Dividend Watch List

Canfor Pulp Products Inc (TSX: CFX, OTC: CFPUF) was the only Canadian Edge How They Rate company to cut its dividend last month. The company reduced its quarterly payout to CAD0.22 per share from a prior rate of CAD0.25. It follows a reduction from CAD0.40 the previous quarter.

Consecutive quarterly dividend cuts are often a sign of precipitous declines in a company’s business fortunes and of worse to come.

In Canfor’s case more cuts are certainly possible. Lower global pulp prices and the strengthening Canadian dollar–which pushed up operating costs–cut cash flow by more than half from year-ago levels. Operating income, meanwhile, was barely a fifth of what it was last year and 30 percent lower than in the fourth quarter.

Net income, meanwhile, was down 41 percent from the fourth quarter and 82 percent from the first quarter of 2011. Even at the reduced rate of CAD0.22 per share the dividend is 169 percent of net income, though just 55 percent of cash flow per share. Cash flow was 26 percent off fourth-quarter levels and 58 percent below last year.

If there is good news in this report it’s that sales have remained relatively stable overall, slipping 12.8 percent from the first quarter of 2011 but actually rising 3.4 percent sequentially. That’s a good sign Canfor is still holding market share and that its facilities are still performing well. This means it’s still a low-cost producer that’s lost none of its long-term competitiveness.

Rather, the problem of slipping profitability is entirely due to falling pulp prices on the global market. And this is quite a problem at the moment: The average NBSK pulp list price is off 9 percent from year-earlier levels in Canadian dollar terms and is 7.5 percent lower sequentially. That was partly offset by an 8 percent drop in unit manufacturing costs, thanks mostly to lower raw materials costs, particularly fiber used to make pulp (9 percent drop).

Management’s goal as an income trust was to pay out substantially all cash flow it earned. It held that focus when Canfor converted to a corporation in early 2011. And it’s maintained the approach since parent and 50.2 percent owner Canadian Forest Products put the partnership generating all its income completely under its control.

Such an aggressive payout policy has always kept Canfor’s dividend volatile, as management passes along the impact of strong pulp prices as well as weak prices. Distributions hit a high of CAD0.25 per share per month immediately prior to Canfor’s conversion to a corporation, when it also paid a special cash distribution of CAD0.30 per share, thanks to robust pulp prices.

The payout was cut to CAD0.40 per share per quarter at conversion, primarily because of taxes that had to be absorbed. The cuts to CAD0.25 with the February payment and to CAD0.22 for the May payout, by contrast, were due entirely to weaker pulp prices.

How low could Canfor’s dividend go? In February 2009 the payout was slashed to just a penny a month. That followed cuts from CAD0.18 to CAD0.14 in October 2007, to CAD0.12 in November 2007 and to CAD0.04 in December 2008.

In November 2009 dividends began rising again, first to CAD0.05, then to CAD0.08 in December 2009, CAD0.12 in February 2010, CAD0.20 in April, CAD0.22 in July and, finally, to CAD0.25 in September 2010.

On the plus side, management cited some reasons to expect improvement during its first-quarter conference call. These include an improvement in pulp prices in Europe and Asia during the quarter. Even in North America prices seemed to stabilize after dropping sharply in January. Canfor has also made progress improving efficiency of operations. And the consolidation of ownership of the partnership under one roof will also cut costs by simplifying the corporate structure.

Responding to a question posed during the call, CEO Joe Nemeth stated “the board took a cautious approach” regarding the dividend based on expectations for “modest” improvement in global pulp markets. That’s encouraging. And it’s important to remember that events like the 2008 downturn that triggered the big dividend cuts are thankfully rare.

That being said, however, pulp markets may or may not have bottomed, and where they go is of paramount importance to what the company can pay out in quarterly dividends. And no one who isn’t prepared for volatility in both the payout and the share price should be involved with this one. Hold.

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

• 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. Note that all staple share companies tracked in How They Rate have now issued plans to deal with new rules on staple shares, most affirming current dividend rates.

Here’s the current Watch List, which reflects fourth-quarter and full- year 2011 earnings releases and guidance calls for 2012 as well as levels of debt as of the end of 2011. It doesn’t reflect the vast majority of first-quarter 2012 results. Consequently, there are few changes from last month. Look for more new entries and hopefully exits next month, after that information becomes available.

Aston Hill Income Fund (TSX: VIP-U, OTC: BVPIF), a closed-end fund, holds a large amount of cash and bonds in addition to stocks, including a large portion of US stocks. That makes its ability to continue paying its current dividend even more difficult to fathom without using a large amount of leverage.

If there is a stumble and a cut, the fund’s price could drop sharply. Sell.

Capstone Infrastructure Corp (TSX: CSE, OTC: MCQPF) management has yet to set what it considers a “sustainable” dividend rate for the future. And until it does a dark cloud is going to hang over this stock, which now trades with a yield of nearly 17 percent.

A reduction to a rate of CAD0.035 per month would still produce a yield of nearly 11 percent. But resolution of the dividend policy depends on an agreement being reached for the Cardinal power plant. There’s been a dearth of news on the progress of negotiations going back nearly two months. And that’s no guarantee anything will be forthcoming anytime soon.

Management’s next opportunity to discuss numbers will be May 15, and it’s possible there will be some hard news then. Until then, however, those holding the stock can only watch and wait. Hold.

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF) has attempted in recent years to diversify its operations beyond its relationship with Air Canada Inc (TSX: AC/A, OTC: AIDIF). That effort now appears to have been in vain, as Thomas Cook has broken a multi-year contract to operate certain planes in favor of tightening its relationship with WestJet Airlines Ltd (TSX: WJA, OTC: WJAFF).

Thomas Cook’s move may or may not have anything to do with Chorus’ ongoing arbitration with Air Canada over the terms of their operating agreement. But the latter’s financial plight has become increasingly desperate, and the contract with Chorus is something its management would definitely like to either abrogate or dramatically amend.

We’ve seen this happen once before, and the result was a dividend cut for Chorus. This appears to be what’s in store this time around as well, even as high oil prices erode airlines’ margins in general. Sell.

Colabor Group Inc’s (TSX: GCL, OTC: COLFF) results appear to have stabilized, and the current dividend should be sustainable.

This is still a business facing tough conditions, but management’s strategic plan to grow by consolidating smaller companies appears to still be on track. This is ultimately the key to Colabor creating shareholder value.

Despite the dividend cut earlier this year, I’ll continue to hold the stock in the CE Portfolio Aggressive Holdings. Hold.

Data Group Inc (TSX: DGI, OTC: DGPIF) has made very little noise since it released fourth-quarter and full-year 2011 earnings in early March. We don’t have to wait that long for numbers this time, as first-quarter numbers are now expected to be released on or about May 14. I’m optimistic results will pick up where generally solid fourth-quarter earnings left off.

That would go a long way toward quelling worries about future dividends, which will likely add a dollar or two to Data’s share price.

There are, however, all too many examples of print-to-digital companies failing to make the jump. And so long as this company is still a work in progress, only aggressive investors should focus on it, and then at lower prices than we now have. Hold.

Enerplus Corp’s (TSX: ERF, NYSE: ERF) debt level is the primary source of worry, as the company attempts to expand its production of light oil and natural gas liquids. The challenge got a lot more difficult this year with the drop in natural gas prices, as management had chosen not to hedge any of its output.

When I sold this stock from the Aggressive Holdings last month it immediately shed a bit more ground. But the share price has since rebounded a bit, as natural gas prices have poked back up above USD2 per million British thermal units.

The company’s ability to issue USD405 million in debt via a private placement plan was impressive, particularly given the modest interest rates. The 12-year note was issued with a coupon yield of 4.4 percent. This debt will be paid off in five equal installments beginning in 2020.

The debt issue does take some pressure off the credit line. Unhedged natural gas, however, fetched less than USD2 per million British thermal units in the first quarter, versus about USD3.41 in the fourth quarter of 2011. Realized selling prices for oil should be higher, providing some offset.

But until we see the next set of numbers on or about May 14, trying to figure out the impact of falling gas on the bottom line is guesswork. My own guess is that the company will generate enough cash flow to cover the distribution. But the sum of capital spending plus the dividend will far exceed cash flows, bringing the day closer when management has to cut the dividend.

I still like Enerplus’ management and its assets, but it’s increasingly between a rock and a hard place. As an investor, I don’t want to join it there. Sell.

EnerVest Energy & Oil Sands Trust’s (TSX: EOS, OTC: EOSOF) problem is that virtually none of the holdings pay dividends. That leaves stock sales and return of capital as the only ways to fund the dividend, which saps the fund of value. Sell.

Extendicare REIT (TSX: EXE-U, OTC: EXETF) management’s contention that cost savings will cover enough of the shortfall from slashed Medicare payments to hold the current dividend level seems credible, and I’m still betting on management to be correct. But I’m also very skeptical, given what the company’s up against.

Although this is still an Aggressive Holding, I view every earnings announcement as make-or-break. So long as there’s progress with the cost moves and cash flows are hanging in there, I’ll stick around. But if there’s notable deterioration or a change in guidance for the worse, I’ll probably sell and take the loss.

The next big date is Wednesday, May 9, when first-quarter results are released. Again, I’m cautiously optimistic, but this stock is for more aggressive investors only. Hold.

FP Newspapers Inc’s (TSX: FP, OTC: FPNUF) primary risk, as is clearly reflected in the stock price and 13 percent-plus yield, is that the traditional print newspapers and advertising business will lose revenue faster than management can grow the digital and online side of the operation.

On the plus side, there has been some success in that area, and acquisitions have altered the revenue mix more favorably. But at last look the print business was noticeably declining, even as the local economy in the Winnipeg area appears to be turning up.

That’s never a good sign, and we’re probably going to have to wait until Jun. 8 or thereabouts to get first-quarter numbers to see if there’s any real improvement. Sell.

GMP Capital Inc (TSX: GMP, GMPXF) has a new chairman in Donald Wright, a former president of Merrill Lunch Canada and one-time CEO of TD Securities, a unit of Toronto-Dominion Bank (TSX: TD, NYSE: TD). Mr. Wright’s stature should help GMP retain its enviable position as a boutique firm with several valuable niches on the Toronto Stock Exchange.

The purchase of a New York bond trader, for example, is paying off both as a business and as a way to increase capability in mergers and acquisitions.

My main problem with GMP is simply its high payout ratio, the result of deteriorating earnings in recent months. I fully expect to see improvement in 2012. But until there are a few quarters of decent results, the dividend will remain at risk. Hold.

New Flyer Industries Inc’s (TSX: NFI, OTC: NFYED) planned dividend cut of at least 50 percent is still arguably not fully reflected in the bus manufacturer’s share price. And that business is hardly in the pink of health, with cash-strapped municipalities and others unable to place orders.

On the plus side, the company has worked a deal with the Canadian Auto Workers at its Winnipeg, Manitoba, transit bus plant that will provide cost stability for the next three years. And there are some interesting developments in its product line that should eventually pay off with solid sales.

At this point, however, new orders are difficult to come by and margins are constantly under pressure. May 9 will see the release of earnings, but investors should not expect to see any improvement. Sell.

Precious Metals & Mining Trust (TSX: MMP-U, OTC: PMMTF) trades at a premium of more than 20 percent to the value of its assets, which is all you really need to know to sell this closed-end fund of mining stocks.

The reason is the yield of nearly 15 percent is still attracting investors. This payout, however, is backed by actual dividend income of 0.13 percent from the fund’s holdings, meaning the cash is being conjured up from leverage and simply selling assets. That’s not a long-term strategy, and when there is a cut investors can expect a steep fall in the fund’s units.

So long as natural resource prices stay strong, mining stocks will eventually recover. That could restore some value to this fund and shore up the dividend. But investors are still paying more than USD1.20 for a buck’s worth of assets, making individual mining stocks a much better bet. Sell.

Ten Peaks Coffee Company Inc (TSX: TPK, OTCL SWSSF) was among the very last in the CE coverage universe to report fourth-quarter and full-year 2011 earnings. And it looks like it will be among the very last to come in with first-quarter 2012 results, with a projected date of Jun. 8.

One thing we can infer in advance, however, is that the strong Canadian dollar is likely to take a bite out of profit. That’s from a lower value of foreign earnings as well as from margin compression, as Ten Peaks’ products are forced to compete with those of companies in countries with lower valued currencies.

This formula has produced a roughly 80 percent cut in dividends since Ten Peak’s initial public offering in July 2002. And it’s hard to see it not producing another cut this year or early next at the latest, taking this stock even lower. Sell.

Zargon Oil & Gas Ltd’s (TSX: ZAR, OTC: ZARFF) capital resources continue to be strained by falling natural gas prices and management’s move to push up liquids production for the small producer. The yield of well over 9 percent is definitely pricing in the threat of another dividend cut already.

More alarming, however, was the steep increase in costs resulting from the shift from gas to oil. If this trend continues a prospective dividend cut will be a lot more than the market now expects. The next set of numbers will be out on or about May 11.

Given the drop in natural gas prices a cut certainly can’t be ruled out, particularly since the company was recently forced to issue new five-year debt at an interest rate of 6 percent. The real number to watch, however, will be costs and if management can get them under control while meeting production targets.

If it can do that, my opinion on this stock will improve. If not, look out below. Sell.

Bay Street Beat

Only a handful of CE Portfolio companies have reported first-quarter 2012 earnings as of press time.

AltaGas Ltd (TSX: ALA, OTC: ATGFF) was the subject of a downgrade by FirstEnergy Capital, to “market perform” from “outperform.” FirstEnergy also reduced its target price for the stock to CAD35 from CAD37. “Market perform” means “hold” in Bloomberg’s standardization of Wall Street analyst-speak. Six other analysts maintained their ratings post-earnings.

Shaw Communications Inc’s (TSX: SJR/B, NYSE: SJR) fiscal 2012 second-quarter numbers inspired EVA Dimensions to “downgrade” the stock to “overweight” from “buy.”

That’s still “buy” according to Bloomberg, and I have no insight into EVA Dimensions’ terminology. Thirteen analysts maintained their ratings on Shaw following the earnings release.

TransForce Inc (TSX: TFI, OTC: TFIFF) earned an upgrade to “outperform” from “sector perform” at National Bank Financial. NBF bumped its target for TransForce from CAD19.50 to CAD22. Eight other analysts maintained their postures on the stock.

Fellow Conservative Holding RioCan REIT’s (TSX: REI-U, OTC: RIOCF) results led seven analysts who cover the stock to maintain their ratings.

Aggressive Holding ARC Resources Ltd (TSX: ARX, OTC: AETUF) also got the chop at EVA Dimensions, from “overweight” to “hold.” EVA doesn’t provide target prices. Macquarie boosted the stock to “outperform” from “neutral” and revised its target from CAD23.25 to CAD25. Thirteen analysts maintained their ratings on the stock.

Colabor Group Inc’s (TSX: GCL, OTC: COLFF) first-quarter results earned it an upgrade at National Bank Financial, to “sector perform” from “underperform” with a static price target of CAD7.50. Six analysts weren’t moved either way by the numbers.

PHX Energy Services Corp (TSX: PHX, OTC: PHXHF) was downgraded by National Bank Financial to “underperform” from “sector perform.” NBF reduced its price target to CAD9 from CAD11. Seven analysts maintained existing ratings on the stock.

Acadian Timber Corp (TSX: ADN, OTC: ACAZF) did enough for four analysts to maintain their ratings following their review of its first-quarter numbers.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH), with 13 “maintains,” and PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF), with 17, provided steady numbers that inspired no ratings changes.

Here’s a rundown of Bay Street buy-hold-sell ratings for the 10 that had announced results and for which we’ve provided analysis, with the average target price among analysts covering the stock in parentheses.

Conservative Holdings

• AltaGas Ltd (TSX: ALA, OTC: ATGFF)–5–1–2 (CAD35.21)
• RioCan REIT (TSX: REI-U, OTC: RIOCF)–3–5–0 (CAD26.51)
• Shaw Communications Inc (TSX: SJR/B, NYSE: SJR)–6–7–3 (CAD20.82)
• TransForce Inc (TSX: TFI, OTC: TFIFF)–8–2–0 (CAD22.13)

Aggressive Holdings

• Acadian Timber Corp (TSX: ADN, OTC: ACAZF)–0–4–0 (CAD11.13)
• ARC Resources Ltd (TSX: ARX, OTC: AETUF)–9–9–1 (CAD25.06)
• Colabor Group Inc (TSX: GCL, OTC: COLFF)–0–5–2 (CAD7.11)
• Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–3–10–2 (CAD9.95)
• PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–14–6–0 (CAD20.56)
• PHX Energy Services Corp (TSX: PHX, OTC: PHXHF)–3–10–1 (CAD11.96)

Tips on DRIPs

Pembina Pipeline Corp’s (TSX: PPL, NYSE: PBA) acquisition of Provident Energy Ltd is now complete. The latter’s dividend reinvestment plan (DRIP) has been suspended. The former–or the now combined company–is trading on the New York Stock Exchange (NYSE) under the symbol PBA.

Pembina Pipeline has not yet made any announcement about its intentions with regard to opening its DRIP to US investors.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH), which replaced Enerplus Corp (TSX: ERF, NYSE: ERF) in the CE Portfolio as of the April issue, sponsors a DRIP that is available to US investors, with some limitations. Information is available here.

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.

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.” 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. 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, Just Energy, Shaw Communications 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)
• Penn West Petroleum Ltd (TSX: PWT, NYSE: PWE)
• 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)