Best Risk / Reward Income Investments, Part II: Canadian Energy Infrastructure Stocks

Stocks for the fear AND greed in all of us.

The Problem: Conflicted by Fear and Greed

In the current market, many income investors are feeling very conflicted.

• They are afraid of buying into an overextended rally
• They are also afraid of missing further gains and dividend yields while sitting in cash

In Part 1, we discussed the following Canadian Electric Power stocks: Atlantic Power (ATPWF.PK), Great Lakes Hydro Inc Fund (GLHIF.PK), Innergex Power Income Fund(INRGF.PK), Maxquarie Power & Infrastructure (MCQPF.PK), Northland Power Income Fund (NPIFF.PK). Now we look at the best of the energy infrastructure sector

A Solution: Selected Canadian Energy Infrastructure Stocks for Steady, High Returns

As my regular readers know, I am not a believer in the current rally, yet I hear the pain of conservative income investors who seek yields that are not only safe, but high.

Reward/Risk Overview

Why Buy These Canadian Energy Infrastructure Stocks?

If you must go long, these Canadian Electric Power stocks are all weather stocks that you can feel safe buying even in this volatile market.

• Safety: They sport some of the safest, most reliable dividends to be found, backed by steady revenue streams and sustainable payout ratios. While they can and do suffer
• High yields that keep you ahead of taxes and inflation
• Payment in Canadian dollars, providing a critical element of diversification out of the “Obamanable shrinking US dollar” for those with heavy USD exposure
• Most are relatively green power producers that will benefit from government incentives

Thus when/if the markets pull back, you can afford to sit with these because they pay you very well while you hold them.

Why NOT to Buy Them

They are relatively low risk, but not without risk. Primary risks include

• Overall market risk: Like most stocks, these will fall if the overall stock market pulls back, and there are plenty of reasons to suggest that it will. High valuations compared to earnings, a still deeply weakened US and world economy, continuing job losses that threaten whatever fragile recovery there is, a banking system still on life support, etc.
• Low liquidity: These are thinly traded, and thus tend to drop harder than the overall market.
• Currency Risk: If global markets retreat, the CAD tends to fall against the safe-haven currencies: the JPY, USD, and CHF. Thus those seeking diversification out of the USD would suffer additional losses in currency value in the event of another major stock market decline.

These risks are real. That said, however, we believe the CAD will appreciate further over the long term against the USD. Canada’s banking system largely avoided the subprime mess, sparing Canada the need to expand their money supply (which devalues the currency) on anything like the scale of the US. Also, Canada is the West’s largest source of energy, and supplies other key commodities.

The selections below are not ranked in order of preference. All make excellent investments that will pay you well in all but the most dire conditions, and have continued to pay (and in some cases raise) dividends throughout the current crisis, proving their reliability.

CANADIAN ENERGY INFRASTRUCTURE STOCKS – Our Top Recommendations for Income and Safety (click to enlarge)

NOTES

ALTAGAS INCOME TRUST (ATGFF.PK)

The main criteria for evaluating conservative income stocks are 1) coverage of the distribution with distributable cash flow 2) performance of the major business lines 3) access to credit 4) ability to grow

5) Management’s commitment to sustaining and growing the distribution.

The good news: ATGFF did well on the first three.

• Payout ratio was steady at 93%, an acceptable level for a steady revenue business like this.
• Continued their expansion program, including
  • 1900 megawatts of renewable energy development. It also finalized a contract with NOVA Chemicals to support the expansion of its Harmattan co-stream project with a 20 year, fee based deal
  • Management plans for an over 20% increase in capital expenditures for 2009-10, which will be enhanced by recent successful debt and equity offerings, as well as reliable cash flows from the company’s infrastructure in gathering/processing, natural gas, liquids, and power generation.
• Additional 8.9% cut in operating costs in Q2
• Debt remains very reasonable at 36.1% of capital, below their 45% targeted level

The bad news: ATGFF management intends to reduce distributions from a current CAD$ 2.16 per share to between CAD $1.10-$1.40 (6.5%-8.5% vs. the current approximately 11%) per share when it converts to a corporation, likely around late 2010. It will maintain its current level until then. Their rationale is that it will use the saved capital to fund growth. That’s a disappointingly large cut, but still worthwhile with future growth potential. Given the magnitude of the cut, however, we prefer to wait and buy this one when/if it comes in to the recommended price, in order to bolster the yield.

KEYERA FACILITIES INCOME FUND (KEYUF.PK)

Results included:

• Gathering & processing income up 10% despite decreased drilling from the worst recession in decades
• Natural gas liquids infrastructure net income up 23% on robust demand for fee-based storage and fractionation services

PEMBINA PIPELINE INCOME FUND (PMBIF.PK)

Highlights include:

• Revenue up 15.2%
• Net operating income up 18% due to a doubling of earnings from its oil sands infrastructure, the result of the completion of the Horizon Pipeline system (other new projects in process)
• Midstream & Marketing business suffered as a result of falling commodity prices, but that part of the business will get a boost in Q3 from the addition of the Cutback facility, a deal completed this summer.
• Management plans to maintain the dividend through 2013-2014, possibly longer (it converts to a corporation in 2011)

Conclusion

In the coming installments of this series, we will present additional ideas for uniquely safe, high yields.

Disclosure and Disclaimer: The author has positions in the above mentioned instruments.

Comments

[Cliff Wachtel:]

huh?


On Aug 28 07:45 AM MSCI wrote:

> .

Aug 28 08:27 AM

[Toronto Day...:]

Cliff - love the coverage on the income stocks. I'm going to use some of your picks to do the "Smith Manoeuvre" (google it) here in Canada.

Aug 28 09:07 AM

[dogwilli:]

Cliff - your a couple of weeks late, they all went ex-dividend last week.

Aug 28 09:09 AM

[jg1945:]

cliff how do you find info on dividends, pe, even company websites for these oink sheets. Would like to buy some, but lack of readily available info on them scares me away.

Aug 28 01:01 PM

[User 384308:]

The only problem you have not covered is that many of these stocks sell their product - like ATF sells power to the US. Others have holdings in the US. If they are paid in declining US dollars, won't their bottom line be hurt when they convert them in CAD?
I have been doing what you are suggesting long before I found your blog - mostly good, but I still hold Algonquin power. Ouch! That's not a recommendation. Thanks for your insite

Aug 28 05:18 PM

[Old Trader:]

jg,

Assuming that you're able to get the correct symbol, some of the basic info can be found at bloomberg.com and also at bigcharts.com.

Hope this helps a bit.


On Aug 28 01:01 PM jg1945 wrote:

> cliff how do you find info on dividends, pe, even company websites
> for these oink sheets. Would like to buy some, but lack of readily
> available info on them scares me away.

Aug 28 07:27 PM

[GrantQ:]

Several if not all of these equities are sold on the TSE. Why would an investor go to pink sheets to trade them instead of the exchange?

These income trusts are going to get a tax hit in 2011. Not directly a problem for canadians (they get a dividend tax credit) but it will reduce income paid to foreigners. This could easily ding share prices (depends how much of the tax hit is baked into current prices).

Be aware!

Aug 29 06:00 AM

[User 409818:]

Cliff,

do you follow CONSUMERS WATERHT UT(Other OTC: CSUWF.PK) Income Fund?

I enjoy your analysis on the Canadian trusts, and already own several.

Any analysis you might have will be appreciated. Thanks in advance.

ED

Aug 30 12:16 AM

[Richard Sch...:]

Atlantic Power ATPWF: sounds nice...but––How on earth do you find dividend info, schedules, etc??? It is apparently the stealth company of all time.
Keep up the good work, we like it.

RS

Sep 01 11:13 AM

[1234:]

I also hold Algonquin alkong with several other Canadian trust. I know Algonquin has had issues ,but is it such a loser going forward that no one will commment on it? Any feed back on Algonquin would be helpful. Thanks


On Aug 28 05:18 PM User 384308 wrote:

> The only problem you have not covered is that many of these stocks
> sell their product - like ATF sells power to the US. Others have
> holdings in the US. If they are paid in declining US dollars, won't
> their bottom line be hurt when they convert them in CAD?
> I have been doing what you are suggesting long before I found your
> blog - mostly good, but I still hold Algonquin power. Ouch! That's
> not a recommendation. Thanks for your insite

Sep 02 11:55 AM

[lorddarley:]

For those interested inAtlantic Power, I just put a couple of posts on Cliff W's other article (Part I).

Working out the math for the units -- Atlantic Power is a combination of a subordinated note and stock -- is not for the faint of heart.

Sep 03 08:53 AM

[pabaker34:]

Good information here. Just wondering if I buy these in my Fidelity account how will I receive the dividend? Will it just show up in my account, minus the 15% tax? Is there some fee for the exchange rate? Thanks for the advice.

Nov 20 03:38 PM