High Yielding Trusts With Moderate Risk

We recommend few income trusts. That’s because most trusts involve substantial risk, such as focusing on a single commodity or geographic area.

Here are four trusts we do see as buys. Despite Ottawa’s plan to start taxing trust distributions in 2011, they should continue to pay above-average yields for years to come.

These four trusts should also appeal to BCE investors seeking new sources of income, assuming that the BCE privatization goes through as planned (see box this page). However, you should continue to limit income trusts to no more than, say, 15% of your total portfolio.

BELL ALIANT REGIONAL COMMUNICATIONS INCOME FUND $25 (Toronto symbol BA.UN; Conservative Growth Portfolio, Utilities sector; Units outstanding: 127.0 million; Market cap: $3.2 billion; SI Rating: Above average) is the main provider of telephone service in Atlantic Canada and rural areas of Ontario and Quebec.

Bell Aliant transferred its wireless operations to BCE Inc. as part of the deal that created the trust in July, 2006. BCE owns about 45% of Bell Aliant.

Under a new deal, Bell Aliant will now help BCE upgrade its wireless networks in Atlantic Canada and rural areas of Ontario and Quebec. These upgrades will improve the speed and reliability of connections between BCE’s wireless networks and Bell Aliant’s traditional phone systems. That should help Bell Aliant profit from rising use of mobile devices to receive email and connect to the Internet.

This project will increase Bell Aliant’s capital expenditures by $25 million in 2008. However, these new outlays should not hurt its ability to keep paying monthly distributions of $0.2417 a unit (11.6% yield).

Meanwhile, Bell Aliant earned $74.7 million or $0.58 a unit in the three months ended September 30, 2008, up 8.6% from $68.8 million or $0.49 a unit a year earlier. However, revenue rose just 0.8%, to $815.3 million from $808.5 million. Strong demand for high-speed Internet and data services offset lower local and long distance revenue.

Bell Aliant now trades at just 12.2 times the $2.05 a unit it will probably earn in 2008. It’s possible that BCE’s new owners could sell their units to help pay for the takeover. The lack of a major shareholder could turn Bell Aliant into a takeover target. That’s not reason enough to buy the stock, but it adds to its appeal.

Bell Aliant is a buy.

PRECISION DRILLING TRUST $11 (Toronto symbol PD.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 125.8 million; Market cap: $1.4 billion; SI Rating: Extra risk) is Canada’s largest provider of contract drilling and related services to the oil and natural gas exploration industry.

Precision currently operates 249 drilling rigs, mainly in Canada. However, many of its Canadian customers suspend exploration during the winter.

Precision now aims to expand its operations in the United States with its upcoming purchase of Grey Wolf Inc., which operates 122 drilling rigs in the U.S. Gulf Coast and Midwest regions. The purchase will make Precision one of the largest providers of drilling services in North America.

Based on current prices, Precision will pay roughly $1.2 billion U.S. in cash and units for Grey Wolf. It will also limit the cash portion to $1.12 billion U.S. Grey Wolf investors will own 25% of Precision after the acquisition.

This is a big purchase for Precision, which earned $0.65 a unit (total $82.3 million) in the three months ended September 30, 2008, up 18.2% from $0.55 a unit ($69.7 million) a year earlier. Cash flow per share rose 36.5%, to $0.93 from $0.68. Revenue grew 25.3%, to $285.6 million from $227.9 million. High energy prices spurred strong demand for drilling services.

Precision has secured loans of $1.6 billion U.S. to pay for Grey Wolf. That will increase its long-term debt from $231.8 million to roughly $2.3 billion. However, the extra cash flow from these new operations should help Precision pay down the extra debt, and let it keep paying monthly distributions of $0.13 a unit (14.2% yield).

Precision’s units have moved down recently, along with oil prices. They now trade at just 4.6 times its forecast earnings for 2008 of $2.40 a unit.

Precision Drilling is a buy.

PENGROWTH ENERGY TRUST $11 (Toronto symbol PGF.UN; Aggressive Growth Portfolio, Resources sector; Units outstanding: 254.9 million; Market cap: $2.8 billion; SI Rating: Average) produces oil and natural gas from, mainly from properties in Alberta and British Columbia. It also owns 8.4% of the Sable Offshore Energy project, which extracts natural gas from several offshore fields south of Nova Scotia. Natural gas accounts for 60% of its production, while oil supplies the remaining 40%.

Pengrowth is down lately, along with most other oil and gas producers, due to falling energy prices. However, Pengrowth’s cash flow seems sufficient to let it keep paying monthly distributions of $0.225 a unit. That gives it a high current yield of 24.5%. Pengrowth paid out 62% of its cash flow as distributions in the latest quarter, down from 79% a year earlier.

In the three months ended September 30, 2008, Pengrowth’s earnings soared to $1.69 a unit (total $422.4 million) from $0.66 a unit ($161.5 million) a year earlier. Most of the increase came from unrealized gains on oil and natural gas hedging contracts. Cash flow per unit rose 23.6%, to a record $1.10 from $0.89. Revenue grew 23.3%, to $518.7 million from $420.7 million. A 27% rise in realized energy prices more than offset a 5% drop in average daily production.

In light of the growing uncertainty over oil prices and the value of the Canadian dollar in relation to the U.S. dollar, Pengrowth recently entered into new pricing contracts to cut its risk.

For the remainder of 2008, Pengrowth has locked in prices for 46% of its oil production and 41% of its natural gas production. It has also hedged some of its production for 2009 and 2010.

Pengrowth prefers to replenish its reserves with acquisitions of proven properties that immediately add to its cash flow, instead of investing in uncertain exploration projects.

It recently paid $89.9 million in units for Accrete Energy Inc., which increased its reserves by 3%. Pengrowth also paid $12 million to expand its interest in several other properties. At current production levels, Pengrowth’s reserves should last over 10 years.

Pengrowth is a buy.

RIOCAN REAL ESTATE INVESTMENT TRUST $15 (Toronto symbol REI.UN; Aggressive Growth Portfolio, Manufacturing & Industry sector; Units outstanding: 221.0 million; Market cap: $3.3 billion; SI Rating: Average) is Canada’s largest real estate investment trust. It owns 238 retail properties, including 14 under development, comprising an aggregate of over 58 million square feet.

Ottawa has exempted real estate trusts from its new taxation rules, as long they meet certain technical requirements. RioCan plans to ensure that it continues to qualify as a REIT.

RioCan’s focus on suburban retail malls could hurt its earnings if consumer confidence continues to weaken. However, RioCan gets 83.6% of its revenue from national and anchor tenants such as Wal-Mart and Loblaw. Dominant retailers like these have the financial strength to weather the current downturn. As well, no individual tenant accounts for more than 6% of RioCan’s revenue.

In the three months ended September 30, 2008, RioCan’s earnings grew 15.8%, to $41.6 million from $35.9 million a year earlier. Earnings per unit rose 11.8%, to $0.19 from $0.17, on more units outstanding. Cash flow per unit rose 2.8%, to $0.37 from $0.36. Revenue grew 7.6%, to $185.5 million from $172.5 million.

RioCan’s conservative approach to financing new projects helps keep its debt and interest costs down. That gives it plenty of room to increase distributions. The current annual rate of $1.38 yields 9.2%. RioCan now trades at a reasonable 10.5 times its 2008 forecast earnings of $1.43 a unit.

RioCan is a buy.