAD15 million in the third quarter were better than what Bay Street expected, and the company appears on track for CAD50 million in debt reduction in 2012, providing sizeable interest expense savings.

The company is hardly a one-trick pony, as many of its products and services have proven to be recession resistant. And its payout ratio provides a solid cushion. Many of its services are cost-savers, which are in greater demand in tougher times. And the company was actually able to increase dividends in mid-2008, even as credit was tightening.

A full-blown financial crisis, however, would no doubt slow demand for at least some of its services. That could have an impact on revenue and dividend growth, which the company resumed with the Sept. 30 payment, declared Aug. 9.

Noranda’s potential risks are somewhat greater. First, the independent review of the fund’s future ability to pay dividends might not go as well as hoped. The committee might find the fund’s ability to secure zinc concentrate for processing impaired after 2017, when its current supply contract expires. That, in turn, might mandate a larger reserve for the facility at Salaberry-de-Valleyfield, including potential severance payments, pension and retirement benefit plans and site rehabilitation costs in the event of a full shutdown.

This doesn’t appear likely, given the plant’s location near longstanding customers and ready rail access to domestic zinc concentrate supply, as well as water access to offshore suppliers. The provincial government is also supportive of the facility, and there’s both low-cost electricity and a stable labor force. And in any case it would likely ignite a full-scale rebellion from unitholders, much as the Xstrata offer did.

Moreover, Noranda appears set to easily meet its target of cutting debt by at least CAD90 million by December 2016. As of the end of the third quarter, there was just CAD45.67 million drawn on its CAD150 million credit line set to mature Jul. 28, 2016. There’s also CAD90 million in notes due Dec. 28, 2016, that are set to be paid off with a sinking fund starting Dec. 28, 2013. And the company has consistently paid down debt this year, trimming CAD59.4 million in bank debt this year thus far.

Until the independent committee completes its review, however, there’s no way of knowing just what it will decide. What is sure is that it will be charged to decide based on what it sees are the best interests of unitholders generally rather than simply Xstrata’s.

Another major risk to Noranda unitholders is a recession that reduces industrial demand for processed zinc and byproducts such as copper in cake and sulfuric acid. That could cause the plant to run at less than capacity, reducing revenue, and cut proceeds from sales of products as well. A major rise in input prices and a drop in output from the facility would present the worst-case scenario, i.e. rising costs and falling revenue, crimping margins and reducing ability to pay dividends.

In addition, Noranda is still organized as an income trust and is therefore governed by the terms of its “Trust Indenture.” These include a mandatory requirement to distribute to shareholders an amount equal to its taxable income for the year that hasn’t already been distributed. If not made in cash, the fund is required to make an “in kind” distribution of units, effectively transferring the tax to shareholders.

As of Sept. 30 Noranda had generated CAD33 million of taxable income, versus cash distributions of just CAD1.6 million. As a result management has declared an “in kind” distribution “likely.” Investors may be hit with a tax on cash they don’t receive, as they were last year. The board of trustees is currently considering the impact of converting to a corporation versus remaining a trust, though action is unlikely until next year.

Finally, Noranda’s negotiation over a new labor contract with the United Steel Workers of America has been referred to the Quebec Ministry of Labor. The plant continues to operate, but the company could face higher costs, depending on the ultimate ruling.

All that may be too much for many income-focused investors, despite the upside from building a position in Noranda now. If that’s the case for you, stick with much safer, less complicated Davis + Henderson.

For more information on these companies, go to How They Rate. Davis + Henderson is tracked under Financial Services. Noranda is covered under Natural Resources. Click on their US symbols to see all previous writeups in Canadian Edge and CE Weekly. Click on the Toronto Stock Exchange (TSX) symbol to go to their Google Finance pages for a wealth of information, ranging from news releases to price charts. Click on their names to go directly to company websites.

Davis + Henderson is the larger of the pair, with a market capitalization of CAD877 million. Noranda is smaller at CAD215 million. Both stocks trade with good volume on their home market, the TSX. Both also trade in the US over-the-counter (OTC) symbol market under the symbols DHIFF and NNDIF, respectively.

As is the case with all stocks in the Canadian Edge coverage universe, you get the same ownership whether you buy in the US or Canada. These stocks are priced in and pay dividend in Canadian dollars. Appreciation in the loonie will raise dividends as well as the value of your shares.

Dividends of both companies are 100 percent qualified for US income tax purposes. Davis + Henderson is a Canadian corporation, so dividends paid into a US IRA aren’t subject to 15 percent Canadian withholding tax. Noranda is still organized as an income trust but has paid taxes since January 2011 and should therefore also be exempt from IRA withholding.