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November 1, 2006 |
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For the second year in a row, Canadian Investment Trusts are going to be unexpectedly slammed lower. Last year it was the threat of taxation on Trusts and this year it is a reality of taxation. After the markets closed yesterday (and on Halloween no less) federal Finance Minister Jim Flaherty dropped the bomb and announced the government will start taxing existing trusts by 2011 and new trusts – if they dare become trusts at all – immediately.
As Todd and I mentioned in our report on Priszm (PDF), the majority of Canadian Trusts pay out distributions above that of income, and figuring out distributable income from trust-to-trust can be extremely difficult. Unsustainable payout ratios is masked, by some in the group, by basing payout ratios on distributable income, not necessarily the net income or free cash generated from operations. If a public company were to make similar payouts investors would naturally fear stock dilution to cover 100+% payout ratios to income. However, with trusts these fears oftentimes are ignored, even as many trusts steadily float more units to help pay for distributions. I am not saying the entire trust industry is corrupt. There are companies, like Priszm, who operate successful businesses and make steady payouts without sending the number of units outstanding dramatically higher. Nevertheless, tread cautiously when researching Canadian Investment Trusts -- fully understand distributable cash methodologies and closely track outstanding units over time. Canadian trust investors are going to very upset with yesterday’s announcement: meaning some trusts will find it increasingly difficult to expand their unit base without incurring further unit price declines in the future. If the bloodbath in trusts get bad enough an opportunity could arise. Two trusts we have invested in the past are Swiss Water and Priszm. Also, below are 20-companies Todd and I are currently looking at for potential investment...if the carnage resembles that of last year. Stay tuned...
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