Income trust risk

Discuss your favourite picks, broker, and trading or investment style.
User avatar
gyrfalcon
Contributor
Contributor
Posts: 644
Joined: 22 Feb 2005 12:51

Post by gyrfalcon »

yielder wrote: Apologies. I missed your question. I'm not sure exactly what you're asking here. Could you re-phrase, please?
My question recognizes the fact that the research that you do before buying any Stock is likely the highest of anyone here, with the possible exception of NormR. I didn't want to "lead" your reply, but I do perceive differences in **my** ability to assess RTs and REITs as compared to Business Trusts.

My question was: If you personally were researching Trusts for your own possible purchase, do you feel / have you found, it is / was easier to come to conclusions on RTs, or REITs, or Business Trusts ? If you haven't really gone thru that process for yourself, it's OK to just say so. That doesn't really compromise your generic concerns. gyr.
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

worthy wrote:
cherry-picking
So trust distributions perform better in a time of low interest rates with rising commodity prices than common stock dividends?
Well, royalty trusts certainly tie their distributions to the price of oil and gas. Business trusts can more easily do the accretive acquistion shuffle when rates are lowish. And REITS can increase rents on renewals when they have full occupancy. During the recession in the early 90s, Riocan cuts its distribution from $1 in 1990 to .65 in 91 to .525 in 92 to .34 in 93 before increasing to .46 in 94. ISTM that trusts are very prone to cyclical distribution patterns. Regular stock dividends for most companies aren't as dependent on cycles. The rate of increase may slow but the dividend doesn't often get cut or even more rarely, eliminated. They make distributions that are more sustainable over time. They use share buybacks to smooth dividend payouts and soakup excess cash rather than increase a dividend unsustainably.

For Scotia to say "that certain trusts indeed have the potential for substantial organic or acquisitive growth" when the measuring period is 4 years is cherry picking.
Arby wrote:Also, most Business Trusts would not derive any benefit from the rise in commodity prices.
I didn't say they would. When business trusts increase their payouts through the accretive acquistion exercise, it's because they are able to find assets that have a return higher than the cost of financing. With lowish interest rates, that hurdle is easier to jump. As rates rise, the pool of available assets decreases and the cost of debt servicing increases.

Does anyone have a copy of the Scotia report?
gyrfalcon wrote:My question was: If you personally were researching Trusts for your own possible purchase, do you feel / have you found, it is / was easier to come to conclusions on RTs, or REITs, or Business Trusts ?
I quickly realized on RTs that I have to rely on what the company says about its reserves and that I was going to have to learn a great deal about the industry in order to determine whether A was better value than B was better value than C. For REITs, analysis meant that I was going to have to delve into their real estate portfolios. For business trusts, the problems were even greater. Business trusts that go the acquisition route make financial analysis difficult because you have a moving target. Trying to figure out if the distribution was conservative or aggressive is difficult because you can't tell whether the CAPEX number is being squeezed or not. It's also difficult to determine whether borrowing is leaking into distributions. My experience with the management of Superior and Home Equity Income Trust when each was internalizing the management agreement made me very leery about business trusts. I early on gave up on trying to research individual trusts and opted for the safety-in-numbers protection of trusts of trusts. As more and more flavours were offered, that route became even better. I sold the few individual trusts that I owned and bought trusts like SIN and BAI. I sold them last year because I think that most trusts are cyclical. Since market timing is a crap shoot, I preferred to err on the side of bailing early because my bias is to capital preservation/lower income rather than capital risk/higher income.

It's probable that folks might think that I'm anti-trust but I'm not. I'm critical of some of the disclosure. I'm critical of the growth assumption. But I've owned trusts (up to 10% because they are small cap) and I'd own them again towards the bottom of the business cycle when things are looking bleak. I wouldn't own them right now as we approach the top of the business cycle. I'm cautious about owning any small caps as we approach the top of the business cycle. If I were sitting on a trust with a 50% gain and a current yield of 8% that is increasingly susceptible to a distribution cut, I'd take the gain because it represents 6 years of distributions.
User avatar
Arby
Veteran Contributor
Veteran Contributor
Posts: 3125
Joined: 20 Feb 2005 19:23
Location: Ottawa, ON

Post by Arby »

yielder wrote:And REITS can increase rents on renewals when they have full occupancy. During the recession in the early 90s, Riocan cuts its distribution from $1 in 1990 to .65 in 91 to .525 in 92 to .34 in 93 before increasing to .46 in 94. ISTM that trusts are very prone to cyclical distribution patterns.
It's not valid to use that time period in a discussion about REITs. The REIT structure didn't exist in Canada prior to 1994. Riocan was structured as an open-ended mutual fund during the time period mentioned above, and it didn't convert to a REIT structure until 1994. Those distribution cuts may have been related to problems with the open-ended mutual fund structure.
User avatar
gyrfalcon
Contributor
Contributor
Posts: 644
Joined: 22 Feb 2005 12:51

Post by gyrfalcon »

yielder: Thanks, I appreciate that level of detail. gyr.
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

Arby wrote:Those distribution cuts may have been related to problems with the open-ended mutual fund structure.
Perhaps. It's tough to tell because the financials I have access to have no notes or management discussion. From 91 through 93, net income declined 45% before recovering 18% in 94. Taxes don't come into the equation anywhere because they weren't paying taxes even in the pre-REIT days. There are increasingly large other adjustments over the period that throw them into a net loss position. Perhaps these adjustments have to do with leases being re-written down or possibly written off as vacancy rates increased because of bankruptcies. I haven't looked closely at how leases are accounted for so this may be way off the mark.

I really don't think that it was a structure problem. In the early 90s, I remember looking out at First Canadian Place in the evening and seeing floor after floor after floor with no lights on because they were empty. We were able to go to our landlord, Oxford Properties, when we needed space but still had 5 years on our lease and make an offer for more space on the top floor at a lower rate than we were paying and get them to agree because we were willing to take a 10 year lease. Landlords were hurting during that recession and its aftermath. I know that Toronto core office space is not Riocan's market (was it in the early 90s?) but they must have suffered the same occupancy problems.

In a recession like the one in the early 90s, landlords and lenders (remember Olympia and York defaulting on its bonds?) suffer.
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

gyrfalcon wrote:yielder: Thanks, I appreciate that level of detail. gyr.
Part of the problem too is that many trusts have very short histories which makes it very difficult to get a sense of a historical PE range. That makes it very tough to estimate cheap and expensive. I feel much more comfortable with this kind of profile

Image

than I do with this kind of profile which is both short and erratic

Image
User avatar
zaman
Contributor
Contributor
Posts: 198
Joined: 07 Dec 2005 23:21
Location: BC

Post by zaman »

Business trusts that go the acquisition route make financial analysis difficult because you have a moving target. Trying to figure out if the distribution was conservative or aggressive is difficult because you can't tell whether the CAPEX number is being squeezed or not.
Can anyone (or yielder) shed some light on this statement, especially the part about capital expenditure?
User avatar
scomac
Veteran Contributor
Veteran Contributor
Posts: 7788
Joined: 19 Feb 2005 09:47
Location: The Gateway to Wine Country

Post by scomac »

I think what Mike is talking about is the inability of an analyst to reconcile the cashflow statements with the company's claims of distributable cash and its maintenance capex needs. When a trust is on a continual acquisition binge, you've got no way of knowing just exactly what is normal for the business in terms of cashflow from operations and maintenance requirements, hence the moving target characterization.

Transforce (TIF.UN) is an excellent example (that I'm familiar with) of what I'm talking about. The company has been on a mad pace of acquisitions since it converted to a trust, with over 20. I find it impossible to tell if these acquisitions are truly accretive because of the continuous financings. Is the earnings growth and hence distribution growth real or illusory simply being propped up by OPM? Is the payout ratio really conservative, or are maintenance capex needs being cloaked in acquisition financing? This trust is generally well thought of on "the street" due to its track record of growth and yet I've can't figure out whether it's real or simply smoke and mirrors.
"On what principle is it, that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?"
Thomas Babington Macaulay in 1830
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

scomac wrote:I think what Mike is talking about
Exactly. Retirement Residences REIT (RRR.UN) is another example. This trust has been on an acquisition binge since 2001. Debt has increased by 3.4x and shares O/S by 2.4x but shareholders equity has increased by only 1.9x while cash flow/share, ROA and ROC have steadily declined. The distribution after showing an early increase was cut and has been frozen. Analysts who follow the REIT are expecting a cut in distributions if it is not sold. Michael Smith at National Bank said yesterday [June 28] he expects distributions will be suspended entirely if a deal for all or part of the REIT is not completed.

I wouldn't touch most business trusts until they had been around for at least 5 years. It's the only way to tell how optimistic the prospectus is. (You ain't ever gonna see a prospectus that understates the merits of the business. ;)) Given that investor demand for trusts was and is heavy, it's likely that many of the business trusts that have IPOed over the last few years will have a big disconnect between the business as laid out in the prospectus and the business as it actually unfolds.
arnyk
Veteran Contributor
Veteran Contributor
Posts: 1089
Joined: 04 Dec 2005 10:48

Post by arnyk »

I like to categorize the trusts I analyze with acceptable yields. So playing with this whole risk/reward thing, I have a slo/no growth trust with conservative management, balance sheet's clean, stable cash flows yielding ~9.00%. So that acts as my baseline.

Taking this to the other extreme are trusts that yield around 20.0%, and with these I'm mostly looking for a strong balance sheet (aka are their credit facilities good to last them til December? ;)). What I'm betting on here of course is that most trusts will continue irresponsibly funding distributions through debt/issuing new units until they finally have no more wiggle room and have to call it quits.

Trusts have a much more solid "floor price" propped up by their yield, but their cash flows (payout ratios) are much more tighter and so are prone to cuts/suspensions. Dividend stocks still have a floor, but not as strong. Of course their payouts are much lower and so that gives you the wiggle room to continue paying out for alot longer than trusts.

So IMO, the majority of trusts are crap, so you gotta watch out. Sometimes, though, you can exploit this crappiness by picking super high yielders that will irresponsibly continue distributions no matter what. :roll:
User avatar
kcowan
Veteran Contributor
Veteran Contributor
Posts: 16033
Joined: 18 Apr 2006 20:33
Location: Pacific latitude 20/49

Post by kcowan »

arnyk wrote:...So IMO, the majority of trusts are crap, so you gotta watch out. Sometimes, though, you can exploit this crappiness by picking super high yielders that will irresponsibly continue distributions no matter what. :roll:
Isn't this like buying a low-rated corporate bond? :shock:
For the fun of it...Keith
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Post by AltaRed »

kcowan wrote:Isn't this like buying a low-rated corporate bond? :shock:
As in junk....
arnyk
Veteran Contributor
Veteran Contributor
Posts: 1089
Joined: 04 Dec 2005 10:48

Post by arnyk »

AltaRed wrote:
kcowan wrote:Isn't this like buying a low-rated corporate bond? :shock:
As in junk....
Alot more risky, they're still high yielding equities. You really have to be selective once the yields become unsustainable (20% is NOT sustainable long term).
User avatar
zaman
Contributor
Contributor
Posts: 198
Joined: 07 Dec 2005 23:21
Location: BC

Post by zaman »

Thank you for all your responses! It sounds like things would be much easier if distributable cash equaled earnings.
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

arnyk wrote:You really have to be selective once the yields become unsustainable (20% is NOT sustainable long term).
And you may have to use a pry bar to extract the yield needle from your arm even when you realize that the distribution is likely to be cut. Care to bet what'll happen to RRR.UN's price if when the cut comes. The current price of $7.50 says that there's little to no discounting of a big cut.
peter
Contributor
Contributor
Posts: 662
Joined: 10 Oct 2005 21:37
Location: Alberta

Post by peter »

I noticed the paper issue of MoneySense has NormR's number crunching of trusts. It's a strange experience to hold a paper thing with numbers with no pointing device, but in glancing through it it seemed to me he gave RRR.UN a reasonable mark (B?), whereas 'safe' trusts like HR.UN and REI.UN got lower marks.

I remember the discussion about Peyto from last year's issue, 'safe' means recommended by the usual broker suspects in this case. Still, got me wondering. I'll wait for the spreadsheet to download.


Added: I actually have a bit of RRR.UN, bought last year as part of a split to mimic XRE.
Last edited by peter on 06 Jul 2006 23:10, edited 1 time in total.
arnyk
Veteran Contributor
Veteran Contributor
Posts: 1089
Joined: 04 Dec 2005 10:48

Post by arnyk »

yielder wrote:
arnyk wrote:You really have to be selective once the yields become unsustainable (20% is NOT sustainable long term).
And you may have to use a pry bar to extract the yield needle from your arm even when you realize that the distribution is likely to be cut. Care to bet what'll happen to RRR.UN's price if when the cut comes. The current price of $7.50 says that there's little to no discounting of a big cut.
Well RRR.UN's been doing exactly what I was talking about: irresponsibly funding distributions using debt when it really isn't healthy. They've overextended themselves IMO by now.

The two trusts I took on have alot cleaner balance sheets and I think they can chug along at least until Christmas. I've been known to be wrong.
sydney2
Contributor
Contributor
Posts: 949
Joined: 05 Sep 2005 19:35
Location: Burlington Ontario

Post by sydney2 »

Arnyk: What two trusts did you take on??
Taggart
Veteran Contributor
Veteran Contributor
Posts: 6893
Joined: 05 Dec 2005 07:34

Post by Taggart »

New rules coming on income trust distributions

By end of year. Changes in reporting could hit investors

RAY TURCHANSKY, CanWest News Service
Published: Monday, October 09, 2006

There was little fanfare a few days ago when the Ontario Securities Commission divulged that by the end of the year, it will announce new rules on how income trusts must report distributable cash.

The move could send investors scrambling to see if the changes will affect the distributions paid by trusts they invest in, and likely their unit values. Energy trusts in particular could face some upheaval.
sydney2
Contributor
Contributor
Posts: 949
Joined: 05 Sep 2005 19:35
Location: Burlington Ontario

Post by sydney2 »

I am so sick and tired of listening to broadcaster and journalists alike bashing the income trust market. Do you really think that the whole index is going to come crashing to the ground in the next month or so, I do not!!

There are definitely some sick trusts out there but overall is PennWest going to collapse tomorrow or ARC.

Tonight while listening to Amanda Lang and Kevin O'Leary on their nightly report, I almost fell off my chair when Kevin announced he had bought an energy trust today. I can't listen to this stuff anymore.....
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Post by AltaRed »

Taggart wrote: There was little fanfare a few days ago when the Ontario Securities Commission divulged that by the end of the year, it will announce new rules on how income trusts must report distributable cash.
This will be a good thing. As of now, no one can be sure what a trust is really reporting relative to its competition.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
pitz
Veteran Contributor
Veteran Contributor
Posts: 2878
Joined: 27 Oct 2005 18:41
Location: Canada/Costa Rica

Post by pitz »

sydney2 wrote:I am so sick and tired of listening to broadcaster and journalists alike bashing the income trust market. Do you really think that the whole index is going to come crashing to the ground in the next month or so, I do not!!
Nobody's suggesting that trusts will come crashing down, but when the ratio of untaxed earnings to taxed earnings is only about 1:1.14, when it should be closer to 1:1.30, between the trust index (which is dominated by highly cyclical energy stocks), and the blue-chip index (which is far less cyclical, in comparison), there is a significant problem of valuation.

I suspect the ratio needs to be, to attain equivilancy in valuations, at least 1:1.30-1:1.35, which would imply the trust index needs to suffer a 18%-25% relative loss in store versus the TSX60 index.

For an average investor, a 25% capital loss is a significant deal. And thats just to correct to the same valuation levels as the TSX60 index.
User avatar
arthur
Veteran Contributor
Veteran Contributor
Posts: 4620
Joined: 19 Feb 2005 13:10
Location: The Town of the Blue Mountains

Post by arthur »

Risk is inherant in all Asset Classes, including GIC's, and if Trusts do suffer a 25% Decline but make up 10% of your investable Assets, it is not a catastrophe.

5% of my Assets are in Juniior Gold Mines, if they all fall to 0, I have lost 5 % of my Assets, countrweighed by Income from Bonds and Trusts, so overall, negligible affect.

Junior Mines can quadruple in Price, so the positive aspects outweigh the negative possibilities.

Asset Allocation.

pitz, are you part of that group developing that new condo area?
You want the truth, you want the truth, you can't handle the truth.

The masses have never thirsted for the truth, whoever supplies them with illusions is their master, whoever supplies them with the truth, their victim.

If you do not risk anything , you risk even more. Jong
User avatar
yielder
Veteran Contributor
Veteran Contributor
Posts: 4911
Joined: 16 Feb 2005 07:47
Location: Hastings, Ontario

Post by yielder »

Arthur wrote:if Trusts do suffer a 25% Decline but make up 10% of your investable Assets, it is not a catastrophe.
Exactly but I suspect that many are well over 10% if only because of market appreciation. This is the Nortel effect. Rather than take profits to as prices rise to keep the weighting around 10%, they get greedy or don't want to share half of their gains with CRA. People start out with target weights but then abandon them.
Post Reply