Canadian Clean Energy Trusts: Best High Yield U.S. Dollar Hedge?

A. The Short Version

They’re distributions are very high, very reliable, paid in Canadian dollars, and thus offer a great dollar hedge. The CAD’s relative current weakness against the USD makes these shares both extra cheap and potentially even more profitable.

B. The Detailed Version

These trusts include electric power producers with significant portions of their output from low or no carbon emission sources, like:

• natural gas – the cleanest of the fossil fuels.
• hydroelectric – produces by placing big turbines in carefully channeled falling water, typically from dams.
• wind - typically large groups of hi-tech windmills grouped together in optimially windy spots called wind farms.
• biomass - forms of gas and liquid fuels produced from plant matter and animal waste.
• solar - typically in farms of photovoltaic cells producing electricity. Since production is best in sunny deserts with little rain, none of these Canadian companies have solar facilities (duh, this is Canada, after all). But elsewhere this is a worthy option. It’s very big in Israel, to the point that most Israeli homes and apartments have solar collectors on their roofs to supply hotwater using a simple greenhouse effect rather than photovoltaic cells.

See the company websites for details on their specific portfolios of power facilities. While not technically utility companies, they typically own various shares of power production facilities, and sell their portion of the electricity to the local utility under long term contracts with provisions that ensure an acceptable return on investment.

C. Less Volatility than Oil and Gas Producer Income Trusts, Equally High or Higher Yields.

While these trusts may lack the appreciation potential of the oil and gas producer trusts, the clean power producer trusts have had far more stable revenues and dividends throughout the past year. Like most stocks, their share prices bounced around with the overall market. Unlike most stocks, however, the extreme share price declines did not reflect their fundamentals at all, which remained overall healthy, stable, and at times even growing.

Despite the challenging economic environment and tightening credit availability, their steady revenues, cash flows, incomes and hence dividend streams have stayed steady (or even grown in the case of Atlantic Power Corp (ATPWF.PK) (TSX: ATP.UN) ) during the downturn. Moreover, their payout ratios are usually around 70% of distributable cash, which is quite conservative for such steady-revenue businesses like power generation.

D. Risks

Since plenty of downside risk remains in the market, these recommendations are perhaps the best combination of safety and high yield anywhere, and that’s BEFORE considering the likely appreciation of the CAD against the USD. Nonetheless, there are some risks you should be aware of.

Market Risk. Like virtually all shares, they will move with the overall market. Note that all of these are thinly traded, and thus volatile, since little selling or buying can really move their share prices.

Currency Risk: The CAD could drop further against the USD. At most this will be temporary. The odds are well in favor of the CAD appreciating.

Given the market and currency risk that remains, it’s very possible these will yet again power dive with the market. That’s the best time to add as long as these businesses continue to perform.

Remember: power generation is one of the most recession resistant industries. Thus these are great defensive plays that pay you very well while you wait for recovery.

Thus given the recent market rally, take no more than partial positions at this stage, since we’re likely to see better prices coming in the coming months.

NOTE:

CANADA CURRENTLY HAS A 15% WITHOLDING TAX FOR FOREIGN SHAREHOLDERS, WHICH CAN BE RECOVERED AS A TAX CREDIT BY SUBMITTING IRS FORM 1116 WITH YOUR TAX RETURN. IT’S AS YET UNCLEAR IF OR HOW THAT WILL CHANGE IN 2011.

ALL AMOUNTS QUOTED ARE IN U.S. DOLLARS (USD) UNLESS OTHERWISE NOTED. ALL STOCK SYMBOLS ARE NEW YORK STOCK EXCHANGE UNLESS OTHERWISE NOTED (OTC = OVER THE COUNTER, TSX = TORONTO EXCHANGE). YIELDS ARE AS OF DAY BEFORE PUBLICATION.

6. CLEAN ENERGY INCOME TRUSTS– Specific Recommendations

Take only partial positions until energy prices appear to have stabilized, but be ready to load up on these as the market begins to show interest. Both prices and distributions will soar as energy recovers, giving you high yields and capital gains.

Atlantic Power Corporation (ATPWF.PK), (TSX: ATP.UN) : Buy under 7.50, Strong Buy under 6.50. Yield over 13%.

As noted in my earlier article on ATP Time to Buy Energy Stocks...Plus an Overlooked Power Fund throughout the market downturn, ATP continued to show strength, raising distributions 8%, buying back shares, cutting debt, and expanding production. On March 30^th they released Q4 results. Highlights include:

• 7% increase in operating cash flow, thus reducing payout ratio on its over 13% dividend to just 36% of distributable cash flow for the quarter, and 59% for the year. Note that it’s the annual payout ratio that you need to focus on, since its quarterly payout ratio varies significantly due to a large semi-annual debt payment that makes the payout ratio in Q1 and Q3 much higher than the overall annual ratio. Over the past year I’ve seen it jump to a seemingly unsustainable 160% in Q3, then seen it drop to a hyperconservative 36% in Q4.
• The Federal Energy Regulatory Commission (FERC) tentatively approved a rate settlement for ATP’s Path 15 power line in California, granting a13.5% return on equity and new revenue for 2009 and 2010 in accordance with management expectations. Final approval of the deal is expected this summer.
• The firm has now retired 558,620 of its income participating securities (IPSs), about 14% of its planned total. As noted in the earlier article, the IPSs are a combined common share and subordinated bond. Thus the remaining 86% of the buyback retires the bond portion and reduces debt, and also supports the share price. It also shows management’s confidence in the health of the business.
• Management again confirmed that its current cash flow and currency hedges will sustain the current distribution into 2015 regardless of currency fluctuations. Thus even though the firm operates in the U.S. and earns in U.S. dollars, it can continue its CAD distributions even if the CAD rises (which would thus make the shares and distributions more valuable still).

Energy Savings Income Fund (ESIUF.PK), (TSX: SIF.UN): Buy under 8.50, Strong Buy under 7.50. Yield about 12%.

The fund owns shares in various gas and electricity marketing operations in the U.S. and Canada.

Highlights for fiscal Q3 which ended on December 31, 2008 include:

• Profit margins up 23%, distributable cash up 22%.
• Added about 94,000 new customers in Q4.
• Management affirms full year 09 guidance for growth of 5-10% for margins and distributable cash flow.
• Quarterly payout ratio falls to a conservative 72%.
• Interest expense cut by 25%, showing the firm has no credit problems.
• Bad debt expense under 3% of revenue, thus confirming that despite operating in a somewhat competitive environment ESIUF performs with the reliability of a utility. Contractual arrangements shift 75% of overall bad debt expense to their utility customers.

Despite its share prices having risen well off its December lows, the firm still sells for only about 62% of sales and yields nearly 12%.

Great Lakes Hydro Income Fund (GLHIF.PK), (TSX: GLH.UN): Buy under 14, Strong Buy under 12. Yield about 8%.

Results for Q4 concluded the strongest year for earnings ever.

Highlights include:

• Power generation up 22% on strong water flows and system expansion.
• Payout ratio under 60% for the year.
• Investment of CAD 16.8 million in growth capital and CAD 3.5 million in major maintenance in 2008, with plans to expand these in 2009 to CAD17.3 million and CAD 4.5 million. This confirms managements stated plans to maintain its distribution in 2011 and beyond.

Note: as with any hydroelectric production, revenues can vary with water flow from year to year, but this evens out over the years. Of course, the best managed hydro producers will invest to expand production and grow revenues regardless of annual water flows.

Innergex Power Income Fund (INRGF.PK), (TSX: IEF.UN): Buy under 9, Strong Buy under 8. Yield over 10%.

Possessing a well managed fleet of carbon-neutral power facilities, INRGF is as good as the above firms. It’s portfolio of generation plants is 73% hydro and 27% wind, and is managed by Innergex Renewable Energy under a long term agreement with the fund. Favorable weather and acquisitions of two new wind farms lead to superb performance for the third quarter ending in December, which is usually a weaker quarter. Highlights include:

• Increase in power generation 41% over last year.
• 48% increase in operating revenue.
• 25% increase in distributable cash flow (after capital spending).
• Decrease in payout ratio to 89%.

Like any hydroelectric producer, results can vary with water flows from year to year. Management notes, however, a number of factors that will protect revenues. These include:

• All power is sold under long-term contracts to public utilities, which are among the most recession proof customers.
• Contracts have an average life of 15.6 years, thus these revenue streams are very safe for the long term.
• Their fleet of plants is very young, averaging only 6 years, with an estimated useful life of 25-50 years.
• Exposure to the current credit situation is negligible.
• No credit facilities are due until 2013, and of the total CAD 10 million available, CAD 9.2 is unused! Thus debt can be easily paid off at will, or the credit can be used to fuel future growth with strategic acquisitions.
• 92% of the firm’s credit facilities are fixed rate, with overall effective interest rate at just 4.4%.
• Cash reserves of CAD 25.1 million (worth 10 months of distributions).

Like the others on this list, Innergex is a rare combination of ultra high yield for such a dependable revenue stream. Very thinly traded, its shares have not followed the market up, so it remains an unnoticed deal selling under 1.5x book value. Not surprisingly, insiders have been buying.

Macquarie Power & Infrastructure (MCQPF.PK), (TSX: MPT.UN): Buy under 5, Strong Buy under 4. Yield around 20% prices in possible dividend cut, yet management has affirmed 2009 guidance and the 2009 distribution.

Its power generation asset portfolio is comprised of gas cogeneration, wind, hydro, and biomass. Q4 performance was close to last year’s, with excellent wind and hydro performance offsetting a shutdown at a biomass plant. Highlights include:

• Good cash flow from its minority stake in LeisureWorld (long term care homes in Toronto).
• Payout ratio declined to 89% in Q4, bringing annual payout ratio down to 100%.

The relatively high payout ratio leaves the firm vulnerable to a distribution cut in 2011 unless it succeeds in management’s stated goal of increasing performance to support the distribution in the post 2011 era. Meanwhile the yield around 20% allows for solid returns even if there is a substantial cut, and the current share price is only around 62% of book value due to speculation about a possible dividend cut. With that risk already priced in, the stock is buy at recommended levels.

Northland Power Income Fund (ONPIFF.PK), (TSX: NPI-U): Buy under 8.5, Strong Buy under 7.5. Yield about 10%.

Overall performance slightly below last year due to one-time events, not ongoing operations. Overall operations solid, manageable debt. Selling at just 1.6 times book, low price, thus lower risk. I want to do more research on this one, but looks promising at this time.

7. Conclusion, Disclosure & More Info

This installment looked in detail at the best of the Canadian clean energy income trusts.

In sum, they provide among the best risk/reward available for high dividend investors, and also provide a valuable USD hedge.

Part 10 will deal with other superb Canadian income trusts sectors – energy infrastructure and utilities.

Disclosure: I have positions in most of the above mentioned investments.

Comments

[tc1:]

Cliff, this is a really great series of articles you're sharing with us. Keep 'em coming!

I've got investments in GLHIF and also Boralex Power Income Fund (BLXJF.PK), which has done very well for us since getting in at a low price, and despite the further market drop in Feb-March.

With regard to the energy trusts that have large hydropower segments, I'd be curious if you or anyone knows how to gauge the hydrological strength/weakness in any given year, since these firms generate more power when there is more late Winter early Spring rainfall (not snowfall) for powering their turbines.

Apr 07 05:07 PM

[Conan the B...:]

Thank you, nice spread.

Are any of them subject to the Conversion to corporation Law?

Apr 07 05:32 PM

[Cliff Wachtel:]

Superb question. It's mostly long term weather forecasting. Given the record of even short term forecasters, it has it's margin of error. I could see global warming being a positive as more water gets unlocked from glaciers and the poles. Of course, might lose some customers/plants in low lying areas. Thanks for your comments, Cliff


On Apr 07 05:07 PM tc1 wrote:

> Cliff, this is a really great series of articles you're sharing with
> us. Keep 'em coming!
>
> I've got investments in GLHIF and also Boralex Power Income Fund
> (seekingalpha.com/symbo...), which has done very well
> for us since getting in at a low price, and despite the further market
> drop in Feb-March.
>
> With regard to the energy trusts that have large hydropower segments,
> I'd be curious if you or anyone knows how to gauge the hydrological
> strength/weakness in any given year, since these firms generate more
> power when there is more late Winter early Spring rainfall (not snowfall)
> for powering their turbines.

Apr 08 05:13 AM

[Cliff Wachtel:]

Yes, all income trusts are. Reminder, Atlantic Power is not an income trust, though I include it with this group since it shares all other characteristics. Technically, what you buy is not trust unit but income participation securities. The article mentions where I've written about this in detail. Good question, thanks for commenting, cliff


On Apr 07 05:32 PM Conan the Barbarian wrote:

> Thank you, nice spread.
>
> Are any of them subject to the Conversion to corporation Law?

Apr 08 05:16 AM

[Mr Gadget:]

There are a few "income participation" units out there that are acombination of a share of stock coupled with a bond. Is this one of them?
Thanks for the informative serries.

Apr 08 08:46 AM

[peapack@ver...:]

These suggestions are terrific, but it is hard to get good information on them.

Apr 08 09:39 AM

[kelm:]

Great information though I remain skeptical about the Canadian dollar as a hedge against the US dollar decline. The Bank of Canada always seems to manage to allow the CAD to remain at a discount to the US.

Apr 08 10:27 AM

[JCCIII:]

Cliff. You note pink sheets and TSX symbols for all of the trusts in your article. When purchasing any of these, do you recommend trading via pink sheets or as a foreign ordinary transaction via TSX? What is your reasoning for choosing one vehicle over the other? Thank you.

Apr 08 12:19 PM

[Delojozafado:]

Carney and The BOC have already "indicated, hinted at", that at the end of the meeting of 4/24 they will spell out more precisely the plan and guidelines of Canada's own "Q" easing policy. So far they have indicated that this "Q" easing would be going towards the buying up of corporate debt. At any rate this electronic money machine Loonie creation will likely have a very sharp short term impact on the Loonie. I would expect to see the CAD $ to briefly breach the .78/1.30 mark.
I would see this as a major buying opportunity for (ATPWF),(GLHIF), and the very irascible (BIRDF).

Despite the continued struggle in the OIL Sands arena Bird has pushed sharply higher after recently breaking well below $16CD/Unit. They recently had a big project with Suncor (FireBag) put on hold, delay or maybe to be canceled. Bird exhibits the very bullish W chart pattern.

We can add some insight to the (GLHIF) as a previous poster noted in terms of 1st qtr hydrology. Today GLH announced the date for it's release of the most recent 1st qtr numbers and a conference call. We should expect some poor results against the last three previous quarters. This is perhaps partially reflected in the unit price not performing very closely in line with the over all market averages as of late. @ $12.19 US dollars we see a full 7% monthly distribution rate against the withholding and a .81 currency factor. We are about to see the results of first quarter hydrology reflected in the numbers that will be reported. A good deal of snow and high pressure persisting reducing precipitation and resulting in seasonal accumulations of ice and snow pack detracting from the water flows we would expect to be much improved in the next three quarters. An analyst, a Ms Vargas at Clarus securities of Toronto has placed a buy on GLH as of the first week of March. She has assigned the shares a target price of $18.50. The recent addition of $65 million in new generating assets that were acquired and not contracted to be built became accretive in FEB. A BDF closed in DEC with a subsidiary of (BAM) a majority owner through their subsidiary Brookfield Power, purchasing units at $16Cd per unit. Recently a unit buy back program (NCIB) was initiated proposing to retire 2.4% (1MM units) of the unit float exclusive of the units owned by BAM's subsidiary which has indicated their units will be with held from the market until the NCIB ends in March of 2010.

(ATPWF) despite a long delay 'til the very end of March in releasing their 2008 and 4th quarter results, seems to be validaing some Cliff notes posters who have categorized it as the baby with the bath water. Because of it's tax advantaged structure, a stapled unit, it is particularly appealing to the IRA /401-K investor. Generally only 40% of the distribution is subject to the Canadian with holding. The other 60% ends up being an interest payment. This should be noted by investors as the interest on the note portion will not qualify as a qualified dividend and will be fully taxed by the IRS as interest, as that is what it is.

In terms of the tax situation I thank Cliff for at least remarking, "It's as yet unclear if or how that will change in 2011". I am willing to be sanguine and believe that Labor faction of government is unlikely to gain anything significant, certainly not the PM seat. With the Tory's having a strong political base retaining Mr Harper as PM, tax policies in Canada will be moderate in terms of not wanting to chase out foreign capital. We can see this week the province of Alberta offering to knock down taxes and tariffs to O&G exploration and production as their O&G revenues have fallen off by 52% in just one year.

Apr 08 01:16 PM

[JCCIII:]

Cliff. Some comments and a question. (1) This is a great series of articles; thank you for the time and effort. (2) I believe the symbols for Northland Power Income Fund are NPIFF.PK (pink sheets) and NPI.UN (TSX); or, maybe I totally missed something. (3) You noted Innergex was thinly traded, which made me wonder about the volume of the other trusts. From the TSX site and Yahoo Finance, the trusts noted in your article have the following approximate daily average volume: APT.UN 96K, APTWF.PK, 63K; SIF.UN 236K, ESIUF.PK 2.6K; GLH.UN 61K, GLHIF.PK 4.4K; IEF.UN 25K, INRGF.PK 3.5K; MPT.UN 100K, MCQPF.PK 9K; and NPI.UN 79K, NPIFF.PK 1K. (4) Is the average daily volume metric a factor to you? Thank you.

Apr 08 03:28 PM

[rjhipple:]

Cliff....considering another risk.....if these companies are doing business in the US, and have long term contracts....are they subject to getting paid with inflated dollars ?....and being underwater due to high costs ?

I look forward to your answer....best regards.

Richard

Apr 08 05:04 PM

[DuffBeer:]

Cliff
I recall your first post and said to myself , "self, even I can understand this guy." Great series and look at the followers who also are contributing. Once again big Thanks to Cliff and to all who share and add to his posts. I am going to have to bring alot more then a 6 pak to this party but with all these great income paying ideas I can
buy beer keg !
Cheers, DuffBeer

Apr 08 06:04 PM

[Cliff Wachtel:]

ATPWF is, the others mentioned here are income trusts. There are a few others out there. Depending on certain technical details, they may be called other names, like IDSs (income deposit securities) and something else too, the name of which eludes me at the moment. Cliff


On Apr 08 08:46 AM Mr Gadget wrote:

> There are a few "income participation" units out there that are acombination
> of a share of stock coupled with a bond. Is this one of them?
> Thanks for the informative serries.

Apr 10 08:33 AM

[Cliff Wachtel:]

Thanks again, will keep trying, more on the way.


On Apr 08 06:04 PM DuffBeer wrote:

> Cliff
> I recall your first post and said to myself , "self, even I can understand
> this guy." Great series and look at the followers who also are contributing.
> Once again big Thanks to Cliff and to all who share and add to his
> posts. I am going to have to bring alot more then a 6 pak to this
> party but with all these great income paying ideas I can
> buy beer keg !
> Cheers, DuffBeer

Apr 10 08:34 AM

[Cliff Wachtel:]

Excellent question. Yes, those that have operations in the US and get paid in USD are exposed to USD fluctuations. Thus to varying degrees they buy CADs or other currencies they need to pay out as a hedge, as do most companies with significant operations overseas that get paid in one currency and must pay expenses in another. For example, Atlantic Power has enough hedges to ensure their CAD payout through about 2015, even though they earn in USD. Thanks for your input, Cliff


On Apr 08 05:04 PM rjhipple wrote:

> Cliff....considering another risk.....if these companies are doing
> business in the US, and have long term contracts....are they subject
> to getting paid with inflated dollars ?....and being underwater due
> to high costs ?
>
> I look forward to your answer....best regards.
>
> Richard

Apr 16 09:16 AM

[bruceford:]

Wonderful stuff, Cliff. Thank you. But when you talk yields (Atlantic Power or Macquarie, for instance), are you talking Canadian yields before excange rates and before Canadian 15% tax to US investors?

Apr 19 06:40 PM

[Cliff Wachtel:]

Excellent question. The short answer is that you need to check what currency they pay dividends and operating expenses ( check management discussion and analysis of annual and quarterly reports). If they earn in one currency yet pay out expenses in another, there is a potential for gain or loss on the difference in currency value, so you need to see if/how they hedge that risk. For example, ATPWF operates in the US yet pays out distributions in CAN. They have hedged currency risk so that they can maintain their payout through btwn 2013-2015, I forget which. Cliff

On Apr 08 05:04 PM rjhipple wrote:

> Cliff....considering another risk.....if these companies are doing
> business in the US, and have long term contracts....are they subject
> to getting paid with inflated dollars ?....and being underwater due
> to high costs ?
>
> I look forward to your answer....best regards.
>
> Richard

May 10 05:54 AM

[anarchist:]

Cliff, I think you have covered this point before but I'm too lazy to wade through all the articles and comments. Is it true that the 15% tax levied by the Canadian Government is not recoverable when they are in an IRA?
thanks

May 10 09:41 AM