Dividend Watch List

Only one How They Rate company trimmed dividends during the past month. Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF) has cut its quarterly rate by 37.5 percent to CAD0.25 per share, part of a restructuring announced last month that includes the company’s acquisition of the rest of Canfor Pulp LP.

The company derives all of its income from the limited partnership, so this deal promises to add significantly to cash flow. In return the previous co-owner of the LP–Canfor Forest Products–will now own 50.2 percent of Canfor Pulp Products, which will significantly increase the number of shares outstanding for the company. The upshot should be a more transparent ownership structure and potentially some cost savings, with no real dilution for current Canfor Pulp Products shareholders.

The dividend cut can be wholly blamed on softer conditions in the global softwood pulp market, which took down pulp prices in North America by 8.2 percent from last year’s levels. Prices in Europe fell by even more, 13.2 percent, while the price in China slid 17.9 percent. And as CEO Joe Nemeth stated in the company’s fourth-quarter conference call, Canfor expects the market to “remain soft though the first quarter of 2012.”

Canfor’s cash flow also suffered from an extended maintenance outage at its Northwood Pulp Mill facility, which has now been completed. That was partially funded by a government-subsidized “Green Transformation Program,” which had met CAD122 million of the total CAD155.4 million cost so far. The upgrades should improve efficiency and profitability in coming years as well as limit prospective environmental liability.

Canfor has long been a low-cost producer, a fact that’s enabled the company to overcome difficult market conditions even as rivals have floundered. That still appears to be the case now, which is one reason the stock remained fairly steady in the wake of the dividend cut.

As is often the case for seasonal reasons, Canfor’s distributable cash flow went negative in the fourth quarter. But full-year profits should be able to cover the new annualized dividend rate of CAD1 per share despite the weak pricing environment for pulp. Management is anticipating a recovery of sorts to begin firming up prices later this year, which, combined with new operating efficiencies, should make the difference.

Over the long term Canfor management has shown itself willing to raise dividends when the company’s fortunes improve. That should be the case going forward as well. Its new majority owner Canfor Forest Products is likely to maintain its stake to maximize its cash flows from these operations, as it did in the past by owning a majority stake in the partnership. That means financial support as well as support for the stock.

On the negative side, earnings are going to continue to move up and down with demand and pricing for pulp products, which has proven to be highly cyclical. The stock is not for conservative, dividend-focused investors. But with this long-expected dividend cut out of the way, Canfor Pulp Products remains a solid hold for the more aggressive. The stock is also off the Dividend Watch List, at least for now.

Chartwell Seniors Housing REIT (TSX: CSH-U, OTC: CWSRF) has also earned an escape from the list this month, though for a somewhat different reason: Profits and balance sheet strength have improved enough to take the payout out of danger, despite uncertainty in the US. retirement community sector.

The REIT–which nonetheless pays taxes as a SIFT because it operates property not officially sanctioned for REITs–reported solid fourth-quarter results well within management’s guidance and payout ratio comfort level. That currently stands at about 90 percent of funds from operations, which have proven remarkably steady from quarter to quarter.

Chartwell has whittled its maturing debt through the end of 2013 to just CAD10 million, an amount that could easily be covered with cash on hand. That enabled the company to announce a CAD931 million acquisition of 8,187 suites in 42 retirement communities, located in Ontario and Quebec. The deal is a clear demonstration of Chartwell’s growing financial power and is set to close May 1.

So long as the US Medicare system is under threat of substantial funding cuts, I’m not recommending Chartwell as a buy. And after recent gains in the unit price, there’s no reflection of any real risk in the yield of barely 6 percent. But with near-term dividend risk much diminished, the REIT rates a hold.

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 “staple shares,” which are now targeted by the Canadian government for potential new taxes.

Here’s the rest of the Watch List.  Note we still don’t have fourth-quarter and full-year 2011 results for some of these companies. That will leave a full recap for some of them until the April issue of Canadian Edge. I’ve noted companies yet to release earnings with confirmed or estimated announcement dates:

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF)–Advice: SELL. The closed-end fund’s 9 percent-plus yield is several percentage points above the average yield of its holdings. Management can keep it there with a combination of tactics that aren’t visible to investors–and in fact may be motivated to do so in order to maintain a certain level.

But this is not sustainable. This is a classic black box investment. And if the dividend is cut the price of the fund will come down accordingly, though it does trade at a small discount to net asset value.

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF)–Advice: SELL. The owner of power and other infrastructure assets managed to lock in financing for its Swedish district heating business, though at a fairly high rate of 7 percent for five years. It also reported solid fourth-quarter and full-year earnings, with several of its projects’ results exceeding prior guidance. One of these was the investment in Bristol Water, which contributed half of fourth quarter cash flow.

The biggest uncertainty is still getting a new contract for the Cardinal power plant, before which management won’t be able to clarify its cash flow guidance. That, in turn, makes forecasting a new dividend rate impossible, though the company stated in its fourth-quarter earnings release that it expects to announce a new level “in the first half of this year.”

The numbers here are encouraging. But after last year’s dramatic revision of guidance–just three weeks after third-quarter numbers were announced and commented on–I’m skeptical and steering clear of Capstone, at least until it does set a new dividend rate.

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–Advice: Hold. The problem here isn’t with current earnings numbers. Net profit rose 22 percent for 2011, and free cash flow moved higher by 43.4 percent. That ensured the payout ratio remained very low at 63 percent of free cash flow, leaving plenty of funds for strengthening the balance sheet.

The company now has no maturing debt in the next two years. The underlying business is quite healthy, with passenger counts robust and management doing a good job with its “controllable” costs.

Unfortunately, earnings would be a lot less encouraging were it not for the company’s cost-sharing arrangement with Air Canada (TSX: AC/A, OTC: AIDIF). And that deal is now in danger of being severely altered during ongoing arbitration. Until there’s a decision there’s risk of a payout cut. That seems likely, particularly given that Air Canada has already succeeded in renegotiating its deal with Chorus once before, with the result a dividend cut.

Given the stock’s high yield, a cut is arguably well priced in. That makes it a hold for investors who understand the risks.

CML Healthcare Inc (TSX: CLC, OTC: CMHIF)–Advice: Hold. This company has now refinanced its primary credit facility to reflect its withdrawal from the US market and renewed focus on Canada. We still need to see a couple of quarters of earnings, however, to really get a read on the long-run sustainability of the dividend without US growth. On the plus side there are no debt maturities the next couple of years, which eliminates a rival need for capital.

The Canadian business has been quite steady in recent years, in stark contrast to the now exited medical imaging business in the US. That’s why my guess now is that this company will come off the Watch List later this year without a dividend reduction. But until that’s confirmed, there will be risk.

Data Group Inc (TSX: DGI, OTC: DGPIF)–Advice: Buy @  4. Conventional wisdom is that a dividend cut is all but inevitable when a stock trades at a high-teens yield. By this measure this stock has been pricing in a huge dividend cut for months. But management has continued to maintain the same rate, even after converting from an income trust structure to a corporation earlier this year.

The longer-term challenge is management’s attempt to convert what’s traditionally been a paper-based business into one much more reliant on digital technology while keeping its customers. That’s what Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) has achieved in the banking sector, and it’s the task at which nearly bankrupt Yellow Media Inc (TSX: YLO, OTC: YLWPF) has so ignominiously failed.

The answer to whether it succeeds or not lies in the numbers we see from Data Group in coming quarters. In the meantime its super-high yield makes it a suitable speculation for risk takers.

Enerplus Corp (TSX: ERF, NYSE: ERF)–Advice: Hold. The company’s fourth-quarter results were positive overall, despite it’s posting a meaningless headline loss on a non-cash charge for impaired natural gas assets.

Management reported a 175 percent replacement rate for reserves and continues to tilt the production mix toward oil and natural gas liquids. That’s essential to maintaining solid profits at a time when natural gas prices have fallen through the floor. The payout ratio based on distributable cash flow–Enerplus’ primary measure of profitability–ticked a bit higher, as lower gas prices cut into cash flows. But it was still very well behaved at 68 percent, and combined with cash reserves and credit lines left plenty of financing for the company’s capital spending plans.

The problem is gas prices are lower in the first quarter of 2012 than they were in the last quarter of 2011. That means profits are going to be under even more pressure and the payout ratio is likely to rise further. Management is standing by its current CAD0.18 per share per month payout, pointing out the net asset value of Enerplus has risen even in the face of low gas prices, as it’s been able to execute its production targets in the light oil rich Bakken region. But it may ultimately come down to what’s possible in what seems to be an ever-more difficult environment.

I’m sticking with Enerplus for now in the Aggressive Holdings as a value, as it appears to trade at about 70 cents per dollar of reserves. But falling gas prices have upped the risk for what was an old standby in the Portfolio, and investors need to take note of the increased risk.

Enervest Energy & Oil Sands Total Return Trust (TSX: EOS, OTC: EOSOF)–Advice: SELL. The closed-end fund trades at a discount to net asset value, which may attract some. But few holdings even pay a dividend, so the yield is definitely coming from capital. Look elsewhere for growth and income in the energy patch.

Extendicare REIT (TSX: EXE-U, OTC: EXETF)–Advice: Buy @ 10. Management’s plan to cut costs and limit the impact of Medicare cuts on cash flows beat its guidance in the fourth quarter and full year 2011.

The boost in the payout ratio to 140 percent-plus includes a one-time item–the establishment of a reserve for litigation expenses in the US–and is set to come off markedly in 2012 (see this month’s Feature Article). Management is assuring investors that its plan to convert to a corporation this summer won’t change its dividend policy. But until the conversion and a few more quarters of numbers, there will be uncertainty on the dividend.

FP Newspapers Inc (TSX: FP, OTC: FPNUF)–Advice: SELL. This is another digital growth-versus-paper erosion story. We’ll know a lot more when earnings are finally announced. But based on what we’ve seen the past several quarters here, the trend is definitely negative.

We may see the same payout rate for several more quarters, as management is actually heavily invested in the company. And FP may indeed beat the odds and succeed where many larger newspaper companies in North America have not. In the meantime this looks like one to avoid. Mar. 19 (estimate).

Freehold Royalties Inc (TSX: FRU, OTC: FRHLF)–Advice: Hold. Last month’s successful equity offering was upsized to CAD70.725 million from the originally planned CAD61.5 million. That’s a very big plus for future financing needs and will likely earn the company an exit from the Watch List, assuming first-half results stay on target.

This company is primarily a landowner that collects royalties from others who drill on its lands. Reserves and production are heavily weighted toward liquids, a definite plus in this environment. And that makes the company able to live with a higher payout ratio than would be the case for operating companies.

I want to see the second-quarter numbers, however, before taking the company off the Watch List.

GMP Capital Inc (TSX: GMP, GMPXF)–Advice: Hold. The revival of the Toronto Stock Exchange this year from a generally weak 2011 should be a plus for GMP’s fortunes this year. That’s a real plus given recent quarters of what management has described as deplorable conditions.

The company has no debt maturities through the end of 2013 and is officially in the hunt to acquire a smaller boutique firm to grow its business, a sign of financial strength. Less encouraging is the Ontario Securities Commission’s investigation of a former employee on charges of insider trading.

That’s enough to keep the stock on the Watch List, at least until we see more numbers.

New Flyer Industries Inc (TSX: NFI, OTC: NFYED)–Advice: SELL. Management’s most recent communication with shareholders is to announce talks with an unnamed party to for a “potential commercial and strategic relationship.” The almost certain subtext here is New Flyer is trying to sell itself to a stronger player that can help it ride out today’s horrific operating conditions. That’s definitely a sign of weakness. And it follows the trend of recent quarters, in which earnings have repeatedly lagged prior guidance and order backlog has stumbled.

The company in effect is a direct victim of the fiscal crisis affecting state and local governments across the US. These entities are their customers, and they’re simply not able to pay up for new buses at this time. The company may indeed be heading for a dividend cut even greater than the 50 percent previously projected by management, unless it can find a buyer.

Earnings are expected Mar. 21, at which time we’ll find out more.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–Advice: Hold. The oil and gas producer benefitted from higher prices for its liquids output. But production was flat overall despite a 9 percent boost in capital spending, and there is considerable exposure to natural gas (48 percent of output).

As is the case with other oil and gas producers, the company’s goal is to increase output of liquids and reduce its dependence on dry gas production–which is clearly not profitable at current prices. The question of whether it can hold its dividend depends on its execution, but it’s been made all the more difficult by crashing gas prices.

Two-year debt maturities are just CAD49 million, which is encouraging. So is the fourth-quarter payout ratio of just 42 percent of distributable cash flow. But until we get another couple quarters of results that support the dividend comfortably, there’s risk.

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF)–Advice: SELL. I’m bullish on precious metals for the long term. But all of this closed-end fund’s distribution is now from capital and it trades at more than a 13 percent premium to net asset value. Management can keep paying the current rate so long as it wishes, but doing so does reduce the value of the fund. There are better ways to play precious metals markets.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF)–Advice: SELL. The rise in the Canadian dollar this year may not be a deathblow for this company. It’s basically lived with a rising loonie since its July 2002 initial public offering (IPO). And there are no near-term debt maturities, at least through the end of 2013.

But with the dividend now 80 percent lower than it was at the IPO and the payout ratio heading higher recently, it’s hard to see how another reduction is not in the cards. The next earnings announcement is due out on or about Mar. 19.

I’m not expecting a disaster, as the company appears to have been effective signing on customers to long-term contracts. But the long path here is down and this stock is best avoided.

Bay Street Beat

Bay Street is not the place to look for either the “all-clear” sign or the one marking the apocalypse. This is not a forward-leaning bunch. Their collective glacial actions, however, can shine some light on how the institutional world views our favorites, and changes in official opinion can often result in or explain short-term market movements.

Typical of recent action is Bay Street’s treatment of Just Energy Group Inc (TSX: JE, NYSE: JE) in the aftermath of another solid quarter of customer additions: The stock was downgraded by two houses, but one shifted from “buy” to “overweight,” while the other now says “sector perform” where previously “sector outperform” was the jargon.

Here’s a rundown of Bay Street buy-hold-sell ratings for each Portfolio Holding that has announced quarterly results so far during the recent reporting season, with the average target price among analysts covering the stock in parentheses.

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF) 5–0–2 (CAD34.42)
• Atlantic Power Corp (TSX: ATP, NYSE: AT) 1–3–3 (CAD14.47)
• Bird Construction Inc (TSX: BDT, OTC: BIRDF) 5–2–0 (CAD15.75)
• Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPUF) 5–6–0 (CAD28.08)
• Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) 2–7–1 (CAD23.63)
• Cineplex Inc (TSX: CGX, OTC: CPXGF) 3–9–1 (CAD27.61)
• Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF) 4–1–0 (CAD20.31)
• Dundee REIT (TSX: D-U, OTC: DRETF) 5–1–0 (CAD38.35)
• EnerCare Inc (TSX: ECI, OTC: CSUWF) 3–1–0 (CAD11)
• Just Energy Group Inc (TSX: JE, OTC: JUSTF) 4–3–0 (CAD13.58)
• Keyera Corp (TSX: KEY, OTC: KEYUF) 4–3–1 (CAD49.33)
• Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF) 5–3–1 (CAD30.93)
• Provident Energy Ltd (TSX: PVE, NYSE: PVX) 4–2–0 (CAD12.49)
• RioCan REIT (TSX: REI-U, OTC: RIOCF) 3–5–0 (CAD27.91)
• Shaw Communications (TSX: SJR/B, NYSE: SJR) 7–7–3 (CAD21.98)
• Student Transportation Inc (TSX: STB, OTC: STUXF) 1–1–1 (CAD7.50)
• TransForce Inc (TSX: TFI, OTC: TFIFF) 7–3–0 (CAD21.25)

Aggressive Holdings

• Acadian Timber Corp (TSX: ADN, OTC: ACAZF) 0–4–0 (CAD10.63)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF) 10–8–0 (CAD27.13)
• Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF) 3–3–0 (CAD18.25)
• Enerplus Corp (TSX: ERF, NYSE: ERF) 3–9–4 (CAD26.10)
• Extendicare REIT (TSX: EXE-U, OTC: EXETF) 0–5–0 (CAD8.38)
• Newalta Corp (TSX: NAL, OTC: NWLTF) 9–2–0 (CAD17.34)
• Noranda Income Fund (TSX: NIF-U, OTC: NNDIF) 1–0–0 (CAD8)
• Parkland Fuels Corp (TSX: PKI, OTC: PKIUF) 5–4–0 (CAD14.04)
• Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) 16–2–2 (CAD25.88)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) 11–2–1 (CAD24.73)
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) 5–8–0 (CAD13.32)
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF) 8–4–2 (CAD51.73)

Tips on DRIPs

Provident Energy Ltd (TSX: PVE, NYSE: PVX) has suspended its distribution reinvestment (DRIP) and direct stock purchase plans pending completion of the merger transaction between it and Pembina Pipeline Corp (TSX: PPL, OTC: PBNPF).

The combined Pembina-Provident will apply to list on the New York Stock Exchange (NYSE) once the deal is completed, though nothing has been said yet about a DRIP or a direct purchase plan for the company.

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.

Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE) is now the only CE Portfolio Holding allowing US investors to participate in its DRIP. Information about Penn West’s plan is available here.

Penn West and Provident, because they’re listed on the NYSE, opted into US filing and registration requirements. Whether and when a company lists on the NYSE is a matter of how much overhead expense it’s willing to absorb relative to the potential benefits of accessing a new, larger capital market.

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.

Just Energy Group Inc (TSX: JE, NYSE: JE), which recently listed on the NYSE, has a DRIP but as of yet it is not open to US shareholders.

New Portfolio Holding Shaw Communications (TSX: SJR/B, NYSE: SJR) also hasn’t yet made its DRIP available 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:

• Bank of Montreal (TSX: BMO, NYSE: BMO)
• Bank of Nova Scotia (TSX: BNS, NYSE: BNS)
• Baytex Energy Corp (TSX: BTE, NYSE: BTE)
• BCE Inc (TSX: BCE, NYSE: BCE)
• Enbridge Inc (TSX: ENB, NYSE: ENB)
• EnCana Corp (TSX: ECA, NYSE: ECA)
• Nexen Corp (TSX: NXY, NYSE: NXY)
• Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)
• Potash Corp of Saskatchewan (TSX: POT, NYSE: POT)
• Rogers Communications (TSX: RCI/B, NYSE: RCI)
• Royal Bank of Canada (TSX: RY, NYSE: RY)
• Suncor Energy (TSX: SU, NYSE: SU)
• Telus Corp (TSX: T, NYSE: TU)
• Toronto-Dominion Bank (TSX: TD, NYSE: TD)
• TransCanada Corp (TSX: TRP, NYSE: TRP)