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Trust the Income
09/16/2009 11:35 am EST
These Canadian trusts have been discounted for a tax hit that's not in the cards, writes Roger Conrad in Utility Forecaster.
On Halloween 2006, Canadian Finance Minister Jim Flaherty reversed a Conservative Party promise not to tax income trusts. Since then, many investors have treated the taxation date of January 1, 2011, as an effective doomsday. They’re in for a surprise.
Barring an increasingly unlikely last-minute change in the law, trusts will convert to corporations by 2011. What dividend they’ll pay after that, however, is entirely management’s decision. And a growing number—including eight that have already converted—will absorb the new taxes without cutting dividends.
Since October 31, 2006, trusts have priced in dividend cuts of 30% and worse. As a result, no-cut conversions thus far have generated immediate windfall gains of 30% and more, and there’s a lot more to come.
Yielding 12%, Atlantic Power (TSX: ATP-U, OTC: ATPWF) is organized as an income participating security (IPS) and has no 2011 taxation issues. In 2016, the bond portion of the IPS matures at par value of C$5.767 ($5.25). That leaves a pure equity yielding about 15% at current prices. Atlantic could pay off the debt entirely or, the more likely outcome, realign its debt into US dollars to match its entirely US portfolio.
Meanwhile, the second-quarter payout ratio of 68% demonstrates a secure cash stream that’s ensured against commodity, economic, currency, and interest-rate risk. Management continues to maximize shareholder value, inking a deal to sell for cash its 50% stake in a Georgia plant that won’t contribute to income for several years. Buy Atlantic Power up to $10. [The OTC-traded ADR closed at $8.47Tuesday—Editor.]
Pembina Pipeline Income Fund’s (TSX: PIF-U, OTC: PMBIF) management states its current asset mix will support its dividend for at least five years after converting to a corporation. Second-quarter revenue surged 12%, and operating income ticked up 10%, pushing up distributable cash flow per share 13.9%. Standard & Poor’shas affirmed the BBB+ credit rating, citing the continued low-risk expansion of fee-based energy infrastructure assets.
The latest of these are the purchase of the Cutbank processing complex from Talisman Energy (TSX: TLM, NYSE: TLM) and the construction of the Mitsue and Nipisi oil sands projects, which will start adding to cash flow next year. Buy Pembina Pipeline Income Fund up to $16. [The OTC-traded ADR closed at $14.22 Tuesday—Editor.]
Bell Aliant Regional Communications Income Fund (TSX: BA-U, OTC: BLIAF) has indicated it may trim its 11% yield when it converts to a corporation. But it continues to up-sell customers to broadband service and cut costs at a faster rate than it’s losing basic phone business. Distributable cash flow covered the payout by a comfortable 1.13-to-1 margin in the second quarter. A major government-backed broadband effort in Atlantic Canada promises to further boost cash flow. Buy Bell Aliant Regional Communications Income Fund up to $28. [The OTC-traded ADR closed at $24.96 Tuesday—Editor.]
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