Connors Bros. Income Fund is threatening to join a growing choir of "fallen angels" -- now approaching two dozen -- that are casting a darker pall on the $160-billion income trust sector.
The trust, which sits atop a fish- and meat-canning empire that began with a single sardine cannery in Blacks Harbour, N.B., has warned that it may cut its cash distributions to unitholders, currently $1.50 a unit annually, by up to 10 per cent.
Assuming Connor Bros. follows through on its warning, it will become the 22nd trust to have trimmed or suspended its payout since May, 2003, and the sixth since the beginning of last month.
Connors Bros. did not blame its troubles on the angst that has carved hundreds of millions of dollars from the income trust sector's market capital since the federal government's September pledge to review and maybe rein in the tax advantages that have made the trust structure so popular. Instead, in an announcement late Tuesday, it cited a combination of unusually sharp cost increases and its inability to counter their impact by boosting its own prices.
"It's a classic," Ric Palombi, a portfolio manager at McLean & Partners Wealth Management Ltd. in Calgary, said of Connors Bros. "They can't raise prices and their costs are going up, so their margins are getting squeezed."
Connors is the fourth trust to send out distress signals so far this week alone.
It was preceded by two other food sector entries, dessert and drink mix maker Associated Brands Income Fund, which cut its distribution, and private label pet food producer Menu Foods Income Fund, which warned it also may do so, along with residential mortgage lender FMF Capital Group Ltd., which suspended its entirely.
Analyst Barbara Gray, who follows business income trusts for investment dealer Blackmont Capital, christened those who have cut or suspended their payouts "fallen angels" in a report last April.
As with the other bearers of bad tidings, Connor Bros. has been flayed by investors. Its units plunged by more than 18 per cent on the Toronto Stock Exchange yesterday, although they rallied a little to close at $9.77, down $1.32 or nearly 12 per cent from Tuesday's finish.
Mr. Palombi would have been justified in saying "I told you so" in connection with not just Connors Bros., but also with Menu Foods and Associated Brands.
They all are on a list of 83 income trusts his firm pegs as the most likely to cut or suspend distributions. It published the list a week ago and explained how it used a series of three "red flags" to help identify potential hot spots among Canada's nearly 230 income trusts.
The danger signals are: a ratio exceeding 2 per cent of debt to earnings before interest, taxes, depreciation and amortization (EBITDA); an estimated 2006 payout ratio exceeding 90 per cent of distributable cash; and a pretax yield of more than 12 per cent.
In the report, Connors Bros. triggered two red flags, with a 2.4 debt-to-EBITDA ratio and a pretax yield of 13.2 per cent, while its estimated payout ratio was 81 per cent.
Two other trusts raised all three flags: Clean Power Income Fund, which invests in electric power generating facilities that use renewable energy sources -- and reduced its distributions last year -- and newspaper owner Osprey Media Income Fund.
As it happens, McLean & Partners considers income trusts a little too high risk for the most part and holds units in just six of them for its clients. "We're not big on the whole income trust business," Mr. Palombi said. He also said the firm does not take short positions in these or other securities.
Blackmont's Ms. Gray, who could not be reached for comment yesterday, likely would not disagree with this assessment.
In her April report, she argued that "higher-quality" business trusts are pretty much as risky as junk bonds, while "lower-quality" entries are on a par with lower-grade equities. "We believe that the business trust universe has the financial characteristics of equities with a single-B rating, given that 20 per cent have become Fallen Angels within only 2.4 years, on average, of going public," she said.
As for Osprey, Mr. Palombi would not say yesterday whether he thinks the media income trust is inevitably going to have to cut or suspend its cash payouts. But he did say that if he owned its units, the three red flags would "spur me on to try to figure out exactly what's going on."
Osprey chief executive officer Michael Sifton acknowledged in an interview that the trust's payouts have exceeded the distributable cash its papers have generated, but said it has financed this using working capital and other sources, not by loading on debt.
Osprey's board of directors, Mr. Sifton added, would not have approved the distributions if it did not think their level was appropriate. "At this point, no decisions have been made to reduce [the distribution]," he said. "It's been the opposite. The decision to maintain the level has been a conscious one, month after month."
High risk, no reward
The veil of perceived security has fallen from the income trust sector amid a flurry of suspended or cut distributions to reveal an asset class that bears a greater resemblance to junk bonds than to stable income generators.
| TRUST | BUSINESS | DISTRIBUTION WARNED/CUT/ SUSPENDED | EXPLANATION |
| Connors Bros. | Seafood | Nov. 16, warned | Rising costs |
| SFK Pulp Fund | Forestry | Nov. 15, suspended | Higher costs, higher Canadian dollar |
| FMF Capital | Mortgage lender | Nov. 14, suspended | Interest rates |
| Associated Brands | Powdered foods | Nov. 14, cut | Higher Canadian dollar |
| Art In Motion | Fine art framing | Oct. 6, cut | Higher Canadian dollar |
| Arriscraft Int'l | Masonry products | July 26, suspended | Inventory buildup |
| Boyd Group | Collision repair | May 13, cut | Industry slowdown |
| Advanced Fiber Tech. | Pulp and paper | May 13, suspended | Industry slowdown |
| Menu Foods | Pet foods | May 12, cut | Higher Canadian dollar |
| ACS Media | Alaska yellow pages | May 11, cut | Higher Canadian dollar |
SOURCE: BLOOMBERG FINANCIAL SERVICES
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