Trusts: The big profits have been made
Now that the income trust tax is a fact of life and most trusts have converted to corporations, it’s time to take a fresh look at the securities that made up the successful Survivor Trust Portfolio that we created for my Income Investor newsletter.
These trusts and former trusts were selected based on several key criteria, including the soundness of their business, the quality of the management team, the emphasis on shareholder value, and the likelihood that the trust would maintain its distributions at the same or higher levels after the new tax took effect.
All of the trusts we selected made profits for us, with returns in some cases exceeding 50 per cent as the markets became aware that the securities were undervalued. But that party is now over and we need to move on.
Here is a final look at the portfolio, with prices as of March 18.
As you can see from this table, only three trusts/limited partnerships remain: Brookfield Renewable Power, Capital Power, and Inter Pipeline. All the rest are now corporations including Medical Facilities which trades as an income participating security (IPS).
We scored some truly impressive gains with this portfolio but now it is time to say good-bye and begin the process of dismantling it. The run-up to the trust conversion was a once-in-a-lifetime opportunity and we were fortunately in a position to profit from it. But now that we have scored the big gains, it is time to reassess our positions and decide which securities we should hold going forward and which should be sold.
Before we get to that, however, I want to make one important point. It is no longer advisable to hold any of these securities in a registered plan unless you have no other alternative. All the payments, whether from trusts or corporations, are now eligible for the dividend tax credit in non-registered accounts. That increases the after-tax return significantly. Keeping these securities in an RRSP or RRIF is the worst option because not only is the tax credit lost but all income/capital gains will be taxed at your marginal rate on withdrawal. TFSAs aren’t as punitive since those withdrawals are not taxed, although the dividend credit will still be lost.
Now we come to the critical question of what to keep and what to sell. In making these decisions, our focus, as always, is on choosing securities that offer the best combination of good cash flow at reasonable risk. We will be reviewing all of these recommendations in upcoming issues of The Income Investor but I am advising the sale of one of our Survivor Trust holdings immediately.
Capital Power Income L.P. (TSX: CPA.UN)
This limited partnership was originally recommended in July 2010 at $16.25 and closed on March 18 at $19.14. Formerly known as EPCOR Power L.P., this is one of Canada’s largest power income funds with 19 wholly-owned power generation assets in this country and the U.S. and a 50 per cent interest in a power generation plant in Washington State. The fund pays a monthly distribution of $0.1467 per unit ($1.76 a year) for an attractive yield of 9.2 per cent based on the March 18 closing price.
My concern is that the current payout level may not be sustainable and if it is reduced the share price will drop. The partnership released fourth-quarter and year-end results on March 2 and some of the trends were disquieting. Cash from continuing operations (CCO) for 2010 came in at $125.1 million ($2.27 per unit), down from $142.8 million ($2.65 per unit) in 2009. As a result, the payout ratio for the year increased to 89 per cent and for the fourth quarter it was an uncomfortable 114 per cent.
Also worrisome is the prolonged price negotiation relating to Capital Power’s North Carolina facilities which have been dragging on for months, with no deadline set for completion.
At this stage, there does not appear to be much upside potential to the share price and the risk of a distribution cut is a cause for concern. It’s time to take our profit (total return of 25.9 per cent) and move on. If you own units, ask your advisor if he/she agrees.
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