Fortune Favors the Patient in Canada

04/13/2009 9:55 am EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

High-yielding cash cows are leading Canada's revival, writes Canadian Edge editor Roger S. Conrad.

The broad S&P/Toronto Stock Exchange Income Trust Index is more than 30% above the all-time low it hit in 1998 and again in early 2000. But it's also barely half the early 2006 high, which was revisited briefly last summer. And there have been 77 dividend cuts over the past six months, most by repeat offenders.

Canada's woes still can't hold a candle to the carnage sweeping the US. Its banking system is solid. Ottawa isn't running up mammoth deficits with its fiscal stimulus. And Canadian consumers and businesses are still finding credit, in large part because they never abused it.

Nonetheless, Canada is suffering its worst recession in decades. The energy patch, long a source of strength, is contracting sharply, as natural gas prices crash and oil languishes. Equally crushed are industries that depend heavily on US markets, from timber and pulp to metals and transportation.

[So,] is Canada a deal or a dud? In my view, the biggest positive is extreme value. Dozens of trusts and high-yielding corporations are selling below book value. Companies with healthy and growing underlying businesses and little risk to dividends are yielding as much as 20%.

Then there's the so-called reflation play, a bet that the flood of government money pouring into the global economy will ultimately favor natural resources and the currencies of countries that produce them.

I believe the supply destruction of recent months alone guarantees sharply higher energy prices when the recession ends and global demand returns to normal. That will trigger a sharp recovery in the Canadian dollar. A move back to parity would lift the US dollar value of trusts and their distributions by 25%.

[Of course,] we have no way of knowing when global recovery will arrive, or how bad things will get before that. And until we see one, all things Canadian are going to be extremely volatile. As in late March, Toronto will be off to the races when the economic news looks promising. [But] a return to gloom may trigger greater damage than in New York, as we saw [just before] the March 9th lows.

Over the past several months I've [argued] that this bear market will end as all others before: with a monster rally in stocks and trusts whose underlying businesses have stayed strong against the global recession and credit pressures.

What we're seeing now may mark a real turning point. Or it might be simply a fleeting rally before another major down leg. But there's one strong argument that we've seen the worst for trusts and companies whose underlying businesses have stayed strong: They've been noticeably holding their own in the stock market since late October. In fact, several, such as Atlantic Power (TSX: ATP-U, OTC: ATPWF), have rebounded to where they traded before Lehman Brothers fell in late September.

It's too early to draw conclusions about a market turning point. But companies with strong underlying businesses appear to be gathering investor support. Our strategy remains to stick with them, collecting distributions while we wait.

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