High yield, high risk

Zoomer | November 25th, 2010

The implementation of Canada’s income trust tax on Jan. 1, 2011 means the demise of most trusts. Only a few have announced they will maintain their existing status going forward. The rest have already converted to corporations or will soon do so.

The destruction of the trust sector has left many income-oriented investors scrambling to find alternative investments that offer good cash flow at reasonable risk. If you are in that situation, remember that, as a general rule, the higher the yield on a security, the greater the risk the market is attributing to it. A yield of more than 10 per cent may suggest a greater chance of loss than some people are willing to accept. If you want to minimize risk, choose high-yield securities with yields in the 4 per cent to 7 per cent range.

However, if you are prepared to take on more risk in exchange for a very high yield, here’s a security to ask your financial advisor about.

Medical Facilities Corp. (TSX: DR.UN, OTC: MFCSF)

The business: Medical Facilities Corporation (MFC) owns 51 per cent+ interest in four specialty surgical hospitals, located in South Dakota and Oklahoma. The company also owns 51 per cent of two ambulatory surgery centers in California. The specialty hospitals perform scheduled surgical, imaging and diagnostic procedures and, combined, have a total of 30 operating rooms and 51 recovery beds. The ambulatory surgery centers (ASCs) specialize in outpatient procedures, with patient stays of less than 24 hours. The ASCs have a combined total of five operating rooms and one procedure room. Although MFC operates in the U.S., the company is registered in British Columbia and is a Canadian corporation.

The security: Although this looks like an income trust, it is not. This is an Income Participating Security (IPS). Part of the income is received as a dividend and part as interest on a subordinated note. This is divided as follows: a cash dividend of $0.0302 per unit plus an interest payment of $0.0615 per unit. Therefore, the payments will not be affected by the implementation of the new income trust tax in January 2011.

Why we like it: Let’s start with the yield. The shares pay a monthly distribution of $0.0917 ($1.10 annualized). Based on a price of $10 per unit, that projects to a yield of 11 per cent over the next 12 months.

I also like the business. Demand for specialized health care will continue to increase as the population ages and is pretty much recession-proof. And MFC operates in a highly fragmented segment of the health care industry as there are more than 6,000 alternative surgical facilities in the U.S. This creates the possibility of growth by consolidation.

Risks: Profitability is marginal. For the first six months of the 2010 fiscal year, the company posted a small gain of $800,000. Although that was better than the $2.9 million loss in the comparable period of 2009, there is clearly some financial risk here which helps explain the high yield.

That said, RBC Capital Markets recently published an analysis in which it described MFC’s distribution as “safe” and projected it would remain unchanged through fiscal 2011. Overall, I rate it “higher risk”.

Who it’s for: MFC is suitable for investors who are willing to accept a higher degree of risk in return for enhanced cash flow.

How to buy: The shares trade primarily on the TSX and volume usually exceeds 50,000 units a day.

Summing up: This IPS offers a very attractive yield and it will not be affected by the new trust tax. However, risk is on the high side and investors need to be aware of the company’s less than stellar financial results.

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