Income trusts with solid foundations

Goodman & Co. manages the Dynamic stable of mutual funds. Gibbs, an accountant by training, is a senior member of Goodman & Co.'s equity-income team responsible for a range of funds. These total $4 billion in assets and includeDynamic Equity Income ,Dynamic Strategic Yield andDynamic Global Infrastructure.

Many infrastructure trusts, says Gibbs, have announced plans to convert to conventional corporations in the light of Ottawa's new tax regime on publicly traded trusts, which comes into effect in 2011.

"Infrastructure businesses will continue to be in high demand by investors, irrespective of structure," says Gibbs, who is the lead manager of Dynamic Global Infrastructure. Part of their ongoing attraction "is that they offer essential services and are faced with little competition."

Jason Gibbs

REITs, with the exception of those running a business such as providing lodging or senior care, will be largely unaffected by the new tax regime, Gibbs notes. By contrast, oil and gas royalty trusts will be affected, "though many have tax pools, which will help to shelter some of their income from tax for some time."

On conversion to oil and gas companies, the energy trusts will slot into the middle tier between the seniors and the juniors, Gibbs says. "They will be the mature, steady producers in the Canadian energy sector with an above-average distribution/dividend yield."

Currently, energy trusts yield on average 6.9%. "Their ability to maintain and grow their distributions will depend largely on the commodity prices," says Gibbs.

Business trusts, he says, are a "very" mixed bag. "The best business trusts will either be privatized or become high-yielding corporations."

Gibbs cautions that there are few bargains to be had among the high-quality income trusts in all sectors of the trust universe. "Most are fairly valued, but you are paid a healthy yield to wait."

Goodman & Co. remains one of the significant investment managers in the Canadian income-trust universe. Dynamic Equity Income ($1.13 billion in assets) was originally launched on July 1, 2001, as Dynamic Focus+ Diversified Income Trust. On April 5, 2007, this name was changed to Dynamic Focus+ Diversified Income, and at the end of last year it was renamed Dynamic Equity Income.

At the end of February, the fund had 69.3% in income trusts, 21.9% in common stocks and only modest holdings in cash, preferred shares and bonds. In stock/trust selection, Goodman & Co.'s equity-income team looks for "best in class" businesses that are dominant in their field and have a history of increasing cash flows, high profitability and maintaining strong balance sheets. These trusts/stocks should trade at reasonable valuations. Dynamic Equity Income's three biggest sector weightings are energy, REITs and utilities/infrastructure.

An infrastructure trust that is expected to maintain and even increase its distribution/dividends over time, and also has many of the other virtues that Gibbs and his colleagues look for, is Brookfield Renewable Power Fund BRC.UN.

It is the largest Canadian generator of renewable power and has a market capitalization of $2.2 billion. It owns hydroelectric generating stations in Canada and New England. About 90% of the fund's power generation comes from hydro and 10% from wind. Its current distribution yield is around 6%.

The trust trades at an EV (enterprise value) to EBITDA (earnings before interest, tax, depreciation and amortization) of 12.4 times based on 2010 estimates. This is at a premium valuation to its peers, which average 9.6 times EV to EBITDA.

A Canadian REIT that is "one of the biggest shopping-centre owners in Canada and has a solid tenant list" is Calloway Real Estate Investment Trust CWT.UN, which has a market capitalization of $2.2 billion.

	How holdings have performed versus the benchmark
		1Y	3Y	5Y	10Y
	Brookfield Renewable Power Fund	47.7	8.3	6.1	n/a
	Calloway Real Estate Investment Trust	121.0	-2.9	6.5	28.6
	S&P/TSX Income Trust Index	51.7	6.1	8.0	17.3
	Returns as of April 12, 2010 Source: Morningstar

This REIT, says Gibbs, has interests in 125 shopping centres in all 10 provinces and is developing some 15 properties. "Calloway is the dominant owner of new format, Wal-Mart store-anchored retail centres in the country." The current yield is 7.5%.

The oil and gas royalty trust ARC Energy Trust AET.UN is one of the top 10 holdings in Dynamic Equity Income. The trust, with a market capitalization of $5.2 billion, has a history of proven performance, says Gibbs. "This oil and gas producer has good long-term growth potential, with exceptional production growth prospects." Its distribution/dividend is sustainable post-2011, "as long as commodity prices remain firm." The current yield is 5.8%.

A small-cap business trust that dominates its niche is Keg Royalties Income Fund KEG.UN. This trust receives a 4% royalty on sales from the 102 Keg restaurants currently in the royalty pool.

"Same-store sales have generally increased over time, with 2009 being an exception," says Gibbs. The current yield is "high" at 10.6%. This trust has yet to announce plans to convert to a corporation, he says, adding that "it could cut its distribution post 2011 in line with the corporate tax rate."

The equity-income team has sold its holding in CML HealthCare Income Fund CLC.UN, which is one of the largest providers of medical-imaging services in Canada and also operates in the U.S. Northeast. "It is having its challenges in the United States and is generally under margin pressure," says Gibbs.