Taken from Blogging Stocks.com
The Canadian Income Trusts meltdown has been all over the news lately, but it has received only a few mentions thus far on Blogging Stocks. Perhaps investment news north of the border simply don’t make Blogging Stocks’ top ten business stories of the week? But if you appreciate patriotism, allow me to demonstrate some as I add in my two cents. Sometimes, these market turmoils may prove profitable for opportunistic investors.
I’ve been a very disloyal Canadian investor. For the last two years, I’ve only batted eyes at U.S. companies while the Canadian indexes kept creeping higher. However, I’ve recently taken interest in beaten-down Canadian companies such as Loblaw, and Canadian oil and natural gas income trusts. My interest started with these income trusts due to their pricing issues in July and August, as well as the Amanranth hedge fund debacle. Such negative news always peaks the interest for the contrarian in me. I can’t believe my new interest in income trusts has come at such a time of opportunity!
A Quick Re-cap
Not even a month ago, Forbes published an article espousing about what investors should do about Canadian income trusts. But their crystal ball broke when the Canadian Minister of Finance, Jim Flaherty, unleashed a vindictive tax law to levy additional taxes on trusts. The new taxes are vindictive because the decision came on the heels of announcement by three major Canadian corporations to convert into income trusts — Telus, Bell and Encana.
The issue is extremely political, as the Conservative government renegged on their party’s pledge less than a year ago not to impose additional taxes on the trusts. By taxing trust distributions at regular corporate income tax rates, the federal government effectively eliminating the chief advantage of the trust structure as a flow-through entity. Obviously, it’s easier for the government to go after unpaid taxes by a single entity (in this case, the trust or corporation) than wait to audit all the shareholders who are receiving the pass-through dividends.
A Sell-Off Deja Vu?
The income trusts sector fell almost 20% on the first of November, plus an additional 5-6% the next day. The situation stabilized somewhat on Friday, but don’t be surprised if you see more wild swings in the next week and month. Has this happened before? In fact, about five months ago the income trusts sector experienced a similar drop due to uncertainty inspired by comments from the government. A year ago, the income trusts suffered a similar bruising to their ego under the leadership of Ralph Goodale, the former Minister of Finance. Will this iteration of the loop fully realize itself?
Until the law fully passes, it is still filed under uncertainty. Though Jim Flarhety appears to have the resolve to see this through, who is to say that members of their own party are not concerned with the seniors’ voting backlash all over the country? As well as the perceived abandonment of Western businesses, a traditional stronghold for Conservatives?
Will Any Good Come Out Of This?
I belong in the camp that believes income trusts regulations have gone unchecked for far too long. Though I saw the merits of certain businesses to payout their cash flow, it did not make sense for every business. The high payouts severely hamper profitable businesses from increasing their retained earnings, cramping their ability for further growth. Additional trust units need to be constantly issued to fund expansion plans. By forcing investors to be fully responsible for growth plans that may or may not be realized, eventually some businesses are bound to implode. I’ve stayed out of income trusts because I favor organic growth. In my opinion, a corporation such as Bell choosing to convert to income trusts is an admission that they no longer can grow organically and have given up on such ambitions. The reverse argument is that if a company can no longer compound their earnings effectively, then cash distributions may be the best idea.
Income Trust valuations will keep taking a beating. Lower payouts will mean lower valuations. It is absolutely possible for retiree portfolios who have suffered major setback to get beaten both in the portfolio value and the promised cash flow for the next two years. Those who are getting in now may find themselves entering at a decent support level, as long as they’re prepared for yields to drop from the high teens. But the yields themselves should remain respectable, especially if the interest rate environment remains stable or drops in the near future.
The Next 4 Years
My personal portfolio did take a hit, but not a serious one. I entered my sole position of a Natural Gas Income Trust at a good bottom. The only thing I suffered was that my two week 20% gain was erased. My investment principal has remained intact. I should have used a stop-loss, you say? A stop-loss would not have helped much because it was a small position for me to test the waters. In fact, I’m actually contemplating buying more units, evaluating bruised trusts and enjoying their distribution for at least the next 2 years.
Personally, I believe income trusts will survive just fine. But you must feel for the many Canadians who voted Conservative, who are feeling just as betrayed as Liberal Canadians did during the infamous sponsorship scandal. November 2006 was certainly a month investors will remember!
Vince Chan is an InvestorGeek, and editorializes about investment / financial media at Investorial.com. For an unedited version of this article, visit Investorial.com!