Income trusts getting tasty returns
CREDIT: Getty
Confidence renewed in restaurants. Double-digit yields look attractive despite tax grab looming in 2011.
Income trusts might have given some investors indigestion, but their double-digit returns are still very much in favour with those seeking a high-yield investment. Income trusts swooned after Finance Minister Jim Flaherty’s announcement last fall that existing trusts would be subject to a four-year transition period, after which they would be subject to a 31.5-per-cent corporate tax.
That was sufficient to send trusts, with the exception of real estate investment trusts (REITs), which were exempt from Flaherty’s ruling, into a tailspin. [Suggested REITS ~ "Dundee Real Estate Investment - D.UN" ~ "H&R Real Estate Investment Trust - HR.UN" ~ "Retirement Residences - RRR.UN"]
On Nov. 14, two weeks after Flaherty’s announcement, income trusts had skidded to a 22.6-per-cent loss that erased billions of dollars in market value and stopped others – primarily Telus Corp. and BCE Inc. – dead in their tracks. Today, while the trust sector is still 13.3 per cent below its Nov. 1 mark, it appears some are in recovery mode. Energy trusts still lag badly, down 20.5 per cent, but don’t overlook that the entire energy sector has slipped with the fall in the price of crude oil and natural gas. [Suggested Oil&Gas, Pipeline: ~ "Advantage Energy Income Fund - AVN-UN.TO" ~ "Inter Pipeline Fund - IPL.UN" ~ "Peak Energy Services Trust - PES-UN.TO" ~ "Primewest Energy Trust - PWI.UN & PWI.NYSE" ~ "Vermilion Energy Trust - VET.UN"]
The pipeline sector is down 7.5 per cent and business trusts are down 12.4 per cent. REITs have gained 3.3 per cent.
Restaurant royalty trusts, which form part of the business trust sector along with health care and consumer staples, and discretionary companies, financials and the like, were among the hardest hit. The business sector was down 11.5 per cent, but restaurant royalties crashed 20.3 per cent, losing $196 million.
Restaurants have regained $17 million, or two per cent, which is probably a result of those double-digit yields. Investors’ renewed confidence for the restaurants doesn’t surprise Canaccord Capital diversified trust analyst Chris Rankin.
“Where else,” he asks, “can you get such good returns? Restaurants are among the top performing groups, and the stability of their cash flows is extraordinarily good.
“From a consumer perspective, we’re a society that likes to eat out. If you’re the average Canadian, you occasionally stop by a Second Cup outlet, think nothing of phoning Pizza Pizza for a home delivery and enjoy a steak at The Keg or East Side Mario’s.”
All those establishments are restaurant royalty trusts and are delivering between 9.5 per cent and 15.4 per cent. The decline in their unit value has conversely increased the yields to the point where the risk-reward factor makes them very tempting.
“There’s no question that trusts lost some of their lustre and appeal with the Flaherty announcement,” Rankin said, “but at the same time you can’t lose sight of the fact that there aren’t many competitive yield-oriented investment products in the marketplace. There’s a paucity of yield products and there is a large portion of the investing population that needs yield-oriented investments to fund their retirement.
“While the government has attacked the income trust asset class, I wouldn’t assume that it’s dead. On top of that, I don’t believe that the income trust act is going to change people’s entertainment lifestyle and that they’re going to stop eating out.”
A concern is that as the 2011 phase-out deadline approaches the initial value of the investment will decline further.
“I think that’s already happened,” Rankin said. “That’s what you saw in November. The choice facing issuers now is twofold: They either increase their distributions for now, and then cut them if the tax takes effect in 2011, or they hold distributions constant and see what happens in 2011. Our belief is that issuers will not be unduly penalized for cutting distributions in 2011 if the trust tax takes effect.”
Either way, Rankin said, an income trust that currently yields 10.7 per cent would still pay 7.3 per cent if subjected to a 31.5-per-cent corporate tax.
Prime Restaurants Royalty Income Fund, owners of East Side Mario’s and Casey’s, yields 15.4 per cent. Rankin has a “sell” recommendation on Prime.
He has raised his recommendation to a “buy” on A&W Revenue Royalties Income Fund and Second Cup.
A&W yields 9.5 per cent and Second Cup 11.2 per cent. Rankin also has a “buy” on Pizza Pizza, which yields 10.7 per cent and SIR Royalty Income Fund, which yields 14.5 per cent.
SIR Royalty, which owns the Jack Astor’s, Alice Fazooli’s! and Canyon Creek restaurants, is one of his top picks with an overall total return of 23.7 per cent. Other top picks are Pizza Pizza (19.4 per cent) and A&W (18 per cent).
Rankin has “hold” recommendations on Boston Pizza, which yields 15.1 per cent, and The Keg, which yields 9.8 per cent.
“There’s $174 billion invested in Canadian income trusts, and there’s clear evidence that investors care for the cash flows,” Rankin said.
“And I ask you, where else could all that money flow if investors divested out of income trusts? The Canadian market overall is very tight and there just aren’t enough equities to go around, and that’s renewing strength in the income trust sector and particularly restaurant royalties.”
© The Gazette (Montreal) 2007
KEITH WOOLHOUSE
CanWest News Service
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