There’s no doubt current market perception of trusts’ 2011 risk—well baked into share prices since November 2006—is vastly overblown. The happy result: Answering 2011 questions can unlock incredible values in trusts backed by good businesses.

That’s been the case for Aggressive Portfolio holding Trinidad Drilling (TSX: TDG, OTC: TDGCF): Its shares have been on fire since its Jan. 9 announcement that it would convert early to a corporation. And it will certainly by the case for Conservative Portfolio holding Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF) and Aggressive pick TransForce Income Fund (TSX: TIF-U, OTC: TIFUF).

Atlantic won’t need to reorganize to remain tax advantaged in 2011. That’s because it’s not technically a specialized flow through security (SIFT). Rather, its units are staple shares called Income Participating Securities (IPS), which combine debt with equity into a single high-paying security. The current distribution is roughly 60 percent debt interest and 40 percent equity dividend.

In TransForce’s case, answering its 2011 questions required taking a dramatic step. And that’s precisely what management announced on March 28: conversion from a trust to an ordinary corporation, a move it had been telegraphing for nearly a month. Shareholders will vote on the proposal at the company’s annual meeting in May.

How much value will TransForce’s move unlock? The few days since the announcement are too short a time to get a real read. But the market reaction thus far at least has been generally favorable. Shares have actually recovered most of the ground lost following the Feb. 28 release of what were troubling fourth quarter earnings.

Not coincidentally, Trinidad followed that pattern when it announced its conversion earlier this year. The challenge is keeping that going—now that 2011 taxation questions are answered—depends entirely on how TransForce’s business performs going forward.

As I pointed out in the March 2008 Portfolio section, the trucking and transport company’s payout ratio soared to 155.9 percent in the fourth quarter, nearly double the level of prior periods. Management blamed the shortfall on the depressing impact of higher fuel costs, the weak US economy and the rising Canadian dollar, which resulted in an 18 percent drop in distributable cash flow from operating activities. That combined with the costs of TransForce’s aggressive acquisition program—chiefly added debt—to depress cash flow available for distribution.

I wrote then that TransForce’s distribution didn’t look sustainable, given management’s cryptic comments in its fourth quarter earnings report and the outlook for further US economic weakness at least in the first half of 2008. However, I also thought that realistic risk to distributions and the business itself was more than priced in.

That, more than anything else, was the basis for my decision to hold onto TransForce last month rather than sell in the face of uncertainty. And as it turned out, that nonmove was the correct one. In fact, the market was pricing in a lot worse than the eventual cut in the dividend rate to a quarterly 10 cents Canadian a share.

Now that the 2011 uncertainty is gone, however, we’re faced with even more important questions: Just how strong is TransForce’s underlying business, and are its shares worth holding, with its yield at current prices between 5.5 percent and 6 percent?

The answer is yes. First and foremost, successful investing is all about underlying businesses, whether your objective is income or growth. And despite its recent troubles because of the macro economy in the past year, TransForce has relentlessly executed on its strategy of acquiring smaller transport companies to consolidate its market share.

For example, despite the ongoing reorganization, management completed the acquisition of a 50 percent stake in a Quebec landfill site the company didn’t already own. And management said it’s currently in “advanced discussions” for deals worth CAD100 million more.

The conversion and resulting distribution cut means less immediate cash flow for investors. But it will free up a great deal of cash for the trust to continue expanding, and the opportunities are staggering: More than 70 percent of the USD55 billion in annual revenue the Canadian transport industry generates still comes from companies garnering USD25 million or less. Every one of those companies is a potential target for TransForce, which has nearly quadrupled revenue since 2002 to USD2 billion in large part by inking some 75 individual deals.

Management sees business as challenging at least through the end of 2008. But what’s tough for a giant like TransForce is at least doubly so for industry fry, which should translate into better prices for acquisitions and ultimately greater growth for the company.



As noted last month, TransForce has never been in any danger of insolvency, with annual cash flow covering total debt on the books by a 1.23-to-1 margin as of the end of 2007. Shepherding more of its cash flow should enhance management’s ability to keep debt under control and will probably improve credit terms. Meanwhile, the dividend of 40 cents Canadian as a percentage of taxable 2007 earnings per share is only 48.1 percent, which allows considerable room for growth as the company expands.

TransForce is only the second trust to follow the Trinidad model for early conversion. And again, it’s too early to tell just what value investors will ultimately attach to these entities that yield somewhere in between traditional corporations and traditional income trusts.

As long as the company executes its strategy, it will become more valuable as a business, and that will ultimately translate into a higher share price and more dividends. Moreover, with the exception of transport companies that are still Canadian trusts, it’s the highest-yielding play on this industry in North America. And you won’t find anything cheaper on other measures either, at nine times trailing earnings, 1.35 times book value and 34 percent of annual sales.

TransForce Income Fund is a buy up to USD9. Note that trust units will automatically be exchanged into shares of stock when the conversion is made, though unitholders will be asked to vote on the deal next month. I recommend voting yes.

As for Atlantic, it’s not an operating business per se. Managers run a portfolio of interests in 14 power plants primarily in the US, as well as California’s Path 15 high-voltage transmission line. The key to running this business well is risk management, and CEO Barry Welch and his team are well suited for it, having come out of the insurance business.

The surest proof is in continuing strong results, including fourth quarter numbers released last week. Atlantic’s end-year reporting period is longer than that of operating companies, largely because management must wait on results from all of the various projects and partnerships in which it has interests. Fortunately, these results were very much worth the wait.

Atlantic’s cash flows from operating activities rose 97.6 percent over fourth quarter 2006 levels, triggering a 78 percent jump in cash available for distribution. Cash available for distribution per share, in turn, surged 39.1 percent, despite a 10.3 percent boost in IPS shares to finance growth. That produced a payout ratio of 80.3 percent, the company’s lowest fourth quarter tally in history and down sharply from last year’s 117.4 percent.

Underlying numbers were arguably more impressive still. Not every project had sterling results.

But of Atlantic’s 11 largest investments, eight generated significantly more cash flow in the fourth quarter of 2007 than the year earlier. Moreover, management successfully controlled all its key risks, from currency fluctuations to fuel costs and individual project performance, which is essentially the key to the consistent, reliable shareholder returns Atlantic generates.

The full-year payout was 83 percent, which should come down further in 2008 as Atlantic reaps the benefit of new projects completed last year and absorbs acquisitions. That leaves room for an increase in the already generous 10 percent-plus distribution.

Management may elect to shepherd cash to further enhance growth. The company recently added to the merger-and-acquisition talent in its executive ranks, and Welch has made no secret of his desire to further flesh out the asset base, both to enhance cash flows and control overall risk. That makes more deals a certainty, which ultimately means more cash flow and greater ability to pay dividends.

There’s also a possibility that Atlantic will elect to redeem the debt portion of its IPSes. At the bottom of p. 51 in the company’s 2007 Annual Information Form—accessible at its Web site, listed in the How They Rate Table—management states its “current intention is to exercise” its “call on the earliest feasible date following November 19, 2009.”

Should it elect to do so, the IPS would immediately separate into equity and debt portions. The debt portion—which is an 11 percent note with a due date of Nov. 18, 2016—would then be redeemed for 105 percent of its principal amount. That premium adjusts down to 104 percent if redemption occurs after Nov. 19, 2011 and then falls a percentage point each year to parity in 2016.

The principal value of the notes is CAD5.767 per IPS. That would put their November 2009 redemption value at roughly CAD6.06 per IPS. Here’s how it breaks down, if management elects to redeem the notes.

First, IPS holders will get CAD6.06 in cash. Second, they’ll retain the equity portion of Atlantic IPSes, which will essentially be common stock. Based on Atlantic’s current price, that future stock is valued at about CAD4.19 per IPS.

How valuable will that stock be? First, assuming no distribution increases between now and November 2009, Atlantic will pay a dividend of 3.55 cents Canadian a month. That’s the current equity portion of the overall distribution of 8.84 cents Canadian a month. The annual rate is 42.6 cents Canadian a year, or a yield of more than 10 percent on the current equity value of Atlantic IPSes—roughly what Atlantic IPSes are yielding right now.



Atlantic will also save some CAD36.7 million in annual interest payments that are currently based on the 11 percent coupon rate of the notes. That will further deleverage the balance sheet and should improve credit terms, though management will likely have to borrow elsewhere to come up with the cash to pay for redemptions.

Trying to figure out what management will do is speculative. The point is, as long as the business stays healthy and growing, Atlantic IPS holders will make out fine either way. In fact, our investment is likely to grow a lot faster should management make the redemption. And redeeming the debt portion of the IDS may also bring a higher valuation to the resulting stock by removing a complication to this investment that seems to routinely befuddle brokers.

How well we do ultimately with Atlantic will depend squarely on what Welch and his team do from here. That’s true with any stock.

It’s doubly true for what’s basically a diversified portfolio of power assets. Happily, 2007 results have affirmed again that Atlantic’s team is worthy of our bets. Atlantic Power Corp’s IDSes remain a solid buy anytime they trade under USD12.

For more information on both Atlantic Power Corp and TransForce Income Fund, visit the How They Rate Table. Click on the “.UN” symbol to go to the Web site of our Canadian partner MPL Communications for press releases, charts and other data. These are substantial companies, so any broker should be able to buy them, either with their Toronto or over-the-counter (OTC) symbols. Ask which way is cheapest.

Note that both trusts’ dividends are considered qualified for tax purposes in the US. Tax information to use as backup for filing them as qualified—whether or not there are errors on your 1099—is listed in the Income Trust Tax Guide.

Also, as is customary for virtually all foreign-based companies, Canada withholds 15 percent of distributions to US investors at the border. This tax can be recovered by filing a Form 1116 with your US income taxes. The amount of recovery allowed per year depends on your own tax situation, though unrecovered amounts can be carried forward to future years.

TransForce Income Fund & Atlantic Power Corp
Toronto Symbol	TIF-U	ATP-U
US Symbol	TIFUF	ATPWF
Recent USD Price*	7.70	10.16
Yield	5.2%	10.3%
Price/Book Value	1.37	5.47
Market Capitalization (bil)	CAD0.677	CAD0.632
DBRS Stability Rating	none	none
Canadian Edge Rating	4	2

*Recent USD Price as of 04/03/08