Dividend Watch List

Four Canadian income trusts cut distributions last month, versus 13 that raised payouts. As expected, Keystone North America (TSX: KNA.UN, OTC: KYSNF) reduced its monthly disbursement to unitholders by 23.8 percent.

The move is part of the trust’s dissolution of its income participating securities (IPS) by converting the junk-bond portion into common stock. It was completed May 16, as 91 percent of shareholders elected to exchange the bond portion for five newly-minted common shares. The common shares now trade under the symbol KNA on the Toronto Stock Exchange (TSX) and sell for roughly CAD1.17 each.

Keystone has now submitted a proposal for a reverse stock split, which will effectively create one post-consolidation share for every six now trading. That move will effectively restore the share price back to its predissolution level and is subject to a vote at the company’s upcoming June 24 annual meeting.

Last month, I advised steering clear of Keystone until the IPS retirement issue was settled. Because that issue is now behind us, the owner of 200 funeral homes and 16 cemeteries across the US and in Ontario is in better financial shape than it’s been for some time. Business is very steady, and management is reportedly focused on expansion, which should pump up future cash flow.

Despite the distribution cut, the yield is still in double digits. And after a roughly 25 percent decline this year, the shares look relatively inexpensive. Consequently, I’m upgrading the Keystone North America shares to a buy up to USD1.20 or a post-consolidation price of USD7.20.

For those who held Keystone and didn’t make the conversion, the future is cloudy. The IPS is still quoted, but management has telegraphed it no longer intends to bear the expense of keeping it listed on the Toronto Stock Exchange. Dividends and interest will keep flowing as long as Keystone stays healthy. But delisting would make it next to impossible to buy and sell. My advice, if you want to own this company, is to sell the IPSes while you can, and buy the common stock.

Aeroplan Income Fund (TSX: AER.UN, OTC: AOIPF) has announced its conversion to a corporation to be named Groupe Aeroplan. The move must be approved by a two-thirds vote of shareholders at a special meeting planned for June 19, 2008. As part of the conversion, the distribution will be reduced from the current monthly rate of 7 cents Canadian per share to a new quarterly rate of 12.5 cents Canadian, an effective 40.5 percent reduction.

Aeroplan’s move has the same motivations as the conversions earlier this year by two Canadian Edge Portfolio picks: TransForce (TSX: TFI, OTC: TFIFF) and Trinidad Drilling (TSX: TDG, OTC: TDGCF). Namely, management has stated a goal of growing faster, and the move is designed to increase needed access to cash.

I’m fully convinced conversion will be bullish for shareholders at TransForce and Trinidad. I’m not so convinced it will be at Aeroplan, which is apparently being hit hard by slower economic growth in North America.

The shares are already down more than 30 percent this year, and a low-yielding stock isn’t very attractive in such a volatile industry. Sell Aeroplan Income Fund.

InterRent Properties’ (TSX: IIP.UN, OTC: IIPZF) 31.5 percent distribution cut last month is proof positive that some stumble even in a strong market. The good news is, after the cut, the distribution for the fast-growing apartment REIT is better aligned with reasonable assumptions for cash flow. InterRent continues to grow rapidly, and there’s plenty of opportunity to expand, even in its home market of Ontario. And it trades for just 61 percent of book value.

On the other hand, the REIT hasn’t logged a single quarter where cash flow covered distributions. Debt is very high, and management is still focused on growing rapidly, as it did by boosting suites under ownership by 52 percent last year. As a result, InterRent Properties remains a hold for speculators only.

Essential Energy Services Fund (TSX: ESN.UN, OTC: EEYUF) cut its distribution by 70 percent in early June and simultaneously sold its transportation division. On the plus side, the long-expected move should leave the trust in much better shape financially as the drilling sector continues to cycle out of current woes. After the recent sharp decline, Essential Energy Services Fund is a hold.

Turning to other suspect distributions, Connors Brothers Income Fund (TSX: CBF.UN, CBICF) is now off Standard & Poor’s Creditwatch-negative but retains its negative outlook from the rater. Further, Standard & Poor’s notes the trust’s “declining revenue, narrow product portfolio, supply variability, limited financial flexibility [and] very mature and somewhat commoditized canned seafood and meat business.” It also cited vulnerability to supply disruptions and product recall, which weakened the trust last year.

On the plus side, Connors has held up far better than rival Clearwater Seafoods Income Fund (TSX: CLR.UN, OTC: CWFOF), which has been forced to suspend distributions indefinitely in the face of weak results. And it’s also avoided the kind of meltdown that knocked Menu Foods Income Fund (TSX: MEW.UN, OTC: MNUFF) into a death spiral, from which it now appears to be emerging.

Menu and the other companies sued over tainted wet pet food have apparently reached a global settlement of the lawsuits that once threatened to put it out of business. Hold Menu Foods Income Fund.

But as long as the US dollar and economy are weak, Connors’ distribution remains at risk, and conservative investors are better off staying out. Sell Connors Brothers Income Fund.

Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN) remains the only oil and gas trust with an endangered dividend. The trust’s problem is short term: Its refining business is being squeezed by a combination of rising crude oil prices and a weak US economy, which has thus far prevented prices of refined products from keeping pace. In addition, it’s hedged very large quantities of its oil and gas output—79 percent in the first half of 2008, 68 percent in the second half and 53 percent in the first half of 2009—which means it will only benefit from higher energy prices over time.

First quarter cash flows didn’t cover the distribution, and they may not in the second quarter either. To date, management has given no indication it would consider cutting the payout and, in fact, continues to express confidence in its long-run strategy. The shares, meanwhile, have performed well this year, surging more than 25 percent.

We’re better off getting out of this one, at least until we get some more visibility on how the refining business will fare in the latter half of 2008. No other oil and gas producer trust is exposed to the volatile refining business. There are much better ways to go if you want to bet on oil and gas. Harvest Energy Trust remains a sell.

Priszm Income Fund’s (TSX: QSR.UN, OTC: PSZMF) ongoing recovery got a boost last month, as it settled a five-year boycott of KFC Canada restaurants by animal rights activists. The company agreed to buy from suppliers who kill chickens painlessly and who phase out their use of growth hormones and drugs. Ultimately, this, too, may benefit the owner of fast food franchises.

For now, the settlement sounds a positive note for the rest of the year. Hold Priszm Income Fund.

TimberWest Forest Corp (TSX: TWF.UN, OTC: TWTUF) got a vote of confidence from the Dominion Bond Ratings Service (DBRS) last month. DBRS affirmed the company’s bond rating of BBB (high) with a stable trend, citing the value of its lands and modest current leverage on its balance sheet.

I wouldn’t argue with that. Unlike DBRS, however, I’m very concerned that management now “does not expect to generate sufficient distributable cash in 2008 to cover its distribution obligations.” Instead, it intends to borrow to keep paying at the current rate.

DBRS believes this to be a temporary measure, stating “the North American building products sector is close to the bottom of the cycle.” That would certainly be good news to TimberWest, which has already seen a huge decline in log sales.

Unfortunately, it’s not something anyone can really count on, and that’s an unacceptable risk for any dividend seeking investor. TimberWest is off substantially this year. But my advice remains the same: Sell TimberWest Forest Corp.

Here’s the rest of the Dividend Watch List. Note that first quarter payout ratios are now shown in the How They Rate Table.

Acadian Timber (TSX: ADN.UN, OTC: ATBUF)
Boralex Power Income Fund (TSX: BPT.UN, OTC: BLXJF)
Canadian Oil Sands Trust (TSX: COS.UN, OTC: COSWF)
Canfor Pulp (TSX: CFX.UN)
Connors Brothers Income Fund (TSX: CBF.UN, OTC: CBICF)
Essential Energy Services Fund (TSX: ESN.UN, OTC: EEYUF)
Harvest Energy Trust (NYSE: HTE, TSX: HTE.UN)
Mullen Group Fund (TSX: MTL.UN, OTC: MNTZF)
Newalta Income Fund (TSX; NAL.UN, OTC: NALUF)
Newport Partners Income Fund (TSX: NPF.UN, OTC: NWPIF)
Noranda Income Fund (TSX: NIF.UN, OTC: NNDIF)
Precision Drilling (NYSE: PDS, TSX: PD.UN)
Priszm Income Fund (TSX: QSR.UN, OTC: PSZMF)
Sun Gro Horticulture (TSX: GRO.UN, OTC: SGHRF)
Swiss Water Decaf Coffee Fund (TSX: SWS.UN, OTC: SWSSF)
TimberWest Forest Corp (TSX: TWF.UN, OTC: TWTUF)
Tree Island Wire Income Fund (TSX: TIL.UN, OTC: TWIRF)

Bay Street Beat

Baytex Energy Trust (NYSE: BTE, TSX: BTE.UN) scored a perfect 5.000 average in Bloomberg’s most recent survey of Bay Street analyst opinion, then validated the confidence with a 25 percent distribution hike.

Baytex also reported that it’s completed the Burmis Energy acquisition announced April 9 and that its bank credit facilities have been increased from CAD370 million to CAD485 million.

Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) and Enerplus Resources (NYSE: ERF, TSX: ERF.UN) also earned the top average score.

Daylight recently announced a deal to purchase Cadence Energy in a move to consolidate ownership of assets in the Sturgeon Lake South Leduc oil pool of northwestern Alberta.

Cadence reported just more than CAD280 million in tax pools at the end of the first quarter, which will benefit Daylight after the 2011 kick-in of the entity-level tax on trusts. Daylight’s tax pool base climbs from CAD824 million to more than CAD1.1 billion.

Enerplus’ sale of its 15 percent stake in the Joslyn mine could be held up because of a new round of environmental scrutiny.  

Joslyn is drawing tighter regulatory scrutiny than other oil sands projects; Canada’s Environment Minister John Baird said in April the project would face a public hearing and environmental review by an independent panel convened by federal and provincial regulators, rather than a solely provincial hearing. The federal regulator looks at all oil sands developments but doesn’t step in unless a project is deemed particularly sensitive.

Environmental activity is delaying many new projects and increasing cost pressures already intensified by labor and materials shortages.

Stand Down, Stephane

If Arizona (and perhaps Virginia) rejects John McCain, he’s toast. Barack Obama must have Illinois. Had New York (or Arkansas or Pennsylvania) turned its back on Hillary Clinton, this thing would have been over long ago.

According to the best gauge of public opinion in Quebec, Stephane Dion’s home province ain’t buying what he’s got to sell. L. Ian MacDonald of the Montreal Gazette writes:


Additional recent polling suggests that, were Canadians to go to the polls for a federal election immediately, the Tories would win another minority government.

But the nominal opposition Liberal leader said June 2, “I would prefer to not be in a situation where Canadians would not have to vote in the middle of July. I don’t think they would appreciate that.”  

The minority Conservative government, elected in January 2006, can, in theory, fall at any time. But the Liberals have kept them in power, and Dion made it clear he’d continue to do so for the next few months at least. Threatening idly, Dion said he was more inclined to force an election than he was some months ago.

Given Dion’s failure thus far to lead, our working assumption is that we won’t see a federal election until the required date of October 2009. There will still be time for the Liberals, should they win, to follow through on their commitment to revisit the tax on income trusts.