More than four years later, the night of Oct. 31, 2006, still rankles a lot of investors who had billions of dollars in more than 200 Canadian income trusts. That was the night Finance Minister Jim Flaherty announced that, as of Jan. 1, 2011, income trusts (with the notable of exception of qualifying real estate investment trusts) would be taxed just like corporations.
In the following days in what came to be called the "Halloween massacre," the income trust sector lost more than 15 per cent of its value. Trust investors were howling. But Flaherty wouldn't budge, saying the income trust structure was responsible for "tax leakage" from federal coffers in the hundreds of millions of dollars.
Over the coming years, the trust universe shrank steadily. About 75 trusts were taken over. Another 40 suspended their distributions, going private. These were companies that probably never should have been in the public markets. Most ended up converting to corporations by this New Year's Day deadline.
Now that the conversion dust has settled, one thing is abundantly clear — despite all the worry over how the new tax rules would affect the trust names, it's seems to be business as usual for many of them.
Many former income trusts that used to pay handsome distributions are now doing the same thing — only now as newly minted corporations spewing out robust dividends that, so far at least, appear to be quite sustainable.
|Dividend yields for some former income trusts|
|Company||Yield (as of Jan. 14/11)|
|Crescent Point Energy||6.45%|
|Canadian Oil Sands||3.00%|
"What these conversions are proving is that corporations can pay out a higher portion of their earnings and still grow," says Harry Levant, who's closely followed the trust sector as the research analyst at IncomeResearch.ca (formerly IncomeTrustResearch.com).
Levant put together a list of 52 high-yielding names that he considers "top recommendations" for his yield-oriented subscribers. Of those names, more than 40 are former or present income trusts (a handful of income trusts have opted to remain as trusts). Some of his top picks include Veresen (formerly Fort Chicago Energy Partners), A & W, New Flyer, and Inter Pipeline Fund.
In some cases, these names yield much higher than what your average blue chip bank or utility stock yields. But their payouts may be at greater risk of being cut. "The risk doesn't go away on conversion," Levant says. "There's still risk." But he views the names in his "high-yield index" as being on the higher end of the quality range.
This is not to say that the whole trust conversion picture was a painless exercise. Many trusts served notice that, in the process of converting to corporations, they would cut their distributions.
Sometimes, the cuts were brutal. Waste management company BFI Canada Income Fund chopped its distribution by 73 per cent when it converted to a corporation in 2008. The company said it wanted to keep more cash to use for acquisitions. Out with the income trust and in with the growth stock. The company — now known as IESI-BFC Ltd. — currently yields 2.17 per cent as a dividend-paying corporation.
More recently, Canadian Oil Sands Trust surprised its investors in late 2010 when it announced a 60 per cent cut on conversion to a corporation. The yield went from over seven per cent as an income trust to about three per cent as a corporation.
|Payout plans for trusts that converted to corporations in 2010|
|Will increase payouts: 12|
Will keep payouts the same: 41
|Will cut payouts: 40|
|Haven't said how payouts will change: 4|
But usually, the news for trust unitholders wasn't as drastic. In 2010, when most trusts underwent their conversions, Levant tracked almost 100 that made the switch in that busy year. Twelve actually increased their payouts. Another 41 said they would maintain their new dividends at the same rate as their old distributions. Of the 40 trusts that said they would pay out less, the reductions ranged from 16 to 66 per cent.
For investors in taxable accounts, maintaining the dividend can amount to an increase in after-tax income, because the distributions the former trusts spewed out often contained income that was fully taxed. Dividends, on the other hand, get preferential tax treatment.
The investing community has watched the conversions and has declared that many of the new corporations are well worth owning.
"The companies didn't go away; the structure went away," says Paul Taylor, chief investment officer at BMO Harris Private Banking. "There's still juicy yield available in the [former income trust] market. It's just coming in a different form."
Taylor counts Crescent Point Energy and Cineplex Inc. (formerly Cineplex Galaxy Income Fund) as two of the former trusts his firm likes. "They continue to generate significant cash flows."
For now, the folks at Standard & Poor's have decided to maintain their S&P/TSX Income Trust Index, even though there are just a few non-REIT income trusts left in it. The majority of the 39 constituents of the index are now corporations.
The index returned 17.5 per cent in 2010 but had a 2.7 per cent compound annual loss over the last five years. As the experts say, the risk hasn't gone away.