Leslie Lundquist and Les Stelmach, co-lead managers ofBissett Income, say that some of the most compelling values in the Canadian income-trust universe are to be found among business trusts.
Furthermore, these Calgary-based managers with Bissett Investment Management note that many of the more favourably valued business trusts are smaller caps. "They are under-followed by the brokerage industry and have been overlooked by larger institutional investors," says Lundquist, a veteran manager of income trusts.
Bissett considers many real estate investment trusts and oil and gas royalty trusts to be currently fully valued. "REITS have become expensive," says Lundquist. She notes that they will largely be unaffected by the new tax regime governing listed income trusts that comes into force in 2011, and there is therefore less uncertainty about their distributions.
The REITS have had a big run-up, as have many energy trusts and energy companies, she says. Lundquist and Stelmach have been selling down some of their REITs and boosting their business-trust exposure.
In the energy sector, the two have taken some profits in certain holdings and used the proceeds to invest in energy producers that they consider offer better relative value. Bissett Income, with assets of $420 million, consists predominantly of income trusts, most of which will become taxable, high-dividend-paying companies on conversion, says Stelmach.
The structure is not the issue, says Lundquist. The question is: "What is the capacity and willingness of the entity to generate and distribute free cash flow to investors?"
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| Leslie Lundquist | |
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The fund has 46% of its assets predominantly in business trusts and also in some common shares, including the telecommunications-services giant Telus Corp. T. In other sectors the fund has 26.5% in energy, 14.5% in infrastructure and power and 13% in REITs. There are 38 holdings, so the fund is fairly concentrated.
The biggest holding is a business trust, Morneau Sobeco Income Fund MSI.UN, which represents 4.7% of Bissett Income. With a market capitalization of $548 million, Morneau Sobeco is a major Canadian-owned pension and benefits services provider. It offers consulting and outsourcing in this "complex" field, says Lundquist, as well as "workplace health and productivity solutions." In all, the trust has more than 8,000 organizations as clients in Canada, the United States and globally.
Morneau Sobeco was an initial public offering in Canada in 2005 at $10 per unit. "We bought it on the IPO and have added to it since," Lundquist says. The trust currently trades at "a double-digit discount to our estimated intrinsic value of the business," she says, and at roughly 10 times estimated 2010 cash flow per unit. "This is a reasonable valuation, given the high level of free-cash-flow generation."
A smaller-cap business trust that offers value, the Bissett managers say, is Badger Income Fund BAD.UN, which has a market capitalization of $170 million. This is North America's largest provider of non-destructive excavating services. "Its technological advantage is the Badger Hydrovac truck, which is used primarily for digging in areas that are difficult or dangerous to access with traditional drilling equipment," says Stelmach. Customers are mainly utilities, construction and energy companies.
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| Les Stelmach | |
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This trust has high and "remarkably stable" EBITDA (earnings before interest, tax, depreciation and amortization) margins of more than 25%. It has announced its intention to convert to a corporation at the end of this year and "to pay out a dividend of between 75% and 100% of its current distribution."
On the assumption that its earnings will be fully taxable in 2011, Badger trades at a price-earnings multiple of 12 times 2011 estimates, "which is quite reasonable given its historically high return on equity and other strong fundamentals," says Stelmach.
When it comes to REITs, says Lundquist, the strategy is to invest in a range of them so as to have diversification by property type and geography. An apartment REIT that is "more reasonably valued than its peers" is Northern Property Real Estate Investment Trust NPR.UN, with a market capitalization of $570 million.
The largest residential landlord in the Northwest Territories, Nunavut and Newfoundland and Labrador, this REIT is also a significant residential landlord in northern Alberta and B.C. In addition, it owns commercial buildings in its main markets. "It dominates its niche in the northern part of Canada," says Lundquist.
Northern Property REIT trades at 13.4 times free-cash-flow estimates for 2010 versus other apartment REITs such as Boardwalk REIT BEI.UN, which trades at 17 times, and Canadian Apartment Properties REIT CAR.UN, which trades at 14 times.
| Trust or index | 1Y | 3Y | 5Y | 10Y | ||
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| Morneau Sobeco Income Fund | 31.2 | 1.8 | n/a | n/a | ||
| Northern Property REIT | 50.7 | 3.4 | 9.5 | 12.6 | ||
| S&P/TSX Capped Energy Trust TR | 44.1 | 5.5 | 8.8 | n/a | ||
| S&P/TSX Capped REITs TR | 64.9 | -3.5 | 8.0 | 13.8 | ||
| S&P/TSX Income Trust TR | 45.3 | 5.6 | 7.7 | 17.2 | ||
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| For periods ended April 19 Source: Morningstar |
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In the energy sector, the two managers recently established a position in Canadian Oil Sands Trust COS.UN, which has a market capitalization of $15 billion and is the largest income trust.
"We consider that it offers good relative value in this sector," says Stelmach. The trust produces oil, which is enjoying a firm commodity price, and uses natural gas, which has a relatively weak commodity price, as an input, he notes. It is also a proven producer in the oil sands and has the advantage over conventional oil producers in that it has long-life assets.
Canadian Oil Sands' current yield is "on the low side" at 4.5%, Stelmach says, but the good news is that this trust has a low payout ratio and could boost its distribution. The trust has announced its intention to convert to a corporation and "maintain a high-dividend policy," he adds.
Lundquist and Stelmach have reduced their holding in Crescent Point Energy Corp. CPG, which is predominantly an oil producer. This company converted from Crescent Point Energy Trust in the summer of 2009. "This was a flawless conversion," says Stelmach, and "investors like the stock for good reasons, but it is expensive at this stage."
