Editor’s Note: What follows is the executive summary of the March 2013 issue of Canadian Edge. Thanks for reading. — RSC

The Keystone XL pipeline is still apparently the political third rail the Obama administration doesn’t want to touch. This week the president reportedly dined with a group of Republican senators, who urged him to approve the pipeline but were later referred to his energy advisor, Heather Zichal.

Neither President Obama nor Secretary of State John Kerry has been willing to indicate publicly in any way how they’ll eventually rule on the project. That’s despite the cover of a State Dept report indicating little if any environmental impact from building the “northern leg” of Keystone, or even that a decision one way or the other would affect the development of the Canadian oil sands itself.

Canada’s determination to push ahead certainly appears clear from the way companies are still ponying up to continue projects, despite record price differentials between Canadian and US oil due to lack of pipeline capacity.

But at its heart Keystone XL has become a highly emotional issue and therefore an unpredictable one.

Builder TransCanada Corp (TSX: TRP, NYSE: TRP) currently anticipates a mid-2013 approval for the project. And if that proves to be the case management projects a startup date for late 2014 or early 2015.

But with more than a month left in the “comments” period and potentially 90-day consultation between federal departments following that, there’s a lot of potential for further delays.

As I pointed out in the February In Focus feature Canada’s Oil Discount: Opportunity and Risk, the chief consequence of inadequate energy transportation capacity is wide price differentials between oil that’s closest to Gulf Coast refineries and black gold that’s further away as in Canada.

There are still potential outlets for Canadian bitumen from the oil sands if Keystone XL is nixed. Rail, for example, is becoming a major resource for many Canadian oil producers, including new Aggressive Holding and March Best Buy Enerplus Corp (TSX: ERF, NYSE: ERF). The longer pipelines don’t get built, however, the longer big price differentials will exist and the more profits will get pinched across the energy patch.

Some of the best news from fourth-quarter and full-year 2012 earnings season was the numbers put up by energy producers that were still able to sell their oil at robust prices and by services and midstream companies that stayed active.

Unfortunately, they were outnumbered by those suffering from falling prices and less drilling. And from the way 2013 has started the rest of the year is likely to prove equally challenging.

At this point Canadian Edge Portfolio energy producers are down to a very hearty few. And as fourth-quarter numbers again showed, our recommendations whose primary business is serving producers are also very well positioned, focused on fee-based operations and stronger companies as customers.

Rather, where I’ve suffered from exposure to economic headwinds this reporting season has been with two companies I once deemed suitable for even the most conservative investors, Atlantic Power Corp (TSX: ATP, NYSE: AT) and Just Energy Group Inc (TSX: JE, NYSE: JE).

Both posted 2012 numbers that were basically in line with management’s previous guidance. But they also issued sharply lower calendar 2013 guidance, based in large part on a very dour outlook for the North American wholesale electricity market. Both companies cut dividends, and both stocks took hard hits.

We’ve poured out a lot of virtual ink on both companies in the aftermath of this news, and there’s more in this issue. Despite losses and the investor fear attached to them, I’m willing to keep betting on the eventual success of their business plans, within the balance of the CE Portfolio.

The important lesson here, however, is there’s no guarantee that companies successfully weathering past debacles will always be able to do so without taking hits. Both Atlantic Power and Just Energy actually raised dividends in the midst of the 2008 meltdown, and they successfully converted to corporations in 2011 without cutting them as well.

The depth and length of the slump in power prices, however, forced management to make adjustments to keep long-term growth plans alive.

Diversification and balance are the only real defense against such unexpected debacles. That means taking money off the table when an investment in a stock grows out of proportion to the rest of what you have. It also means not pursuing emotional strategies such as averaging down a falling stock.

The biggest surprise for me putting together this issue of Canadian Edge is the fact that, despite big drops in two longtime holdings, the overall Portfolio is still right around breakeven year to date. And that includes a drop of nearly 4 percent in the Canadian dollar exchange rate versus the US dollar.

Spread your bets.

Roger Conrad
Editor, Canadian Edge

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Portfolio Update

 

Our focus for the past several weeks has been Portfolio earnings.  I’ve highlighted the news and numbers of individual companies in a series of Flash Alerts that are archived at www.CanadianEdge.com as well as in the February issue.

The March Portfolio Update highlights results for the following companies:

• Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)
• Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)
• Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)
• TransForce Inc (TSX: TFI, OTC: TFIFF)
• Vermilion Energy Inc (TSX: VET, OTC: VEMTF)
• Wajax Corp (TSX: WJX, OTC: WJXFF)

I’ve published a complete list of links to my analysis of all Portfolio companies, along with tables showing recommendations’ performance and how they currently stack up under the CE Safety Rating System.

Note that Vermilion Energy Inc (TSX: VET, OTC: VEMTF) is slated to list on the New York Stock (NYSE) on or about March 12.

I’ve made two Portfolio changes this month. I’m adding March Best Buy Enerplus Corp (TSX: ERF, NYSE: ERF) to the Aggressive Holdings. I’m also moving Atlantic Power Corp (TSX: ATP, NYSE: AT) into the Aggressive Holdings to reflect a risk/reward balance more befitting risk takers.

Portfolio Update has the latest numbers, news and moves.

 

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Best Buys

Both of this month’s Best Buy selections have actually cut dividends in the past 12 months, have suffered in the stock market but are now on the come.

I’m restoring Enerplus Corp (NYSE: ERF) to the Aggressive Holdings following the company’s release of very solid fourth-quarter results. The producer has successfully made the jump to reliance on oil and natural gas liquids from natural gas while keeping its debt leverage at a manageable level.

There are still some headwinds, including still hefty oil price differentials. But here too management has shown its dexterity by utilizing rail transport. Buy Enerplus Corp up to USD15.

The other Best Buy is food and related products distributor Colabor Group Inc (TSX: GCL, OTC: COLFF). The company won’t announce its fourth-quarter and full-year 2012 earnings until March 22, at which time we’ll have a Flash Alert. But my expectation is to then move the stock from the Aggressive to the Conservative Holdings, thanks to a series of transactions announced in recent weeks.

The biggest of these is the purchase of T. Lauzon’s meat businesses, which adds revenue and scale to shore up the dividend. The company also pulled off a successful CAD30 million private equity offering and attracted pension investor The Caisse as a major investor.

Colabor Group is a buy up to USD8 for more aggressive investors while we wait on the numbers.

Best Buys–which features the top two candidates for purchase in March–is the place to start if you have money to put to work right now.

 

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In Focus

In 2011 former Canadian income trusts converted en masse to corporations, roughly half reducing dividends to reflect higher taxes. The big surprise for many investors was that most have rallied strongly since, including some of those that cut dividends the most.

Since then there have been separate 36 dividend cuts in the How They Rate coverage universe. In contrast to conversion-related cuts, underlying business weakness was at fault.

Yet in most cases cutters have wound up on higher ground several months later.

In Focus highlights the past two years of dividend cuts in Canada, including the magnitude of reductions, subsequent share price performance and any future action on dividends paid. And I have several key takeaways to help us decide when a dividend cut is really a buying opportunity for a stock, and when it’s a reason to cut and run.

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Dividend Watch List

Atlantic Power Corp’s (TSX: ATP, NYSE: AT) surprising change in its capital strategy accounted for the only dividend cut in the How They Rate universe since the February issue.

We first highlighted the initial news in a March 1 Flash Alert, Atlantic Power Disappoints, Four Other Holdings Don’t. We followed up with more information later that day in the Flash Alert Four Solid Reports and More on Atlantic Power. And on March 6 we released Atlantic Power: What Happened, which highlighted our interview with CEO Barry Welch and our ongoing strategy for this stock.

To review, it’s now a hold and I’ve moved it to the Aggressive Holdings to emphasize changed risk/reward parameters from management’s new strategy. I’ll consider changing my recommendation in coming months depending on how the company stacks up on the following benchmarks:

• Successful completion of the sale of the Florida plants at the stated price.
• Successful syndication of the Canadian Hills financing.
• At least one new project announcement.
• Successful completion of the Path 15 power line sale.
• Payout ratio in line with guidance.

Dividend Watch List has more on Atlantic Power as well as updates on members of the How Rate Coverage universe whose current payout rates are vulnerable.

 

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Canadian Currents

The news on North American employment is good, the Middle Kingdom reiterated commitments to spend and grow, and the Canadian dollar is looking like a great value at these levels.

Canadian Currents has the latest Statistics Canada and the US Dept of Labor reports on February job creation, the word from China’s annual parliament meeting and a perspective on the recent descent of the loonie.

Bay Street Beat–Analysts on Canada’s equivalent to Wall Street have had their say on Atlantic Power Corp’s (TSX: ATP, NYSE: AT) new direction. And there are several other companies whose statures have changed in the eyes of analysts.

Bay Street Beat has the latest on what analysts are thinking about our favorites.

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How They Rate Update

 

Coverage Changes

We’re adding four more companies to How They Rate coverage this month, three to the Oil and Gas section, Argent Energy Trust (TSX: AET-U, OTC: ANGYF), Eagle Energy Trust (TSX: EGL-U, OTC: ENYTF) and Parallel Energy Trust (TSX: PLT-U, OTC: PEYTF), and one to Electric Power, Crius Energy Trust (TSX: KWH-U, OTC: None). All four were profiled in the February Canadian Currents and start out as holds.

There are no deletions from How They Rate coverage this month. But CNOOC Ltd (Hong Kong: 883, NYSE: CEO), the listed subsidiary of China National Offshore Oil Corp, has completed its takeover of Nexen Inc for CAD27.50 per share in cash. The deal was completed March 1, and shareholders of the former Nexen should be receiving their cash very shortly, if they haven’t already.

Also note that trading in Poseidon Concepts Corp (TSX: PSN, OTC: POOSF) has been halted as of Feb. 15. The latest update from the company is the interim chief financial officer and former CFO have now both stepped down, per the mandate of the Special Committee. My advice is still to sell Poseidon Concepts at the first available opportunity.

Advice Changes

A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF)–To Hold from Buy @ 22. Same-store sales were healthy in the fourth quarter, but taxes have taken the payout ratio up to 115 percent of distributable cash flow. It’s time to be a bit cautious.

Atlantic Power Corp (TSX: ATP, NYSE: AT)–To Hold from Buy @ 11. Management’s dramatic shift in strategy has hardened the company against a weak North American power market. But the company needs to meet some benchmarks (see Dividend Watch List) before it’s worthy of new money.

Bonvista Energy Corp (TSX: BNP, OTC: BNPUF)–To Hold from Buy @ 15. Fourth-quarter results were solid but not inspiring. This company needs higher natural gas liquids prices.

EnerVest Energy & Oil Sands Total Return Trust (TSX: EOS-U, OTC: EOSOF)–To Hold from SELL. The fund’s portfolio has apparently shifted to a more conservative mix of undervalued companies.

Exchange Income Corp (TSX: EIF, OTC: EIFZF)–To Buy @ 28 from Hold. Strong fourth-quarter results and an accretive acquisition announced last month earn this new How They Rate entry a “buy” rating.

Manitoba Telecom Services Inc (TSX: MBT, OTC: MOBAF)–To SELL from Hold. Fourth-quarter results showed erosion in the company’s wireless business for the first time.

Pengrowth Energy Corp (TSX: PGF, NYSE: PGH)–To Buy @ 5 from Hold. Fourth-quarter results demonstrated for the first time the success of the company’s transition to oil-weighted production. The dividend appears well covered by cash flow even at very low natural gas prices.

Wajax Corp (TSX: WJX, OTC: WJXFF)–To Hold from Buy @ 45. Fourth-quarter profit covers the dividend but showed the strain of reduced drilling in western Canada. Management is counting on a strong second half 2013.

Ratings Changes

A&W Revenue Royalties Income Fund (TSX: AW-U, OTC: AWRRF)–To 4 from 5. The payout ratio rose to 115 percent of distributable cash flow, as taxes took a sharper bite.

Atlantic Power Corp (TSX: ATP, NYSE: AT)–To 2 from 4. Fourth-quarter numbers were actually in line with the previous forecast. But details in the 2013 guidance cloud future earnings visibility, at least until certain benchmarks are met.

Barrick Gold Corp (TSX: ABX, NYSE: ABX)–To 3 from 4. The CAD3.8 billion writedown of the company’s copper assets is definitely a stumble and clouds the future outlook, despite still massive margins on gold sales.

Dundee Industrial REIT (TSX: DIR-U, OTC: DREUF)–To 5 from 4. The REIT’s first distribution increase in its brief history provides strong visibility on future results and earns the company a Safety Rating System point.

Manitoba Telecom Services Inc (TSX: MBT, OTC: MOBAF)–To 3 from 4. Shrinking wireless revenue diminishes future earnings visibility for this company, which last cut its dividend in August 2010.

Wajax Corp (TSX: WJX, OTC: WJXFF)–To 2 from 3. The company loses a point for its payout ratio, which rose to 96 percent in the fourth quarter of 2012.

Yellow Media Ltd (TSX: Y, OTC: YLWDF)–To 1 from 0. The company’s emergence from managed bankruptcy means it no longer has debt coming due between now and the end of 2014.

That earns it a Safety Rating System point, though it’s more than offset by a noticeable fourth-quarter deceleration in the growth of its online business. Fourth-quarter revenue overall shrank another 15.6 percent.

Safety Ratings

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

• Payout Ratio–A ratio below our proprietary industry baseline.
• Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
• Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
• Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
• Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
• Dividend History–No dividend cuts over the preceding five years.

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Resources

 

The following Resources may be found in the top navigation menu at www.CanadianEdge.com:

• Ask the Editor–We will reply to your queries via email or in an upcoming article.
• Broker Guide–Comparison of brokers for purchasing Canadian investments.
• Getting Started–Tour of the Canadian Edge website and service.
• Cross-Border Tax Guide–What you need to know about taxes and Canadian investments.
• Other Websites–Links to other websites to help you get the most out of your Canadian stocks.
• Promo Stocks–Guide to the mystery stocks we tease in our promotional messages.
• CE Safety Rating System–In-depth explanation of the proprietary ratings system and how to use it effectively.
• Special Reports–The most recent reports for new subscribers. The most current advice is always in your regular issue.
• Tips on DRIPs–Details for any dividend reinvestment plan offered by Canadian Edge Portfolio Holdings.