MONTREAL - Canadian income trusts have taken a beating over the past year but their lure remains strong even though thousands of spooked investors sold off their investments in response to the federal government's decision last year to tax trusts starting in 2011.
The trusts suffered an 18 per cent hit in the days after Finance Minister Jim Flaherty's surprise Halloween announcement on Oct. 31, 2006. But the trust index has regained some of its lustre, restoring some eight per cent of its value.
"There was that huge selloff but many of these income trusts have come back nicely," says Don Cranston, former chairman of the Investment Counsel Association of Canada.
Panic selling gradually gave way to renewed interest in the fundamentals of investing, he said in an interview. Investors began to focus, as they should have from the outset, on the business fundamentals of the assets instead of their tax advantage.
Despite enduring such a volatile year, the trust sector is in better shape than might have been expected, said income trust specialist Leslie Lundquist, who oversees $1.3 billion in investments for Franklin Templeton Investments Corp.
Takeovers have reduced the number of trusts to 213 from 245. The ScotiaCapital Income Trust Index's value is down 11 per cent in the year to $175 billion from $196 billion before the Oct. 31, 2006, announcement.
Many trusts are almost back to where they were before last year's bombshell. Energy trusts have been hit hard, but much of that has more to do with challenges in the oil and gas sector than with the tax issue, Lundquist said.
"It certainly has been a volatile year," she said in a conference call with reporters. "But when we look at where we're at today, there are still some very healthy and viable trusts out there."
Lundquist said the financial results of the trusts have been quite positive. And she expects there will be many good opportunities in the three years remaining before the sector has to undergo a dramatic overhaul.
Among Franklin Templeton's favourites are Cominar Real Estate Investment Trust (TSX:CUF.UN), Crescent Point Energy Trust (TSX:CPG.UN) and Noranda Income Fund (TSX:NIF.UN).
Even though Franklin Templeton is reducing its REITs portfolio, Lundquist said Cominar offers exposure to real estate at a relatively good price compared to its peers.
Crescent has one of the best development profiles for an oil and gas trust. And Noranda, which owns North America's second-largest zinc processing facility in Quebec, has a cheap cash flow multiple and little to no commodity risk, added Franklin Templeton analyst Les Stelmach.
The investment company also favours small capitalization restaurant trusts such as Boston Pizza Royalties Income Fund (TSX:BPF.UN), A&W Revenue Royalties Income Fund (TSX:AW.UN), and the Keg Royalties Income Fund (TSX:KEG.UN).
The recovery of the trust sector doesn't, however, vindicate Flaherty, Lundquist said.
"I think what's been vindicated is the strength of the businesses underlying the trusts themselves."
Industry observers also look favourably at CML HealthCare Income Fund (TSX:CLC.UN), the largest private provider of medical imaging services in Canada; BFI Canada Income Fund (TSX:BFC.UN), a Toronto-based North American waste disposal company; and North West Income Fund (TSX:NWF.UN), which is expected to get a boost from Indian residential school settlement payouts.
Many investors were drawn to trusts not just by the promise of strong distributions, but also by capital gains from the growing value of their units, said Clay Gillespie of Rogers Group Financial.
Companies that converted to trusts saw their unit prices increase by 10 to 15 per cent.
Despite taking a beating, most investors will retain their trust holdings over the coming years before gradually selling them before 2011, Gillespie said in an interview from Vancouver.
"There's a lot of good ones out there and there are a lot of good ones you're going to hold forever."
The cash flows of the larger trusts are very similar to dividend paying companies. Investors holding the investment for income may even hold the stock after 2011 because there are only so many places to earn such income.
He points to strong trusts such as Yellow Pages Group (TSX:YLO.UN) and Precision Drilling Trust (TSX:PD.UN).
The decision to sell will depend largely on the investor's strategy.
"If you're holding for income, some of the bigger ones are still pretty good," Gillespie said.
Instead of earning 12 to 13 per cent rates of return, the trusts will pay a still healthy return of eight or nine per cent.
"The mistake people made is they put too much money with them. It was just the greed factor," he said.
"Now, people are no longer using them for capital gains, they're using them for income-producing vehicles and some of them are going to be good income producing vehicles."
Ross Healy, president of the Strategic Analysis Corp., said far too many trusts survived only by growing to fund their distributions.
"My concerns about the income trusts have only been heightened by the last year when the weaknesses have been exposed," the longtime critic of trusts said.
A good trust keeps its payout within reasonable bounds so its balance sheet is stable and it can grow, Healy said.
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