6 Clean Power Income Trusts: A Good Way to Access High Yields

Last week, Tom Konrad brought you a piece on the Algonquin Power Income Fund (AGQNF.PK), in which he opined that a shift in investor attention away from capital gains toward yield might eventually provide a catalyst for the prices of yield-focused securities such as income trusts to rise.

So-called utility trusts, or income trusts where the underlying corporation is engaged in utility activities such as power generation, are a common feature of the Canadian income trust sector (the mother of all income trust sectors). A sub-set of utility trusts is the clean power utility trust, where the power generation assets consist of technologies such as wind, small hydro, biomass and waste-to-energy [WtE]. Though new tax rules have effectively made it impossible for new income trusts to be brought to market (barring certain exceptions such as REITs), existing clean power utility trusts (existing as of Oct. 31, 2006) get to operate under the old tax regime until 2011.

The clean power utility trust model is similar to the clean power Independent Power Producer (IPP, see definition) model, whereby firms are pure-play clean power generators (i.e. they own only generation assets) that sell their electricity to utilities, with the exception that the tax treatment awarded to income trusts allows them to pay higher yields by avoiding double taxation.

While changes in legislation mean that this investment vehicle is dying a slow death, Tom was correct to point out that in times where the prospects for strong capital gains are uncertain and interest rates low, income trusts provide a good way for investors to access high yields. What's more, clean power utility trusts, this most unique of Canadian investment sub-sector, allows investors (including U.S. investors) to play North American clean power in a way that does not entail a risky bet on a technology play but is rather much more akin to a utility investment.

Clean Power Utility Trusts

Name	Ticker	Related Corp. Entity (Ticker)	Yield (%)*	Assets
Algonquin Power Income Fund	AGQNF.PK	N/A	9.16	Hydro, Cogen, WtE, Wind, Water/Wastewater
Boralex Power Income Fund	BLXJF.PK	Boralex (BRLXF.PK)	19.77	Biomass (wood residue), Hydro, Nat Gas Cogen
Macquarie Power & Infrastructure Income Fund	MCQPF.PK	N/A	18.88	Nat Gas Cogen, Wind, Biomass (wood residue), Hydro, Long-term Care Home
Innergex Power Income Fund	INRGF.PK	Innergex Renewable Energy (INGXF.PK)	10.81	Hydro, Wind
Northland Power Income Fund	NPIFF.PK	Northland Power (not public)	9.44	Nat Gas Cogen, Wind
Great Lakes Hydro Income Fund	GLHIF.PK	N/A	8.01	Hydro

*As at close on Friday Jan. 9, 2008

One of the major risks facing income trusts is distribution cuts, something that generally happens when the fundamentals of the underlying business are severely diminished or distributions were set too high to begin with (in order to attract investors).

As can be noted from the table, the yields on some of these trusts (i.e. Boralex Power Income Fund (BLXJF.PK) and Macquarie Power & Infrastructure Income Fund (MCQPF.PK) appear to indicate that investors are anticipating distribution cuts and are demanding a risk premium. Yet preliminary screens on both funds don't uncover much evidence that distribution cuts are in the cards (caveat: these were very preliminary screens).

While growth will be challenging as long as credit conditions remain tight (individual projects typically use over 50% debt), the underlying business model and existing assets of these funds remain largely immune from a slowing economy - they are utilities with a clean twist.

Barring another major round of indiscriminate selling in equity markets, investments in one or more of the clean power utility trusts is a good way of generating returns in the form of cash yields (something that's worth a lot more than the promise of future capital gains in this economic environment) from a comparatively low-risk sector.

Some of the things to look for as red flags in assessing these trusts are: liquidity position (cash on hand; quick ratio) and ability to borrow for emergency purposes (undrawn line of credit); leverage level (debt-to-capital ratio) and the need to roll over debt in the next 12 months; any signs that operating conditions have deteriorated (e.g. for wood biomass, indications that pulp/saw mill closures related to the bad economy are decreasing fuel supply).

DISCLOSURE: Charles Morand does not have a position in any of the securities discussed above.

Comments

[longoil:]

>>>One of the major risks facing income trusts is distribution cuts, something that generally happens when the fundamentals of the underlying business are severely diminished or distributions were set too high to begin with (in order to attract investors).<<<...

In regards to oil and gas income trusts, distribution cuts are normally not seen as a bad thing by investors. With the recent drop in crude oil prices, it makes sense the distributions should be cut as well. Quite often, these companies use the opportunity to acquire new assets at distressed prices or maintain debt targets. This is seen as a sign of good management.

From ERF news release:
"Enerplus Resources Fund ("Enerplus") is planning a conservative approach to 2009 in light of falling commodity prices with reductions in capital spending and distributions. We intend to preserve our financial strength and maintain flexibility in order to position us to take advantage of future opportunities to add quality assets in an increasingly attractive acquisition market. "

From COS news release:
""While our Syncrude operation is sound and strong, as a result of the deterioration in economic conditions, in particular the significant decline in crude oil prices and the heightened risk in the credit markets, we deem it prudent to reduce the distribution in order to maintain our strong balance sheet."

Jan 14 08:28 AM

[macsmart:]

I'm surprised you do not mention the very best utility trust of all: Atlantic Power Income Fund. ATPWF.PK. or ATP.UN in canada. Check it out on the Globe and Mail investor site. They just increased their monthly dividend...again.They have just acquired a power plant in Florida and have an agreement with Progress Energy that provides cash flow through 2013.. They own various power plants in New England and upstate NY.

It has also extended through 2013 its forward purchases of Canadian dollars in amounts sufficient to make the current level of monthly distributions.

Also, since it is not a oil or gas trust, it is still a question as to whether it will be affected by the tax changes in 2011.

Jan 15 11:16 AM

[casey00001:]

Pink sheet stocks are garbage. You can never sell them when you want to.

Jan 15 06:20 PM

[MichaelAK:]

That is one question I have outstanding is what happens in 2011 to these trust. Mentioned REITS are grandfathered but what about the oil & gas and power trust. I went into oil & gast trust in 2001 and sold in 2006 but went back in just in time for the October massacre. When Oil and Gas were moving these trust did not recover on the stock side but the monthly income even reinvested did not help in the recovery. So concerned about what happens to these trust in 2011 before I would invest. I know it is 2 years away but like to DRIP these trust as much as possible.

Michael,

Jan 16 01:16 PM

[blonde molly:]

Instead of dipping our noses into this junk, why not these US Trusts? DOM & SBR

Jan 19 02:43 AM

[Delojozafado:]

??? "Pink sheet stocks are garbage" ??? This poster appears to be an ignoramus and seems to have no understanding of the recent restructuring of the marketing of global equities as a result of Archipelago and NASDAQ merging. This has just been a natural evolution of trade globalization. I do not believe that shares of for instance of VWDRY.PK, definitely stirred and NOT to be shaken, or SBGSF.PK any more than
PWR are garbage!
`
A separate note... I own both GLHIF and ATPWF. I fear the ATPWF has some issues that are obscured perhaps by their recent acquisition in Fla that did NOT materially increase debt. The majority of the financing will be out of the cash stream generated and the asset is mostly immediately accretive. The problem is if the Commodity & O&G concentric economies eventualy see a resurgence in their currencies due to world wide infrastructure stimulus the Loonie could rally sharply. We see instead that it has just over the past long holiday WE dropped below .80. We have it dropping some more today as the BOC has just lowered rates again this morning. This is a positive as ATPWF is inversely levered to the Loonie with their distributions, debt payments and their debt being in Loonies and nearly all of their production and infrastructure being in the US. ATPWF IMO has a lot of debt. That may or may not be an important issue but it is how "it appears to" me. The recent increase in the distribution due the Fla acquisitions cash flows may be a man behind the curtain. ATPWF does not qualify as part of the theme that launches this thread.

GLHIF is in the opposite situation and this "Gem of purest ray serene"... "Like a river flows gently to the sea " is in a value situation not often seen except in some time frame of sychrocicities as we now have. Glhif had record generation of Gigs and revenues last year. The hydrology however in the 1st qtr is unfavorable, with huge strong high pressure asserting itself over northeastern North America only to give way to infrequent lows that drop snow instead of rain. Low rainfal and snow pack lead to poor 1st quarter production and unit market weakness. The Loonie continues to slide from an over par 1.05 > 52 week high against the dollar. If as yesterday GLHIF advances 1.4% as it did on 1/19 on the TSX it would rise less as the Loonie knocked off another 50cents in US currency. Why is GLHIF such a bargain here? Because Bruce Flatt of BAM has just invested 75 MMCAD $s in a bought deal financing @ $16/unit. A non-public offering of new units. This share dilution has left the units priced lower than the deal went off at. You have the entire financial research resources of BAM guesstimating that this trust has an intrinsic valuation of $16, and now you can buy it below that (NAV?). As with ATPWF however $65 MM of this infusion will be immediately accretive as it is being used to acquire additional hydro in BC and new wind farming on the norther shores of the Lakes.
`
If the Loonie continues to weaken the unit bargain to be had on GLHIF should improve. A better buying opportunity. The ATPWF shares should continue to rise. Players in this game should keep an eye on an interactive chart of ATPWF,GLHIF and FXC. Not only does the share price adjust against currency rates the distribution adjusts by the same percentage. GLHIF is the bargain of a life time and ATPWF IMO is reaching full valuation.

Jan 20 09:48 AM