Editor’s Note: In Brief is the executive summary of the January 2012 issue of Canadian Edge. Please use it as a guide to reading the issue. — RC

A poll this month from Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) reveals that 72 percent of Canadians are confident they’ll eventually reach their financial goals. That’s a stark contrast to similar polls south of the border, where prevailing sentiment seems to be that 2011 was a horrible year and 2012 is shaping up even worse.

I’ll wager not many are aware the S&P 500 was actually up 2 percent last year, versus a loss of 10.7 percent for Canada’s equivalent, the S&P/TSX Composite Index. Or that Canadian Edge Portfolio stocks beat both indexes with a 4.4 percent average return.

But perception, not reality, is still ruling the markets in early 2012, as it did in 2011. And the result is certain to be continued volatility and wide differences in pricing of dividend-paying stocks, as investors scramble to avoid perceived risks.

In a Dec. 28, 2011, Flash Alert I noted that CE Portfolio Conservative Holdings–chosen for their ability to pay dividends regardless of economic ups and downs–appeared to be headed for a 2011 total return of around 13 percent. The Aggressive Holdings–picked for their ability to capitalize on Canada’s growing global economic stature–were on course for a decline of about 8 percent. The final numbers were 13.1 percent and minus 7.6 percent, respectively.

I’m gratified both sides of the Portfolio beat the S&P/TSX. That was despite taking big losses in Capstone Infrastructure Corp (TSX: CSE, MCQPF), Perpetual Energy Inc (TSX: PMT, OTC: PMGYF) and Yellow Media Inc (TSX: YLO, OTC: YLWPF), stocks I didn’t sell before their underlying businesses fell apart.

The bigger story, however, was the divergence in 2011 returns between Portfolio companies whose businesses stayed healthy.

That difference in performance had little to do with actual business numbers but rather with perceived risks that to date haven’t materialized.

When a company’s stock is punished on the basis of perceived risk, one of two things can happen. Perception can become reality, in which case its dividend is cut and the shares fall further.

Or, it becomes clear at some point that investors have overestimated and therefore overpriced the risks. The share price recovers, and the scarier the fall the more robust the recovery.

Several CE Portfolio stocks staged notable recoveries in the waning days of 2011, erasing prior losses and in some cases rolling up big gains for the year. Parkland Fuel Corp (TSX: PKI, OTC: PKIUF) rose more than 60 percent off its early October low to finish the year nearly 20 percent in the black. Provident Energy Ltd (TSX: PVE, NYSE: PVX) came back nearly 50 percent from its early August nadir to finish nearly 30 percent ahead for 2011.

Colabor Group Inc (TSX: GCL, OTC: COLFF) came back from more than 40 percent down to close near breakeven. Bird Construction Inc (TSX: BDT, OTC: BIRDF) was off more than 30 percent in late autumn before rallying almost back to the black. IBI Group Inc (TSX: IBG, OTC: IBIBF) did finish in positive territory after a 30 percent decline at one point. So did Extendicare REIT (TSX: EXE-U, OTC: EXETF).

These stocks still lagged well behind the likes of AltaGas Ltd (TSX: ALA, OTC: ATGFF), which benefitted from the perception of pipeline stocks’ invincibility. But their fourth-quarter comebacks proved once again that as long as a company’s business stays strong, its stock will eventually recover a bear market pummeling, no matter how panicked investors get in the near term.

That, in my view, will prove the single most important piece of market wisdom for income investors to follow in 2012. To be sure, there are some very real dangers to dividends now, including exposure to Europe’s economic weakness and the second-half 2011 crash in natural gas prices.

The advice changes and Portfolio moves I’ve made this month are again focused on improving the overall quality of our holdings and ensuring risks are understood. And I can’t emphasize enough how important it is to diversify and to not “average down” in falling stocks.

The ideal holding in early 2012 is a stock where investor perception is negative but business reality is positive. Some may falter. But as we saw even in dangerous, uncertain and volatile 2011, most will recover, handing buyers hefty capital gains as well as some of the richest dividends on the planet.

Portfolio Action

There are three changes to the Canadian Edge Portfolio for January. First, I’m selling Mutual Fund Alternative Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF), a high-yielding but nonetheless disappointing bet on mining stocks. In its place I’m adding First Asset Pipes & Power Income Fund (TSX: EWP-U, OTC: FAPPF).

Both are closed-end funds. While Precious Metals trades at a 15.5 percent premium to the value of its assets, First Asset Pipes sells for a 2.4 percent discount. Moreover, First Asset’s collection of low-risk power generation and pipeline stocks is a better fit with the generally conservative focus of the Canadian Edge Portfolio.

The current yield is considerably lower than what’s paid by Precious Metals & Mining Trust. But First Asset has a history of raising dividends, and another increase looks likely with the Mar. 15, 2012, payment. And its payout is almost fully backed by investment income from the fund’s holdings, whereas Precious Metals has almost no investment income. Buy First Asset Pipes & Power up to USD8.

Second, I’m adding High Yield of the Month Shaw Communications Inc (TSX: SJR/B, NYSE: SJR) to the Conservative Holdings. The provider of broadband cable television and Internet and satellite television services has boosted its dividend 11 times since mid-2005. Unlike rivals it’s stuck to its core competency of running a broadband network.

As a result earnings and dividend growth are reliable, as is the current yield of around 4.5 percent. Fiscal 2012 first-quarter results will be announced Jan. 12, with another payout boost likely then as well. Buy Shaw Communications up to USD22.

Third, I’m moving Extendicare REIT (TSX: EXE-U, OTC: EXETF) from the Conservative Holdings to the Aggressive Holdings. The owner and operator of long-term care facilities strengthened its balance sheet and reduced operating risk last month, selling its US group purchasing organization for USD56 million, or an after-tax gain of USD32 million.

The stock, meanwhile, has surged more than 20 percent since, reflecting reduced dividend risk. The company faces the risk of further Medicare cost cuts. Until this situation is clarified, the stock belongs in the Aggressive Holdings. Extendicare remains a buy up to USD10 for readers who don’t already own it.

High Yield of the Month

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

This month’s choices are both Conservative Holdings, new addition Shaw Communications Inc (TSX: SJR/B, NYSE: SJR) and longtime denizen Just Energy Group Inc (TSX: JE, OTC: JSTEF).

Shaw’s focus on its core business has supported 11 dividend increases over the past half-decade, and management will probably announce a twelfth on Jan. 12, when it reveals fiscal 2012 first-quarter (ended Nov. 30, 2011) results. The current yield of around 4.5 percent is as reliable as they come. Buy Shaw Communications up to USD22.

Just Energy stock has rebounded roughly 20 percent from December’s low but still yields well north of 10 percent. Last month management affirmed its intention to continue paying at that rate, with Executive Chair Rebecca MacDonald stating “not only are our current dividends sound but we do not see any circumstance which would constrain our ability to continue to pay them in the future.”

The company also announced a plan to buy back up to 10 percent of its shares outstanding. Coupled with continuing sales growth, that’s a package that should generate strong returns for Just Energy in 2012. Just Energy is a buy up to USD16 for those who don’t already own it.

Feature Article

2011 was the best of times for the business of selling oil and natural gas liquids (NGLs).

In contrast, surging production from shale drove down natural gas prices to their lowest winter level since the 1990s. Gas today sits at barely USD3 per million British thermal units. Despite rising to a 29.5 percent share of US electricity generation in December, few expect any meaningful rebound for at least several years.

Ironically, a focus on oil rather than gas was no guarantee of strong stock market performance for producers. And concentrating on gas wasn’t always the kiss of death. Rather, stocks of companies that were able to increase production meaningfully–whether of oil or gas–performed the best.

In this month’s Feature Article I look at what separated winners from losers in Canada’s energy patch in 2011 and how it will continue to make or break companies in 2012. I highlight the best producers and drillers as well as those that should be avoided now.

Canadian Currents

The Canada Revenue Agency has extended until Jan. 1, 2013, the effective date of new rules requiring verification of eligibility for lower dividend withholding rates contemplated by international tax treaties such as the Convention Between the United States of America and Canada with Respect to Income and Capital.

That means it’s business as usual for 2012 as far as dividend withholding amounts are concerned.

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—Westshore Terminals Investment Corp (TSX: WTE, OTC: WTSHF) was the only Canadian Edge How They Rate company to announce a dividend cut last month.

The owner and operator of a key metallurgical coal and loading terminal in British Columbia stated it will pay a combined CAD0.261 per “stapled share,” including CAD0.13 in equity dividend and CAD0.13125 in interest on the 10.5 percent note portion of the security. That’s 10.3 percent less than what it declared on Sept. 14, 2011, for payment Oct. 15, 2011.

Encouragingly, the company expects a 10 percent-plus boost in volumes for 2012, and demand for metallurgical coal is expected to remain robust in Asia. Westshore, however, also faces some uncertainty regarding its stapled share structure. The stock is still a buy up to USD24, but only for aggressive investors who don’t already own it.

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF is now off the Watch List. Management issued guidance last month that the oil-weighted producer would increase output by 15 percent next year. Some 87 percent of that is oil drawn from the company’s Bakken and Cardium plays.

The company also noted that a “significant” portion of production was coming from wells with low rates of decline. And it put December 2011 production at better than 48,000 barrels of oil equivalent per day (boe/d), up 23 percent from third-quarter levels.

PetroBakken also posted a fine third quarter, as a 15 percent boost in year-over-year output lifted funds from operations by a solid 5 percent. That indicates operations are back on track and, coupled with high oil prices, provides a good signal for solid fourth-quarter results.

There’s still the matter of CAD1.13264 billion drawn on a CD1.35 billion credit line that matures Jun. 2, 2014. But so long as it continues results like these, the company will have little problem servicing that and eventually raising the dividend. It’s a buy on dips to USD10.

Here’s the rest of the Watch List. Note the list is basically the same as last month, as very few companies actually reported earnings.

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF)–Advice: SELL. The payout still greatly exceeds investment income. Management has also devoted a large portion of its portfolio to betting on currencies. That adds up sizeable risks not reflected in the price.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–Advice: Hold. Pulp and paper market prices are likely to soften if eurozone economies slow as much as feared. Being a low-cost producer ensures the company won’t be undercut, but any slippage in cash flow could hit the dividend.

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Advice: SELL. Management’s abrupt reduction in 2012 cash flow guidance didn’t include a forecast for the dividend, just a warning that a cut was likely. Until there’s more certainty, this power generator is best avoided.

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF)–Advice: Hold. The big unknown here is how much shrinking Medicare budgets will impact overall US medical expenditures.

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–Advice: Hold. An amicable resolution of the company’s dispute with Air Canada (TSX: AC/A, OTC: AIDIF) would go a long way toward eliminating uncertainty about the dividend. Unfortunately, a dividend cut looks likely.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Advice: Hold. I’m anxious to see how much the sale of US operations will hit sales and cash flow. We’ll get our first indication on or about Mar. 5, when Bay Street expects fourth-quarter and full-year results to be announced. Until then there’s too much uncertainty to take CML off the Watch List.

Data Group Inc (TSX: DGI, OTC: DGPIF)–Advice: Buy @ 4. The document management company is new to How They Rate coverage after completing its conversion from income trust to taxpaying corporation this week.

Data Group has elected to maintain its current dividend for the time being but is clearly priced for a steep cut. The good news is it won’t take much to beat gloomy expectations, and third-quarter distributable cash flow did cover the payout by a 1.1-to-1 margin.

EnerVest Energy & Oil Sands Total Return Trust (TSX: EOS, OTC: EOSOF)–Advice: SELL. The fund’s holdings will no doubt fare well as activity picks up in the energy patch. With no investment income, however, the dividend is speculative.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: SELL. A soft economy has apparently accelerated the move of certain industries away from print and toward the Internet. This stock pays a huge yield, but the best investors can realistically hope for is a small dividend cut.

Freehold Royalties Ltd (TSX: FRU, OTC: FRHLF)–Advice: Hold. The focus on oil-producing properties is a plus. So is the company’s ability to make acquisitions, as it did this month. But the payout ratio is quite high for such a volatile industry.

GMP Capital Inc (TSX: GMP, GMPXF)–Advice: Hold. The company’s earnings and share price won’t recover until mergers and acquisitions pick up in Canada. Management is committed to the dividend for now but has acknowledged it can’t pay at this rate indefinitely. Earnings have to improve.

NAL Energy Corp (TSX: NAE, OTC: NOIGF)–Advice: SELL. The company plans to release 2012 operating and financial plans on Jan. 11, 2012. That will likely include guidance on the dividend as well.

The key issue may be a CAD80 million bond maturing Aug. 31, 2012, and CAD302.74 million outstanding on a CAD550 million credit facility that matures Apr. 30, 2012. The betting in the market seems to be that falling gas prices might induce banks to attach conditions that require a lower dividend.

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–Advice: SELL. The posted yield still doesn’t reflect the projected 50 percent dividend cut management announced when it elected to convert from a stapled share structure to an ordinary corporation. The real reason for the “sell,” however, is the bus manufacturing business doesn’t appear to have touched bottom.

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF)–Advice: SELL. I’m removing this closed-end fund from the Mutual Fund Alternatives in favor of First Asset Pipes & Power Income Fund (TSX: EWP-U, OTC: FAPPF).

It may still do well if mining stocks make a run. But there’s little or no investment income to support the distribution, which could therefore be cut at any time.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF)–Advice: SELL. The company’s insiders are believers, judging from recent buying. But the 80 percent-plus reduction in the dividend since the July 2002 initial public offering is a pretty clear sign this isn’t a good business model for paying dividends.

Bay Street Beat–We take a look at how analysts on Canada’s equivalent to Wall Street view natural-gas-weighted companies in the Oil and Gas section of the How They Rate coverage universe.

TTips 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-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 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

I’m adding Data Group Inc (TSX: DGI, OTC: DGPIF) to How They Rate coverage under Information Technology. I’ll be dropping Daylight Energy Ltd (TSX: DAY, OTC: DAYYF) next month, as China Petroleum & Chemical Corp, better known as Sinopec (NYSE: SNP), has completed its acquisition of the company for CAD10.08 in cash. The funds should by now have shown up in investors’ accounts.

Note that I’ll also be deleting Arctic Glacier Income Fund (TSX: AG-U, OTC: AGUNF) next month, if indeed the Toronto Stock Exchange elects to delist the company on Jan. 19, 2012, as is now planned. At that point it’ll be practically impossible for anyone to sell shares, making it difficult for anyone still hanging on to get a tax loss. Don’t delay: Sell Arctic Glacier now.

Advice Changes

Here are advice changes for this month. See How They Rate for changes to buy-under targets and other data.

Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV)–To Hold from Buy @ 6. The sharp drop in natural gas prices means management will have to carefully guard capital to meet CAD165 million in debt maturities, which will make following through on expansion plans iffy.

Athabasca Oil Sands Corp (TSX: ATH, OTC: ATHOF)–To Hold from Buy @ 18. The sale of the company’s remaining 40 percent stake in the MacKay River oil sands project to China National Petroleum will net the company CAD680 million.

Management, however, also states the move will reduce targeted 2012 capital expenditures by CAD190 million. That’s an odd move for a company whose stated goal is to develop new properties and could be masking other weaknesses.

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–To Hold from Buy @ 32. The company is operationally strong and has no near-term debt maturities. But the sharp drop in natural gas prices will almost certainly impact cash flow.

Boralex Inc (TSX: BLX, OTC: BRLXF)–To Hold from Buy @ 10. The company’s European power generation is largely locked into long-term contracts, but revenues in Canadian dollar terms would be hurt by weakness in the euro.

Daylight Energy Ltd (TSX: DAY, OTC: DAYYF)–To Acquired from SELL. The company has now been acquired for CAD10.08 per share in cash, which should have shown up in investors’ accounts by now.

Enerplus Corp (TSX: ERF, NYSE: ERF)–To Hold from Buy @ 33. The dramatic drop in natural gas prices could eventually force management to choose between holding the dividend and following through on capital spending plans.

The company has no near-term maturities and plenty of room on its credit lines but will need to successfully boost liquids output over the next year. And it needs oil prices to stay strong as well.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–To SELL from Hold. The company’s print-based business appears to be shrinking much faster than the Internet business is growing. That’s not good for the dividend, though the stock is definitely pricing in a cut.

NAL Energy Corp (TSX: NAE, OTC: NOIGF)–To SELL from Hold. Approaching debt maturities of CAD302 million this year could force a dividend cut if bankers get nervous about falling natural gas prices.

National Bank of Canada (TSX: NA, OTC: NTIOF)–To Buy @ 70 from Hold. The bank’s reliance on domestic deposits and strong balance sheet make it resistant to global financial pressures, and dividend growth is robust.

Northland Power Inc (TSX: NPI, OTC: NPIFF)–To SELL from Hold. Weakness of the euro could hurt revenue from the company’s facilities on the Continent, and there’s little margin for error with a third-quarter payout ratio of 738 percent.

Precious Metal & Mining Trust (TSX: MMP-U, OTC: PMMTF)–To SELL from Hold. The fund doesn’t cover its dividend with investment income, and a cut is likely unless mining stocks recover sharply this year.

Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF)–To Hold from Buy @ 15. The company has huge potential to boost production, and a venture with Malaysia’s Petronas may get its gas to Asian markets. But falling natural gas prices are going to hurt cash flow in the near term.

Telus Corp (TSX: T, NYSE: TU)–To Buy @ 60 from Hold. Management is guiding to 6.5 percent sales growth and 6 percent cash flow growth for 2012, which ensures solid dividend growth as well.

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.

Bonavista Energy Corp (TSX: BNP, OTC: BNPUF)–To 3 from 4. The sharp drop in natural gas prices sharply limits future earnings visibility, though the company has been ramping up sales of natural gas liquids.

Encana Corp (TSX: ECA, NYSE: ECA)–To 3 from 4. The sharp drop in natural gas prices in the fourth quarter limits the company’s earnings visibility in 2012. There’s also uncertainty about its ability to ramp up production in the US, given the Environmental Protection Agency’s recent scrutiny of its hydraulic fracturing drilling in Wyoming.

Enerplus Corp (TSX: ERF, NYSE: ERF)–To 3 from 4. The company is moving toward production of liquids as it ramps up output in the Bakken. But the fourth-quarter plunge in natural gas prices leaves a lot less margin for error for these efforts.

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