One of the easiest ways to lose money in the Canadian equity market is to own a trust that cuts its distribution.
So Calgary-based McLean & Partners Wealth Management Ltd. has come up with a way to determine which Canadian income trusts could be the next to cut their distributions. It used three measurements -- a ratio of debt to earnings before interest, taxes, depreciation and amortization (EBITDA), the payout ratio and the pretax yield -- to screen the entire Canadian universe of income trusts.
If any one of the ratios exceed a certain level, a red flag is raised. Of the 200 trusts examined, 83 raised at least one red flag. Two trusts -- Clean Power Income Fund and Osprey Media Income Fund -- triggered all three flags.
Although the flags point to a higher degree of risk, it does not necessarily mean investors should hit the sell button, said Ric Palombi, a portfolio manager at McLean & Partners.
"This report does not say that if you see a red flag, you should sell your trust immediately," Mr. Palombi said. "We want to educate investors to think about the trusts that they own, and the risks that are inherent in them. With interest rates going up and the market being a little jittery, more and more of these units will struggle."
Last month, Clearwater Seafoods Income Fund suspended its distributions for the rest of the year, citing a high dollar, soaring energy and maintenance costs. The trust said it distributed more cash than it generated in the first half of the year and does not have enough to pay investors in the second half.
Clearwater units plunged 35 per cent in the ensuing session and are now down 58 per cent since the start of the year on the Toronto Stock Exchange.
The S&P/TSX capped income trust had a tough October, dropping 11 per cent since Finance Minister Ralph Goodale said the Canada Revenue Agency would no longer provide advance tax rulings to companies considering conversion into a trust.
Some of the trusts that have recently dropped will have a hard time rebuilding their balance sheets, Mr. Palombi said. "Because these funds pay out so much of their earnings, they don't have the capacity to reinvest in the business and build up their balance sheet again."
Clean Power Income Fund raised all three flags, meaning its debt, payout and pretax yield are all high relative to its peers. "There is a lot of stress on the balance sheet of that trust and people should start thinking of what exactly is going on there," Mr. Palombi said.
Advanced Fiber Technologies Income Fund has the highest debt to EBIDTA ratio, according McLean & Partners. Boralex Power Income Fund has the highest payout ratio while Entertainment One Income Fund has the highest pretax yield.
When the debt to EBIDTA ratio is high, a trust cannot keep up with its distributions, Mr. Palombi said. The ratio is important because it is not possible to continually pay out more than one earns. Trusts that choose to issue debt to pay their distributions drive up their debt-to-equity ratio, putting stress on their balance sheets, he said.
"In the last four years, we have not gone through a trust bear market," Mr. Palombi said. But with interest rates going up, investors should stop assuming trust holdings are going to translate into easy money, he said.
Untrustworthy?
According to wealth management firm McLean & Partners, income trusts with three "red flags," such as Clean Power Income Fund, are the most likely to cut their distributions.
| NAME | SYMBOL | DEBT/ EBITDA | PAYOUT RATIO 2006E | 2005E PRE-TAX YIELD |
| Algonquin Power Income Fund | APF.UN | 4.7 | 98% | 9.20% |
| Atlas Cold Storage Income Trust | FZR.UN | 2.4 | 90% | 0.00% |
| Chemtrade Logistics Income Fund | CHE.UN | 2.6 | 89% | 15.60% |
| Clean Power Income Fund | CLE.UN | 3.7 | 101% | 13.70% |
| Clearwater Seafoods Income Fund | CLR.UN | 2.8 | 73%^ | 16.80% |
| Custom Direct Income Fund | CDI.UN | 1.4 | 94% | 13.50% |
| Enbridge Income Fund | ENF.UN | 4 | 97% | 7.40% |
| Fording Canadian Coal Trust | FDG.UN | 0.3 | 95%^ | 13.20% |
| Fort Chicago Energy Partners | LP FCE.UN | 5 | 98% | 8.20% |
| Great Lakes Hydro Income Fund | GLH.UN | 5.1 | 95% | 7.40% |
| Innergex Power Income Fund | IEF.UN | 2.1 | 92% | 8.10% |
| Menu Foods Income Fund | MEW.UN | 2.1 | 51%^ | 20.90% |
| Osprey Media Income Fund | OSP.UN | 2.6 | 100% | 13.00% |
| Pembina Pipeline Income Fund | PIF.UN | 3.7 | 92% | 7.30% |
| Prime Restaurants Royalty Income Fund | EAT.UN | 0 | 101%^ | 13.10% |
| SFK Pulp Fund | SFK.UN | 2.7 | 100% | 11.10% |
| Superior Plus Income Fund | SPF.UN | 3 | 94% | 10.60% |
| TimberWest Forest Corp. (Stapled unit) | TWF.UN | 2.5 | 98% | 7.90% |
| Tree Island Wire Income Fund | TIL.UN | 0.2 | 97% | 13.80% |
| Versacold Income Fund | ICE.UN | 4.1 | 95% | 11.60% |
| Yellow Pages Income Fund | YLO.UN | 3.8 | 90% | 7.40% |
© The Globe and Mail
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