Dividend Watch List

One company in the Canadian Edge coverage universe cut its distribution last month, while another posted numbers good enough to achieve escape velocity from the Dividend Watch List.

Westshore Terminals Investment Corp (TSX: WTE, OTC: WTSHF) was the cutter. The company owns and operates a key metallurgical coal loading terminal in British Columbia, primarily for a unit of giant metals and minerals miner Teck Resources (TSX: TCK/B, NYSE: TCK). Its securities are not an ordinary common stock but a “stapled share,” combining a stock portion with a bond portion with a coupon yield of 10.5 percent. The result is a distribution that’s paid quarterly and is approximately half equity dividend, half debt interest.

The payment announced for Jan. 13, 2012, is a total of CAD0.261 per share, with CAD0.13 in equity dividend and CAD0.13125 in interest on the 10.5 percent note. That’s 10.3 percent less than what Westshore declared on Sept. 14, 2011, for payment Oct. 15, 2011. It’s also 46 percent less than what the company paid a year ago, when it was still organized as an income trust.

Much of that gap is due to the taxes Westshore now pays as a corporation. That burden could get larger in July 2012, when a new edict from Canada’s Department Finance is slated to take effect for stapled shares. This edict would in effect deny the company’s ability to deduct interest on the 10.5 percent note.

Westshore’s directors have formed a committee to explore the company’s options. The current plan is to submit a proposal for shareholder approval at the June 2012 annual general meeting. At this point it’s hard to imagine the company would elect to keep the stapled share format, given there would no longer be a tax advantage.

That means a restructuring that would almost surely leave a lower percentage of available cash for distributions and therefore another dividend cut. It could also mean management will shop the business to an interested buyer for whom the tax consequences of stapled shares would be meaningless.

Whatever the path chosen, the good news is Westshore is fundamentally quite sound as a business. For the 11 months ended Nov. 30, 2011, the company reported it loaded 24.7 million tons, up 10.8 percent from the previous year. It now expects a full-year total of 27 million tons, a new throughput record and a 9.3 percent increase from the prior year.

That’s as much a testament to the strategic location of the company’s primary assets as the continued robust health of the global market for metallurgical coal. The company expects volume to be interrupted for roughly two weeks in March 2012 because of major replacements of transfer chutes as well as in September for another planned maintenance and expansion project.

But it still expects to roughly match this year’s throughput levels, even as it enjoys a rate boost. And by early 2013 capacity is on track to hit 33 million tons per year, a further 20 percent plus boost.

Capacity additions and rate increases will boost cash flow, offsetting at least some of the impact from higher taxes. Meanwhile, it’s hard to argue the stock is expensive, given the security of its revenue and growth prospects. Westshore Terminals is still a buy up to USD24 for more aggressive investors.

This month’s Watch List escapee is PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF. The company’s stock has more than doubled since hitting bottom in late September 2011. Nonetheless, it still finished the year in the red by nearly 40 percent, the legacy of continually missing management targets over the past several years.

At one time the stock yielded nearly 16 percent, as most investors took it for granted a dividend cut was inevitable. Then the company posted a fine third quarter, as a 15 percent boost in year-over-year output lifted funds from operations by a solid 5 percent. The performance was a marked improvement from the second quarter, when output was hampered largely by factors beyond management’s control. But investors were in no mood to be tolerant.

Last month the company issued guidance that output would rise by 15 percent in 2012. That was in addition to a 23 percent jump in December output over year-earlier levels to better than 48,000 barrels of oil equivalent a day. And it at last confirmed that the company executing on its plans to develop and produce primarily from its considerable long-life, light oil reserves in Canada’s Cardium trend as well as North America’s Bakken oil bonanza.

PetroBakken is also getting a lift from renewed strength in the price of oil, which with gas liquids is 87 percent and rising of its total output. That’s further boosting cash flow, which covered the payout by a better than 5-to-1 margin in the third quarter of 2011. And the numbers appear set for an even better showing when fourth-quarter results come out, probably in early March. By then we should also be seeing a rather bullish report on the company’s reserves and winter output.

The upshot is after a couple years of routinely failing to live up to its hype, PetroBakken’s operations are meeting targets management originally set out. A lot could still come unraveled. For example, the company has CAD1.13264 billion drawn on a CAD1.35 billion credit line that matures Jun. 2, 2014. That will have to be drawn down in coming years, which should be no problem with production rising and oil prices strong–but could again be a threat if one of those factors changes.

The stock, however, currently trades at less than 40 percent where it did following the initial public offering. That’s a lot of potential upside if management continues to deliver and it makes a dividend boost a lot more likely than a dividend cut. Buy PetroBakken on dips to USD10.

The List

Companies land on my list of endangered dividends for one or more of three reasons:

• The underlying business is weakening enough for the dividend to be at risk. This is typically due to profits lagging the payout but may also be caused if debt becomes too high to service or roll over.
• A closed-end mutual fund is paying out significantly more in distributions than it’s making with investment income, meaning dividends are being paid with leverage, sales of assets or by returning fund capital to investors.
• Companies are organized to pay distributions as “stapled shares,” which are now targeted by the Canadian government for potential new taxes. That’s the problem faced by Westshore Terminals.

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. My biggest worry with this fund is that its payout still greatly exceeds investment income.

Management is making up for it in other ways. For example, as of about a month ago more than 7 percent of the portfolio was in a spot market position in the US dollar. That position likely benefitted from the rush to safety this fall that pushed up the US dollar’s exchange value versus the Canadian dollar. But it’s fundamentally a trade, not the kind of long-term investment I think many income investors think they’re getting.

Moreover, 14 percent of the portfolio is retail stocks and a third is bonds and cash. A guess wrong and the lofty dividend is toast.

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF)–Advice: Hold. Pulp and paper markets continue to see fairly solid demand in Asia. And China’s assertion it will be growing more slowly, notwithstanding, that should continue to provide support to the market even if the European economies do falter as badly in 2012, as the nearly unanimous consensus expects.

The company is also protected by the fact that it’s a low-cost producer and has made great strides taking down costs further. But the high payout ratio doesn’t leave much margin for error for 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. That, to me, was probably its worst sin, and management hasn’t exactly been overflowing with information since.

The analyst community seems mostly non-plussed, with some willing to bet the company won’t cut dividends as much as feared. But until there’s more certainty, I’m following my rule to cut and run whenever a company cuts its dividend or guides to a reduction.

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.

Management has assured investors repeatedly since the rollbacks began last year that its revenues were generally secure against what’s been announced thus far. But given Washington’s budget troubles, it’s hard to see any area of the healthcare sector avoiding all the damage.

There’s also the question of the company’s continued status as a specified investment flow-through entity, or SIFT. Anyway you slice it, this stock is more aggressive than it appears at first glance.

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 that appears to be very unlikely, given the dire straits Air Canada is in and the way negotiations over the cost sharing agreement have gone in the past.

The main reason to hold at this point is that investors are clearly pricing in an outright catastrophe, with the yield over 18 percent, while completely ignoring management’s assurances that the dividend will hold. That leaves a lot of room for positive surprises, including a dividend cut that is less than expected. But there are clearly risks.

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, 2012, when Bay Street expects fourth-quarter and full-year results to be announced.

Given that the US operations have been mostly a drain on cash flow in recent years, I’m really not expecting to see much of anything negative. The company’s prior management had been counting on growing the US market, in part because growth in Canada was slow. Getting rid of the US operations will cut risk, but it also means slower growth.

So long as the dividend holds, that still leaves a decent return. But until there are hard post-sale numbers, CML deserves to remain on the Watch List.

Data Group Inc (TSX: DGI, OTC: DGPIF)–Advice: Buy @ 4. I’ve just picked this company up for How They Rate coverage, though I’ve followed its prospects for some time. As a result I’m comfortable recommending the stock for more aggressive investors.

The provider of document services has occupied a favorable niche that few apparently expect to last. The company completed its conversion from income trust to tax-paying corporation this week, holding its current dividend steady as management had previously pledged. The yield of nearly 17 percent is a clear sign few expect they’ll be able to continue at that level for long, despite the fact that third-quarter cash flow did cover it by a 1.1-to-1 margin.

My own expectation is for an eventual dividend cut but one that’s less significant than the market apparently expects. That should hand speculators a tidy gain in addition to hefty cash payments.

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, and its managers have a great track record spotting value. That may create some capital gains down the road. But this is a tough environment for that now and the fund generates no investment income to speak of. That’s not the kind of fund where any income investor should be looking.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: SELL. I’ve gone from favorable to distinctly bearish on this company over the past few quarters.

The problem is the numbers haven’t given me any reason or justification to be positive on this company, which looks more and more like another print company with a rapidly vanishing core business. 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. And that’s really hoping against hope at this point.

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.

Also, being primarily a collector of royalty income means the company is vulnerable to other companies’ decisions to pull production. That’s not likely for the oil properties, but the natural gas lands are increasingly at risk. And the higher payout ratio leaves little margin for error, despite the company’s generally low capital development costs for its industry.

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

How likely is that? I’m generally bullish on the Canadian economy and markets over the long term, and there are plenty of valuable companies where we could well see M&A activity in coming months. The company has done a good job defending its niches as well. But continued poor market conditions would force management’s hand with the dividend, and that would further add to last year’s losses in the stock.

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.

My main worry is that lenders will attach tougher conditions as the price of enabling the company to roll over the CAD80 million bond maturing Aug. 31, 2012, and CAD302.74 million outstanding on a CD550 million credit facility that matures April 30, 2012. The company has had some success in boosting its production of liquids, and the payout ratio based on third-quarter cash flow was less than 50 percent.

Keeping the switch to liquids going, however, means a great deal of capital spending. And cash flow is bound to contract due to the steep drop in natural gas prices. The company may avoid a dividend cut, but tread with care.

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 stapled share to an ordinary corporation.

The real reason for the sell, however, is the bus manufacturing business doesn’t appear to have touched bottom. At worst we could see far worse cash flows for the company than when management first announced the conversion to a corporation. That, in turn, would mean worse than the 50 percent cut that management has warned but that doesn’t appear fully reflected in the share prices.

New Flyer continues to repurchase the subordinated note part of its stapled share and appears likely to complete the job by July 2012, when Finance Ministry rules will disallow the tax deductibility of interest costs from staple shares. But until bus order volumes and prices bottom, New Flyer is at risk to a steeper fall.

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 Power & Pipes 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. In fact, maintaining the current dividend stream by necessity is drawing down the asset base, and the fund trades at a 15 percent plus premium to net asset value as well.

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.

Fourth-quarter earnings should avoid falling off a cliff, as the company has had some success with marketing agreements and the Canadian dollar had been steady to down-trending in 2011, as opposed to steeply rising in 2009 and 2010. But that hasn’t prevented the stock from sinking to an all-time low in recent weeks. This is clearly one to avoid.

Bay Street Beat

A precipitous decline in natural gas prices since mid-2008–a slide that accelerated over the second half of 2011–has left Bay Street analysts about as bearish on a group of companies as they get. That is to say opinion is clearly mixed as opposed to murkily positive among this group of professionals who typically hew to an upbeat line, in keeping with the best interests of the industry within which they work.

The tone remains relatively bullish on Canadian Edge Oil and Gas companies on the whole. But several companies for whom natural gas represents more than 50 percent of overall production have earned neutral-to-positive/neutral-to-negative and even the rare and dreaded net negative buy-hold-sell lines from the analysts that cover them.

Advantage Oil & Gas Ltd (TSX: AAV, NYSE: AAV), which is how a hold in CE in the aftermath of our review of gas-weighted Oil and Gas companies under How They Rate coverage, reported a 15.2 percent decline in revenue on a 4.9 percent production decline in the third quarter of 2011. The seven Bay Street analysts who rate the stock a “buy” must have really appreciated the nearly 35 percent reduction in outstanding bank debt, but there remains a CAD165 million credit line maturing Jun. 16, 2012. Four analysts rate the stock a “hold,” but none say “sell.” The mix is 93 percent gas, 7 percent oil.

ARC Resources Ltd (TSX: ARX, OTC: AETUF), with its perpetually rising production profile and ample access to credit, is as well placed as any natural-gas-weighted (64 percent as of Sept. 30, 2011) producer to endure even an extended period of low prices. Ten Bay Street analysts rate the stock a “buy,” seven rate it a “hold” and one says it’s a “sell.” Canaccord Genuity has initiated coverage with a “buy” rating, perhaps with an eye on management’s forecast 12 percent production increase in 2012.

Bellatrix Exploration Ltd (TSX: BXE, OTC: BLLXF), at 63 percent gas production, and Bonavista Energy Corp (TSX: BNP, OTC: BNPUF), at 62 percent, both reported revenue gains for the third quarter of 2011. Bellatrix remains a hold and Bonavista’s been downgraded as of this issue of CE, but both sport impressive buy-hold-sell lines on Bay Street. Bellatrix chalks up a 10-two-zero, while Bonavista checks in with a 13-four-two.

Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) produced 89 percent gas, 11 percent oil for the quarter ended Sept. 30, 2011. But this is the lowest-cost producer in the coverage universe, and output was up more than 40 percent for the most recent reported period. The company recently paid down debt with a new, over-subscribed equity offering. Ten analysts say “buy,” one says “hold,” one says “sell.” The “sell” rating, issued Nov. 10, 2011, is from Veritas Investment Research Company. This house has a CAD21 price target on the stock. As of this writing Peyto is trading at CAD24.54.

Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF), with 87 percent gas production, also has rare and compelling growth metrics, with output up more than 40 percent in the third quarter of 2011 and another gain of 20 percent on tap for 2012, according to management’s forecast. Thirteen analysts rate the stock a “buy,” four call it a “hold” and one says it’s a “sell.” The “sell” rating is the initial call from EVA Dimensions, which picked up coverage of the stock today, Jan. 6.

AvenEx Energy Corp (TSX: AVF, OTC: AVNDF) reported solid production and revenue increases for its third quarter; though gas makes up 57 percent of its output–and the sample size is small–AvenEx has a generally positive one buy-one hold-zero sell line on Bay Street. Oil will determine the future of the dividend here.

Encana Corp (TSX: ECA, NYSE: ECA), with a 96 percent/4 percent gas/oil production mix as of its most recent accounting, sports seven “buy” recommendations according to Bloomberg’s standardized terminology for equity analyst nomenclature across brokerage houses. But 17 analysts rate it a “hold” and three more call it a “sell.” The stock has also suffered two downgrades since Dec. 9, 2011, the date of the last issue of CE.

Enerplus Corp (TSX: ERF, NYSE: ERF), a longtime Canadian Edge Portfolio Holding downgraded to “hold” in this issue, has a five-eight-two buy-hold-sell line, of similar neutrality to Encana’s line. EVA Dimensions, in the process of issuing new, revised and reiterated ratings for several CE Oil and Gas stocks in the early days of 2012, started coverage of Enerplus with a “buy” rating.

The downgrade to hold in these pages is based more on an overabundance of caution in the face of collapsing natural gas prices than it is anything to do with Enerplus specifically–other than the obvious fact of its production mix, which as of Sept. 30, 2011, was 55 percent gas, 45 percent oil. Management has offered its own reiteration of its commitment to the current dividend rate, and the company has sufficient access to capital to continue growing.

NAL Energy Corp (TSX: NAE, OTC: NOIGF), with gas making up 64 percent of production that dipped in the third quarter, is seen as particularly vulnerable because of its CAPEX commitments; the market has bid the yield to 10.7 percent, a clear sign it expects a dividend cut.

The company has a significant credit line to roll over in the spring of 2012, with the looming possibility that bankers will insist that management reduce the payout. The buy-hold-sell line is a net negative two-10-four, the four “sells” outweighing the two “buy” calls. NAL has also earned a downgrade in How They Rate, to “sell” from “hold.”

Perpetual Energy Inc (TSX: PMT, OTC: PMGYF), sold from the CE Portfolio Aggressive Holdings in an Oct. 20, 2011, Flash Alert, has been hit particularly hard by the 2011 slide in natural gas prices. The commodity accounts for more than 90 percent of its output. Management stopped dividend payments in late 2011, as it struggled with how to tackle its debt burden while maintaining a commitment to boosting production. Two Bay Street analysts rate the stock a “buy,” six rate it a “hold” and three rate it a “sell.”

Tips on DRIPs

In January 2011 Baytex Energy Corp (TSX: BTE, NYSE: BTE) opened its dividend reinvestment plan (DRIP) to US investors. Baytex’s DRIP, like other plans of its kind, will allow shareholders to reinvest their monthly cash dividends in additional shares without paying commissions.

Baytex joins other New York Stock Exchange-listed Canadian companies that extend the convenience of a DRIP to US investors. US securities laws restrict participation in DRIPs sponsored by foreign companies that don’t register their offering with the Securities and Exchange Commission (SEC). Most plans of Canadian income and royalty trusts that do sponsor DRIPs aren’t registered under the United States Securities Act of 1933, as amended. US investors, therefore, aren’t eligible to participate.

Two CE Portfolio recommendations, Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) and Provident Energy Ltd (TSX: PVE, NYSE: PVX), do allow US investors to participate in their respective DRIP offerings, with certain limitations. Information about Penn West’s plan is available here. Click here for more information about Provident’s DRIP.

Penn West, Provident and now Baytex, because they’re listed on the NYSE, have therefore opted into US filing and registration requirements. It’s basically a matter of how much overhead expense trusts are willing to absorb.

Conservative Holding Atlantic Power Corp (TSX: ATP, NYSE: AT), which listed on the NYSE in July 2010, continues to “evaluat[e] options for a Dividend Reinvestment Program” and “hopes to have this option available to shareholders in the future.” NYSE-listed Aggressive Holding Enerplus Corp (TSX: ERF, NYSE: ERF) has a DRIP for Canadian investors but has not opened it to US investors.

We’ll continue to track Atlantic Power and any other Portfolio Holdings that indicate they’re considering or announce that they will sponsor DRIPs open to US investors.

Companies under How They Rate coverage that sponsor DRIPs open to US investors include (click on the links for more information):

• Bank of Montreal (TSX: BMO, NYSE: BMO)–www2.bmo.com/content/0,1089,divId-3_langId-1_navCode-4993,00.html
• Bank of Nova Scotia (TSX: BNS, NYSE: BNS)–https://www-us.computershare.com/investor/plans/planslist.asp?planid=81&state=eStateDisplayPlanSummary
• BCE Inc (TSX: BCE, NYSE: BCE)–http://bce.ca/en/investors/dividendinfo/drp/#enroll
• Enbridge Inc (TSX: ENB, NYSE: ENB)–www.enbridge.com/InvestorRelations/StockInformation/DividendReinvestmentandSharePurchasePlan.aspx
• EnCana Corp (TSX: ECA, NYSE: ECA)–www.encana.com/investors/shareholder/drip/
• Nexen Corp (TSX: NXY, NYSE: NXY)–www.nexeninc.com/en/Investors/Shareholders/GeneralInformation.aspx)
• Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–www.pengrowth.com/investors/drip_information/
• Potash Corp of Saskatchewan (TSX: POT, NYSE: POT)–www.potashcorp.com/investors/stock_information/dividend_history/drip/
• Rogers Communications (TSX: RCI/B, NYSE: RCI)–https://www-us.computershare.com/investor/plans/planslist.asp?planid=773&state=eStateDisplayPlanSummary)
• Royal Bank of Canada (TSX: RY, NYSE: RY)–http://www.rbc.com/investorrelations/ir_dividends.html
• Suncor Energy (TSX: SU, NYSE: SU)–https://www-us.computershare.com/investor/default.asp?bhjs=1&fla=1&cc=CA&issuerid=scussunq&landing=y&showinvestorcontact=y
• Telus Corp (TSX: T, NYSE: TU)–https://www-us.computershare.com/investor/plans/planslist.asp?planid=121&state=eStateDisplayPlanSummary
• Toronto-Dominion Bank (TSX: TD, NYSE: TD)– http://www.td.com/investor/drip.jsp
• TransCanada Corp (TSX: TRP, NYSE: TRP)–https://www-us.computershare.com/investor/plans/planslist.asp?planid=124&state=eStateDisplayPlanSummary