Navigating the Wild, Wonderful World of Canadian Corporations (Formerly Trusts)

by: Five Plus Investor

“The US is our trading partner, our neighbor, our ally and our friend... and sometimes we'd like to give them such a smack!” -- Rick Mercer, "This Hour Has 22 Minutes"

O, Canada! With deference to our friend Rick Mercer, there’s nothing about Canada I want to “smack”! In fact, our dear neighbor to the north - the ninth largest economy in the world and the U.S.’s largest trading partner - is a bona-fide bonanza for the income investor. If you are looking for higher yield with greater diversification across a wide variety of industry sectors – look north.

“CanRoys” Should Be Called “CanCorps”…

Americans have long viewed Canada as a safe haven for both political and investment reasons. Since its introduction in the 1980s, the Canadian income or royalty trusts (nicknamed “CanRoys”) have lured Americans to send their precious dollars north in search of diversification, security and yield.

An income or royalty trust is an investment that holds equities, debt instruments, royalty interests or real properties. They exist with the express goal of paying out their cash flow as dividends to investors. They are most analogous in U.S. investments to Master Limited Partnerships (MLPs).

For over 20 years these Canadian trusts also enjoyed a favorable tax treatment under Canadian law. However, politicians - being who they are and unable to resist new tax sources when they can find it – in due course set about changing the tax treatment of income trusts.

On October 31, 2006, in what has now been termed in the investing world the “Halloween Massacre”, Canada’s Finance Minister Jim Flaherty announced a new proposal for beefing up Canada’s tax coffers - the “Tax Fairness Plan”. The plan stated that income trusts would be taxed in a similar manner to corporations, at a rate over 30% on taxable income. The plan gave Canadian trusts until Jan. 1, 2011, to convert to corporations, or begin paying corporate-style taxes.

Most income / royalty trusts reacted in the only way they could: they placed themselves on a path to convert to a corporate structure by the deadline imposed upon them.

Fast forward to today, six months past the conversion deadline, and many trusts no longer exist as trusts, but rather as corporations. Thus, it is probably not correct anymore to refer to these former trusts as “CanRoys”. The more correct terminology in referring to these Canadian issues would be “CanCorps”.

The Halloween Massacre Revisited

The dictionary definition of a “massacre” is the “act or an instance of killing a large number of humans indiscriminately and cruelly.” While the Tax Fairness Plan didn’t commit outright homicide, the reaction of the market certainly made investors at the time feel like the plan was committing “stock-o-cide.” While the Halloween Massacre was not just a blip on the stock market radar screen, historical market action puts the market drop in perspective.

Let’s see the effects of the Halloween Massacre on one of the most widely traded CanRoys-turned-CanCorps, Enerplus Corporation (NYSE:ERF).

On October 30, 2006, the stock opened at $54.69. This is the day the Massacre really began. As is often the case with stocks, the bad news began to be priced into the stock before the news actually hit the wires. Thus, on October 30th, by the end of the trading day, ERF closed at $44.26 – a whopping 20% decrease in one day. The next day, October 31st, the “Tax Fairness Plan” was announced. The stock would continue to price in the bad news downward to about the $40.00 mark for ERF - in all, about a 25% decline from its high.

This was a devastating drop for its time…but was merely a shadow of things to come. Take a look at the chart to get the rest of the story. Click to enlarge:

Compare the drop in late 2006 to what happened in late 2008 to early 2009. You’ll see that the “Halloween Massacre” is merely “trick or treat” compared to the “Nightmare on Elm Street” of the financial crisis. ERF suffered a 25% drop during the Halloween Massacre, but a 150+% drop during to the oil crash and financial crisis from March 2008 – February 2009.

The final event in the last five years to affect the performance of CanCorps has been the conversion deadline of January 1, 2011. More than a handful celebrated the passing of this deadline with a dividend reduction.

Taxation and IRA Accounts

International stocks provide a tax advantage for the U.S. investor holding them in taxable accounts, as any tax withheld can be credited on an income tax return. By the same token, the withholding tax has been the bane of CanRoy / CanCorp investors holding them in a tax-exempt account. The 15% withholding tax is still taken out of your IRA, without the benefit of claiming a tax exemption.

A little known provision was implemented in the Tax Fairness Plan which does away with Canadian withholding tax in IRA accounts – but only for corporations, not trusts. I say “little known”, because I could not locate the provision itself in the plan. I say “little known”, because back in 2010 when I called the Investor Relations departments of several CanCorps about the provision, it was news to them. I say “little known”, because my own brokerage house didn’t know about the provision one month before its implementation (December 2010).

The only place where the provision is not so much spelled out but interpreted is on Enerplus’ website:

For 2011, if Enerplus shares are held in a taxable U.S. account, the dividend is subject to a minimum 15% Canadian withholding tax that is withheld prior to any monies being paid to shareholders. US investors may be able to receive a foreign tax credit with respect to this withholding tax. Where shares are held in an IRA, withholding tax should no longer apply.

After pestering my patient account advisor at Scottrade, who interfaced with corporate about the new provision, I was told that it was up to each individual brokerage house to recognize and implement the new provision.

Thankfully, through the diligence of activist investors, most major brokerage houses implemented the change in policy in their customers IRA accounts by the end of January 2011, without much ado or issue.

I was initially excited about the provision. Then I experienced its net effect.

For my position in Exchange Income Corporation (OTC:EIFZF), the 2010 dividend every month was approximately $301. When the 15% was netted out, the dividend showed up as a positive entry for $262, with negative $39 in withholding. I expected that, beginning in 2011, the dividend would be paid in full, without withholding. In other words, I would be paid $301, fair and square.

Not so. The total dividend payment remained $262. There was no negative $39 entry – but neither was the $39 added to reflect the elimination of the withholding.

It ended up being a net zero sum game. I lost nothing on the provision, but neither did it fulfill its promise as a 15% net gain for U.S. investors.

It is a bit of thanks for nothing. Still, if you find withholding on international corporations a nuisance, you will prefer a CanCorp over a CanRoy, as the 15% withholding still applies to income trusts.

The WILD World of Canadian Corporations

Thus we have been introduced to some of the “wild” aspects of the “Wild, Wonderful World of Canadian Corporations”. My original intention was to make this article #4 in my Sleep at Night series. “Sleep at Night” investments provide stable or increasing income; may not vary much in price; may be lower beta; or provide superior price performance to either other issues within their class, or as compared to common stocks.

I had my heart set on CanCorps to make the “Sleep at Night” cut. But after much research, I resigned myself to this conclusion: these animals are not tame. They are, well…WILD. You just can’t compare Fido the Municipal Bond to Montecore the CanCorp!

In addition to the politics of Canada, you have trading risks. Most Canadian issues are traded as OTC or pink sheets entities. (An excellent overview of Pink Sheets can be found here: “Understanding Pink Sheets Stocks” by The Gold Report). The fact that most CanCorps trade as pink sheets means:

  • Trading volume is an issue
  • Financial disclosure can be an issue

When an issue is thinly traded, liquidity is an issue. This means that, in general, the low liquidity makes it difficult to enter a position - at least at the price you want - and the price point can depreciate wildly during a panic selloff. Conversely, the liquidity means the price typically doesn't fluctuate according to the whims of the more liquid major indices.

Companies, especially international ones, use the Pink Sheets as a trading venue to avoid the regulations imposed by the SEC for stocks trading on the major exchanges. This can mean you find a black hole when attempting to locate financial information. However, the good news for CanCorps is that Canada has the equivalent of our SEC, the Canadian Securities Administrators (CSA), and an excellent website equivalent to EDGAR, which is SEDAR. This means financial information is regulated and available to U.S. investors. As such I did not have any difficulty in locating basic financial information on most CanCorps.

The WONDERFUL World of Canadian Corporations

With such a history and their inherently risky nature, why invest in Canadian Corporations at all? Are all CanCorps wild tigers that will maul their owners? Or is it possible to find a wild mustang of an issue that acts like a stallion in your portfolio?

The answer is a resounding “yes”. Let’s look at the “wonderful” aspects of CanCorps:

High Yield with Diversification

Let’s be honest. If you are a high yield investor, the U.S. stock market seems to treat you like a misbehaving child.

First of all, many U.S. stocks simply don’t pay dividends. Of the stocks that do, the S&P average of those stocks that pay dividends is about 2%. If you prefer high yielding (5% or more) stocks, the market puts you in the equivalent of a time-out corner. Sorry, you can only play with energy, utilities, MLPs, REITs and financials. The rest and “best” of the market - technology, health care, conglomerates, capital goods, and retail – are reserved for good little investors who play nice with low yield.

Enter the wonderful world of CanCorps, where “naughty” high yield investors are treated like the head of the class. Unlike the U.S. market, where high yield investors are stuck in a corner with limited sector choices, Canadian Corporations provide the U.S. high yield investor a veritable candy store of sector and industry choices. Want a high yield retail stock? “There’s a CanCorp for that”. How about liquor? “There’s a CanCorp for that”. Technology, timber, paper, media, construction, aerospace, consumer goods, restaurants…check, check, check. For goodness’ sake, there are even CanCorps for school buses, coffee houses and root beer!

Low Liquidity as an Advantage

The low liquidity of Pink Sheets stocks can make it frustrating when trying to buy or sell at the limit price you want. Once you take a position, the thinness of trading volume usually means that the issue can just sit there for days… sometimes weeks… with no movement whatsoever.

This can be frustrating to the investor who values capital appreciation during high-flying markets. However, that stubbornness of movement works both ways.

Yes, it frustrates when you want the darn thing to appreciate. Then again, the lack of reaction to the day-to-day of market machinations makes it advantageous during standard, run-of-the-mill market slumps. During those days I generally find my CanCorps staying on the $0.00 dollar change mark. This provides stability to my overall portfolio, and a comforting dose of “white” when the rest of my portfolio is going “red.”

Strong Economy / Strong Currency

While Canada and the world suffered the effects of the U.S. financial crisis, the effects of the crisis on Canada’s economy was primarily external, not internal. There were no big Canadian banks requiring bailouts, as the banking system is conservatively regulated by a single regulator and is consolidated as an oligopoly. Translation – they just have a better handle on their banking system than we do. They also have a better grasp on their government debt, even with similar systemic risks as the U.S. (like the burgeoning costs of health care). Government debt is also lower at about 36% of GDP, about ½ of the U.S. debt ratio.

Canada is a land rich in natural resources, and enjoys a seemingly permanent “peace dividend” with the U.S., the only country it contiguously borders. Combined with a growing economy (at least as compared to the U.S. and industrialized world), Canada’s currency is expected to remain strong, which provides an advantage for the investor, if indeed you believe the dollar will remain weak.

The Good, the Not-So-Bad and the Ugly

Navigating the wild, wonderful world of CanCorps was an interesting experience. After much research I compiled a Master List of CanCorps for your consideration. Click Here for the link.

Then the motherly / teacherly instinct set in. I really don’t want my readers to be mauled by the wild tigers on the list. So I put together a rudimentary rating system. I placed a rating of “1” on what appear to be the very best CanCorps, to a “5” for the ugliest of the ugly.

This rudimentary rating system looks like this:

Highest Rating - 1

Positive dividend growth for past five years

Price point recovered from both Halloween Massacre and financial crisis

Positive profit margin

Positive fundamentals

High Rating - 2

Positive growth or stable dividend for past five years

May have been launched after Halloween Massacre or financial crisis

Price point recovered from financial crisis

Positive profit margin

Good basic fundamentals

Medium Rating - 3

Dividend is currently stable; may have a reduction in past

Dividend restored to pre-Halloween Massacre level

Price point recovered from financial crisis

May have one or more problems with fundamentals

Medium Low Rating - 4

Recently reduced dividend

Price point not recovered from either financial crisis or Massacre

May have negative profit margin

Low Rating - 5

Consistently reduced or eliminated dividend

Sinking share price

Recent bad news

Negative fundamentals

To obtain FPI’s List of Rated CanCorps, click here.

The list includes CanCorps priced above $4.00 per share and gives the following information:

  • FPI Rating as per above
  • Symbol, Company
  • Sector, Industry
  • Current Dividend Yield, with minimum yield of 5%.
  • Dividend Growth indicated as positive percentage point; overall reduced; stable; or negative percentage.

    Important Note: the positive dividend growth percentage is calculated as over the last five years. The percentage is not calculated according to consistent dividend increases, but rather overall dividend growth from the five year mark to today. Some dividends may have been variable and/or temporarily reduced before restoration of dividend growth.
  • Q/MQuarterly or Monthly payments
  • Selected Basic Metrics Price per Earnings, Price per Cash Flow and Net Profit Margin
  • Notes symbol changes or interesting facts

Your Help is Needed and Welcomed

Constructing this article and the Master List of CanCorps was by far the most grueling article to write to date. In terms of finding and categorizing candidates for the Master List, I felt I only really scratched the surface. In truth, there probably exist hundreds more CanCorps or CanRoys out there that may qualify for the list, but there’s precious little coverage of these issues, both on Seeking Alpha and the investment world in general.

You can help. Let’s make this an interactive process. Please SA mail me and let me know any worthy candidates that should make the list. I welcome your feedback in the Comments section about any CanCorp you believe should be rated differently. It’s my intention to publish an update about twice a year with any new finds, upgraded or downgraded ratings, or any pertinent news of interest.

With your help, we can make the “Wild, Wonderful World of Canadian Corporations” a little less “wild”, and a lot more “wonderful”.

Disclosure: I am long OTC:EIFZF, OTC:CUPUF, OTC:SCUPF.

Disclaimer: Five Plus Investor is written for the retail investor, from a retail investor’s experience and point of view. The articles presented by the author are for informational purposes only. Five Plus Investor is not a professional investment counselor. Before investing one should conduct their own due diligence or seek the advice of a professional as needed.