Income or Growth? Yes

03/10/2010 12:01 am EST

Focus: GLOBAL

Carla Pasternak

Editor, The Income Investor

Two rare Canadian hybrids offer safe double-digit yields and the chance of capital appreciation, writes Carla Pasternak in High-Yield International.

These securities are so rare, no one knows quite what to call them. Stock/bond hybrids, they go by different names—from "income deposit security" (IDS) to "enhanced income security" (EIS) or "income participating security" (IPS). 

Call them what you will, they're really just bonds with an equity kicker. Each security comprises a share of common stock and a high-yield bond. About half their distribution is a common share dividend, and the balance is a bond's fixed income. All of them pay in quarterly installments throughout the year. 

Hospital operator Medical Facilities Corp. (Toronto: DR.UN) now yields 10%. The Toronto-based firm runs three of the largest specialty hospitals in South Dakota. Each hospital is a licensed specialty hospital that focuses on scheduled surgical procedures rather than emergency treatment. Specialties include orthopedic surgery; ear, nose and throat procedures; and neurosurgery.

Transit bus maker New Flyer Industries (Toronto: NFI.UN, OTC: NFYIF.PK) is holed up in the hinterland of Winnipeg, Manitoba, but don't let that fool you. The company is one of the biggest providers of heavy-duty transit buses in both the United States and Canada. Its buses and repair services are used by the largest transit authorities in North America. It boasts a yield of nearly 11%. 

You'll notice the Canadian listings all have ".UN" after their ticker, just like the Canadian royalty trusts such as Enerplus (TSX: ERF.UN). Don't let that throw you off: Income deposit securities are NOT trusts. While the rules are still ambivalent, it's looking more and more as if these income deposit securities will not be phased out and forced to convert to ordinary corporations by this coming December in the same way royalty trusts like Enerplus will be.

Medical Facilities and New Flyer both pay in Canadian dollars. If rising oil prices and a weaker dollar keep pushing the Canadian dollar higher, you'll benefit from a favorable currency translation. The dividend portion should qualify for the reduced dividend tax rate, or may be treated as non-taxable return of capital. The bond portion is taxed at your marginal income tax rate, making these securities equally suitable for a taxable brokerage or tax-advantaged IRA type of account.  

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