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

by: Cliff Wachtel

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 (OTC:ATPWF) (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.




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 (OTC:ATPWF), (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 30th 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 (OTC:ESIUF), (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 (OTC:GLHIF), (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 (OTC:INRGF), (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 (OTCPK:MCQPF), (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.