Three income trusts for all seasons

By Larry MacDonald
Globe Investor magazine online, April 4, 2008

Which income trusts will continue to be good investments regardless of macroeconomic fluctuations and the higher tax burdens scheduled to come into effect in 2011 under the Tax Fairness Plan?

We asked three experts to give us their pick for the one income trust that can maintain or increase its distribution (as either a trust or corporation) through the challenging environment that lies ahead.

Cineplex

Leslie Lundquist co-manages the portfolios of the Bissett Income Fund and the Bissett Income Trust & Dividend Fund. Her choice is Cineplex Galaxy Income Fund ( $17.07/ CGX.UN-T).

"Cineplex Galaxy has accumulated tax pools of $625-million that are available to offset future taxable income," said Ms. Lundquist. "This, along with the company's low payout ratio (60 per cent) and growth strategy, should allow the trust to maintain and grow the current distribution of $1.20 (now yielding 7.4 per cent) past 2011."

Cineplex Galaxy is the largest movie exhibitor in Canada, with a box-office market share of 67 per cent. It thus enjoys pricing power in the cinema market, as well as quantity discounts on purchases from movie producers and concession suppliers. Moreover, an entrepreneurial management team, backed by a solid balance sheet, is acting on a number of opportunities capable of increasing revenues and cash flow even through recessionary environments: In-theatre advertising (controls 90 per cent of this high-growth/margin niche); alternative content such as opera, NHL hockey, and concerts; scene loyalty program (membership growing faster than expected); sale of naming rights to theatres; conversion of one-fifth of screens to permit 3-D projection; and online DVD/movie download sales.

Colabor

Harry Levant is an independent analyst and operator of IncomeTrustResearch.com. He offers Colabor Income Fund ( $10.85/ CLB.UN-T). The units, currently yielding 10 per cent on a distribution of $1.08, are recommended below a price of $11, while the convertible debentures, yielding 6.9 per cent, are recommended below $103.

Colabor, a wholesaler/distributor of food and non-food products, became subject to taxation at corporate rates in 2007, after losing an appeal to exempt its acquisition of Summit Food Service Distributors Inc. from growth guidelines set out in the trust tax legislation. But Colabor has been able to increase earnings by enough in 2007 to offset the trust tax, three years ahead of the trust taxation deadline, said Mr. Levant.

In business since 1962 as a buyers' co-operative, Colabor allows independent wholesalers and distributors in Quebec and Atlantic Canada to take advantage of purchasing power usually available only to integrated chains. On conversion to an income trust in 2005, affiliated wholesalers (representing 99 per cent of sales) entered into 10-year agreements with Colabor.

The January, 2007, acquisition of Summit Food from Cara Operations Ltd. included a 10-year distribution agreement with Cara , plus a five-year option to service the Cara brands in Ontario and Quebec. Summit distributes frozen, dairy, meat, and other products from three Ontario warehouses to thousands of customers, including Cara.

BFI Canada

Gaelen Morphet is first vice-president of Canadian equities at CIBC Global Asset Management Inc. She likes BFI Canada Income Fund (BFC.UN-T), one of the larger non-hazardous waste management companies in North America.

BFI Canada is already taxed on the 60 per cent of its cash flow that originates in the United States. The impending higher tax burden on the remaining 40 per cent could clip the $1.82-per-unit distribution (yielding 8.3 per cent) by 10 to 15 per cent, but that hit can be absorbed by raising the payout ratio, currently near 80 per cent.

BFI Canada is one of the best waste-management firms when looking for organic growth and operating margins, Ms. Morphet said. She particularly likes the seasoned and committed management team, as well prospects for growth through acquisitions of smaller operators. Also, the company operates in a recession-resistant industry and derives revenues mostly from three- to five-year contracts.

The low payout ratio, reduced tax impact, and earnings growth should enable BFI Canada not only to maintain its distribution, but return to the past policy of increases. Supporting this outlook is a financially strong position (owns land fill sites and trucks) and likely an end to the drag on earnings caused by appreciation in the Canadian dollar.

Special to the Globe and Mail