Stick to the Plan

We’ll all be thrilled if the first day of trading proves an auspicious sign of a 2009 bull run. Of course, we won’t know until we get there, but there’s one simple way to get immunized from the emotional volatility fueled by what happens on CNBC everyday: Develop a plan and stick to it.

The S&P/Toronto Stock Exchange Composite Index mirrored the S&P 500 in 2008 by posting its worst year since the Great Depression. The 220-member S&P/TSX shed 35 percent last year, the biggest 12-month drop since 1931, while the S&P 500 turned in its worst year since 1937.

But the S&P 500 has chalked up a 25 percent gain since hitting a low of 752.44 on Nov. 11. And Canadian stocks, as measured by the S&P/TSX Composite, have rallied 20 percent since reaching a five-year low Nov. 20. The S&P/Toronto Stock Exchange Income Trust Index has surged by more than 20 percent off its Dec. 5 all-time low. Thinking globally, Asian stocks opened in positive territory Monday and extended their longest winning streak since August 2004.

And various market indicators that focus more on breadth suggest some stability returned to the equities markets in December. The New York Stock Exchange Daily Advance-Decline Line broke through its 50-day moving average and posted a new recovery high on Dec. 26. Although the S&P 500 made its low in November, other breadth measures such as the High-Low Index, the Summation Index and the Bullish Percent Index all made their lows Oct. 10. These are indications the broad list of stocks has been performing better than the major market averages.

Let’s not get ahead of ourselves, though: Irrational exuberance is as deadly a cloud as perpetual pessimism. It’s easy to get caught up in the heat of a moment and lose perspective, whether all screens flash green or the red ink is flowing.

There are still significant headwinds facing the global economy, and we have only earnest “commitments” from policymakers to do what’s necessary to stabilize the situation. Encouraging, however, is that, with conditions so painful the urgency of massive government spending to boost aggregate demand is almost universally accepted. (We’ll have more on the political uncertainties clouding the prospects for timely fiscal action in North America in Canadian Currents in the January issue of Canadian Edge, due out Friday.)

In the long run, those investors who have a plan and stick to it tend to be more successful. Such an effort requires an understanding of your objectives as well as your risk tolerance. Only you can determine your short-, medium-, and long-term financial goals. And only you know whether you can tolerate wild swings, to the upside as well as the downside.

However, since its July 2004 maiden voyage Canadian Edge has been pointed toward solid businesses that pay sustainable distributions; we’ve never chased the highest yields, and we cast a skeptical eye on trust IPOs and conversions that seemed geared more to management teams’ cash-out interests than in establishing a framework for facilitating long-term operational success and building shareholder value.

In other words, CE has a plan. In recent issues we’ve emphasized the relative balance-sheet strength of energy producer trusts, a point we returned to in this space last week. Low leverage and sufficient access to credit are critical factors that will determine long-run sustainability of market-beating yields right now; those oil and gas trusts that have managed their businesses and their books well have the flexibility to survive and thrive. 

A recovery for energy may not happen until the latter half of 2009, but when it happens, those issues tied to oil, gas and other natural resources will run. The supply and demand challenges that pushed them up before the financial crisis are still in effect today. In fact, by sending commodity prices into a tailspin, the crisis effectively reversed the progress toward conservation, alternatives and development of new supplies that will ultimately be needed to move the balance of market power back to the consumer.

Another beaten down group--boasting similar balance-sheet and operational strengths--will endure even if the recession lasts longer than current forecasts suggest: strong business trusts.

We’ve discussed new CE Conservative Portfolio recommendation Bird Construction Income Fund (TSX: BDT-U, OTC: BIRDF) on several occasions in MLM. It’s been a dominant player in building design and construction services for more than 85 years. Today, the company literally has its hands in every province, supporting projects for everything from oil sands mining to school construction. That puts it in prime position to profit from any new spending out of Ottawa in coming months.

CML Healthcare Income Fund (TSX: CLC-U, OTC: CMHIF), one of Canada’s largest diagnostic services businesses, occupies a similar secure position within its industry. And the fund acquired Baltimore-based American Radiology Services in February 2008, extending its footprint into the US.

Although new technologies and techniques are certainly an important part of CML’s growth efforts, it’s through acquisitions that the fund seeks to boost distributable cash flow. There remain significant opportunities to grow in Canada’s because the non-hospital-based diagnostic imaging market is highly fragmented.

And ARS gives the fund a significant platform on which to build US operations. The US medical imaging industry is also highly fragmented, with approximately 6,000 outpatient centers. Legislative changes impacting US reimbursement rates are forcing consolidation, leading to opportunities for well-capitalized, well-run companies to grow. CML acquired and integrated 14 clinics in Canada and 17 in the US during the first nine months of 2008.

CML negotiated a new credit arrangement in February, and debt to cash flow as of Sept. 30 was 2.2 times, indicating the company is able to efficiently integrate acquisitions funded with debt. Standard & Poor’s affirmed its SR-2 stability rating for CML in February, which reflects S&P’s opinion on the company’s distributable cash flow; SR-1 is the highest rating.

CML generated distributable cash of CAD28.5 million in the third quarter and paid out 84 percent to unitholders.

The CE Portfolio has from inception included ample exposure to electric power generators, including former holdings Primary Energy Recycling (TSX: PRI-U, OTC: PYGYF), Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF) and Algonquin Power Income Fund (TSX: APF-U, OTC: AGQNF). While company-specific operational issues led to their removal from the Portfolio, we’ve maintained exposure to sector through Atlantic Power Corp (TSX: ATP-U, OTC: ATPWF), Great Lakes Hydro Income Fund (TSX: GLH-U, OTC: GLHIF) and Macquarie Power & Infrastructure Income Fund (TSX: MPT-U, OTC: MCQPF).

In the December CE, we increased that exposure by adding Innergex Power Income Fund (TSX: IEF-U, OTC: INGRF).

As long as a company or trust runs its power plants efficiently, it will have a market for its output--and steady cash flows. Power is typically sold under long-term contracts to either giant utilities or government-run entities, which often both build in price increases and include automatic adjustment for change in fuel costs as well. That doesn’t mean a generator won’t run into trouble by taking on too much debt, though.

Innergex’s debt and credit profile is consistent with the power generators it now accompanies in the CE Portfolio. The trust has no credit facilities coming due until 2013, eliminating the need to refinance in the near to intermediate term. Moreover, of that 2013 facility, CAD9.2 million of CAD10 million available is unused, meaning it could be paid off easily with cash on hand and remains a useful financing tool for future acquisitions.

Rounding out the balance sheet details, some 92 percent of facilities are based on fixed rates, and the trust’s effective interest rate is just 4.43 percent. The balance sheet includes a cash reserve of CAD25.1 million, enough to finance some 10 months of distributions even if the trust didn’t earn a dime.

The operative description for CE Portfolio power generators--as well as the energy producers--is “stress tested.” Dating back to the October 2006 Halloween Massacre, these businesses have been forced to work within tight constraints on their ability to raise capital. The economic downturn hasn’t made things any easier.

But, as it’s been since the beginning, the plan is to focus on well-run businesses with strong balance sheets.

If you were to believe the mainstream media, there's little good news coming out of the financial services industry. Failures among smaller institutions continue to rise as losses on problem assets mount, while the Federal Reserve and Treasury Dept are pulling out all the stops to prop up the irresponsible mega banks deemed too big to fail. It's not surprising that share prices in the financial sector have suffered--and, in many cases, deservedly. But at the same time, it pays to look beyond the overwrought strokes with which the media paints the banking system.

Amid the prevailing doom and gloom, there are a surprising number of community banks that shunned the high-risk activities that dominate the headlines and now find themselves in a position for growth.

Click here to download a free preview of Banks of Opportunity, a report prepared by my colleagues Benjamin Shepherd and Peter Staas that highlights some of our favorite bank stocks for growth and income.

Redirect the stress built up during this long bear and bask in the Florida sunshine as winter extends into its extra six weeks: Join me and my colleagues Elliott Gue and Gregg Early Feb. 4-7, 2009, for the Orlando Money Show.

I’ll be talking about my new service focused on exploiting the greatest spending boom in history, New World 3.0, as well as topics related to utilities and the Canadian trust universe.

Elliott, the new editor of Personal Finance, will detail PF’s new direction and provide significant insight into his approach to stock selection and portfolio management. What’s required now amid these difficult times are clarity and focus, qualities Elliott has demonstrated in these pages and through The Energy Strategist for years.

Gregg, a constant at PF for nearly two decades, will be there to address recent developments with the publication. He’ll also discuss the Smart Grid, an endeavor he’s exploring as part of his role with New World 3.0.