Four Years of Outrageous Dividends

On October 31, 2006, Canadian finance minister Jim Flaherty made one of the most important announcements in Canadian economic history...

He declared the death of Canada’s income-trust structure.

In a matter of hours, $25 billion was wiped off the value of Canada’s stock exchanges, and the Canadian dollar dropped like a jet plane in an air pocket.

One writer described it as “third-world politics” and called Canada a “banana republic.” Another writer posted Flaherty’s e-mail address on his website and asked readers to send in protest letters. Forty of the biggest companies in Canada formed a coalition to fight the decision.

The income trust is a type of corporate structure popular in Canada. Companies that convert to income-trust status don’t have to pay corporate tax. In return, they agree to pay out at least 90% of their profits to shareholders.

Hundreds of thousands of investors – in Canada, the United States, and all over the world – have gotten rich off the meaty checks the income trusts sent out every week. Now, they’re fuming that the Canadian government wants to end such a successful plan. I’ve spoken to a number income-trust investors in the last few weeks. Several of them lost more than $100,000 the day the announcement hit the market.

I don’t want to antagonize the investors who lost money on Flaherty’s announcement, but frankly, I think we have an opportunity to make extraordinary profits here... without the risk.

I spoke to a prominent stockbroker with a long history of doing business with Canadian investors. I asked him how his clients had reacted to the news. “Sell first. Ask questions later,” was his one-line response. It was a bloodbath, he said. He couldn’t convince anyone to hold their royalty plan stocks.

This was a true panic. Result: Some income trusts now trade with extremely attractive dividends. Look at this sample of energy trusts (yields calculated on Wednesday):

Here’s the thing: The political risk is already priced in. How much further can these stocks fall?

On the other hand, I can see plenty of upside. All the stocks above have a four-year exemption from paying corporate tax. So you’ll receive the same chunky income streams until 2011.

But here’s the unknown. Canada created the income-trust structure for energy companies back in the ‘80s. It worked very well. The government proposed closing the scheme now that all kinds of businesses – such as banks, telecoms, and retailers – started abusing the system to avoid tax. What if the Canadian government decided to make an exception for the energy and natural-resource sector? Four years is a long time in politics. Energy trust stocks would jump by 20% in one day.

Veteran trader and frequent contributor to these pages, Dennis Gartman, thinks the same thing. “We suspect that those trusts already extant will be exempted or ‘grandfathered in,’” he says. “The only losers here? Those who sold their trust shares amidst the panic liquidation.”

Buying the best businesses is the key to this opportunity. Don’t worry about the politics. Choose the strongest energy and resource income trusts you can find. Buy them cheap. Enjoy the huge income streams for the next four years... maybe more.

Good investing,

Tom