Mergers Abound with Canadian Income Trusts
Stock-Markets / Canadian Stock Market Jun 25, 2007 - 06:07 PMBy: Roger_Conrad
Remember when investors could retire and live well on a modest nest egg? Remember when taxes were only 15% a year, and when you didn't have to worry about losing your shirt before the closing bell?
That way of life has gradually been taken from you. But this letter is going to bring it all back, courtesy of the Canadian government.
They've invented a whole new kind of investment, one that's pulling hundreds of billions of US dollars across the border into Canada today.
In a nutshell, Canadian Income Trusts are a brilliant structure that allows a business to avoid taxes--all taxes. That's one pretty obvious reason they're so popular.
The other big reason is that by Canadian law, nearly all the earnings from a trust business must flow right through to its
investors, which in this case means you. You no longer have to settle for the bread crumbs we call “dividends” here in the South 50!
Here's how trusts work up North: A trust uses what it receives from its product sales to pay general expenses and service any debt, and it also sets aside a little bit for exploration or development.
Trusts are very careful to set aside no more than 15% of their gross profits, so at least 85% normally goes directly to your mailbox every month. In other words, you usually get a check for about 85% of the true earnings. Sometimes it's near 100%!
Life doesn't get any smoother than that. Canadian income trusts aren't structured for the benefit of their CEOs, but their shareholders. What a concept!
Canadian Income Trusts: A Screaming "BUY" Opportunity
On Halloween day last year, Canadian Finance Minister Jim Flaherty decided that no more companies should be allowed to convert into trusts and that virtually all existing trusts should lose their tax-exemption starting in 2011.
We've seen this tax-grab before. The previous Labor government proposed taxing income trusts a year earlier, but ran into such heavy opposition that it was forced to shelve the idea.
Will this latest scare simply be a repeat of 2005's false alarm? I can't promise you anything, but we certainly have plenty of reasons not to panic.
First of all, the proposed legislation still needs to be approved by Parliament.
Second, since the proposal provides a four-year grace period before existing trusts are taxed, current trusts will continue to pay their fat distributions.
Third, the proposed law as currently written might never see the light of day. Four years is an eternity in politics. It gives
Canadian authorities plenty of time to allow certain businesses back into the income trust fold. (I'm convinced that what they really want is to restrict the format to the natural resource companies it was intended for--not to kill the trust format altogether.)
A year from now, I bet we'll barely remember this Halloween scare. And look on the bright side: It's hard to lose if you buy in now.
Trust prices have fallen in the face of uncertainty, giving you a great entry point and super-sized yields. Trusts that were yielding 10% the day before Halloween are now yielding more than that. The actual businesses underlying these trusts haven't changed a bit.
Conservatively run, high-quality income trusts are as solid as ever, and I have no doubt they'll prevail for years to come.
Remember, the current yields still hold until 2011. So the owners of Paramount Energy, just to pick one of my favorites, will still receive 13.8% on their capital for the next four years.
And even if they're taxed four years from now, these companies will still be paying yields that dwarf your options in the Dow and S&P.
Dozens of trusts now yield more than 10%, some as high as 17%.
Bottom line: I'm pounding the table because there are still plenty of trusts worth buying and holding for the long haul as their businesses grow.
Shorter term, the investment opportunities shine even brighter.
Several of the highest yielding trusts are so grossly undervalued private capital firms are moving in. As the merger and acquisition activity heats up, a handful of my favorite trusts will likely command premiums of anywhere from 25% to 65% over where they're currently trading!
By Roger Conrad
KCI Communications
Copyright © 2007 Roger Conrad
Roger Conrad is regularly featured on television, radio and at investment seminars. He has been the editor of Utiliy Forecaster for 15 years and is also the editor of Canadian Edge and Utility & Income . In addition, he's associate editor of Personal Finance , where his regular beat is the Income Report. Uniquely qualified to provide advice on income-producing equity securities, he founded the newsletter, Utility Forecaster in 1989. Since then, it's become the nation's leading advisory on electric, natural gas, telecommunications, water and foreign utility stocks, bonds and preferred stocks.
KCI has assembled a team of top investment analysts to create the finest financial news service possible. With well-developed research skills and years of expertise in their particular fields, our analysts provide quality information that few others can match.
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