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Harry Koza


"Singin through you to me; thunderbolts caught easily
Shouts the truth peacefully Eeeeeee-lec-tri-ci-teeeeeeee

High voltage man kisses night to bring the light to those who need to hide their shadow deed
Go into bright find the light and know that friends don't mind just how you grow

— Captain Beefheart, "Electricity," from the 1967 LP "Safe as Milk." Buddha Records

TORONTO (GlobeinvestorGOLD) — Ah, spring. When an investor's fancy turns away from dwelling on just how wrong you were — again — about Nortel, to more vernal subjects, like how to finance that half-scale replica of the Hanging Gardens of Babylon that your wife has planned for the backyard, or whether you really need an industrial strength power-washer.

There's no end of yard-work, a plethora of planting projects to pursue, not to mention the compulsory trips "up North" to make the seasonal blood-offerings to the legions of hungry blackflies that infest this country's hinterland. It leaves you less time to fret about your investments. You may want to follow the old Bay Street axiom, "sell in May and go away."

While I personally need a long vacation as soon as possible, I do hate to give my hard-earned money any time off, so I 'm planning to park some of it where it will be safe and productive for the summer. And since I'm planning the family's summer road trip, it's appropriate that we also go on a timely investment road trip.

Horace Greeley once said, "Go West, young man," but — much as we love the West — we've been there, done that, we're long the oil patch up the yinyang: we're going East. It's only a hop, step and a jump to Quebec — La Belle Province, home of poutine, wine-selling depanneurs, Montreal smoked meat sandwiches the size of your head, and hydro-electric power, lots and lots of hydro-electric power.

Given Ontario's recent experiences with the Californication of the electricity sector, it's not surprising that we — or me, anyway — think of electricity when I think of Quebec. (I also wonder why they seem to have so little trouble getting generating plants built there while here in Ontario it seems so difficult. Curious, isn't it?).

La Belle Province

Forget Hydro Quebec as an investment, although if you're much younger than me you might want to look at long Hydro Quebec strips and residuals, now yielding around 6 per cent. Slap some in your RRSP and forget about them. Anyway, I'm not thinking mega-projects like Baie James, I'm thinking private hydro, and in Quebec there are a couple of electricity income trusts worth a look: Boralex Power Income Fund and Innergex Power Income Fund.

Boralex, headquartered in Kingsey Falls, Quebec, has 10 generating stations with a combined total output of 191 megawatts. It owns the only combined-cycle co-generator in Quebec, a 31 megawatt plant. Boralex pays 90 cents a year per unit, and at its current price of $9.96, yields 9 per cent.

Innergex has stakes in six hydroelectric power stations in Quebec and one in Ontario, with 70.5 megawatts of installed capacity. It's a new trust, and hasn't been around long, but it pays at the rate of 93.5 cents per unit per year. At its current price of $10.10, that's 9.12 per cent.

The Fed factor

Borlax Power Income Fund (1-year OHLC chart as of May 17, 2004)

Innergex Power Income Fund (1-year OHLC chart as of May 17, 2004)

Now, with markets in a tizzy these days about Federal Reserve chairman Alan Greenspan — will he raise rates, won't he raise rates, and by how much and how soon — everyone seems to be recommending that you eschew electricity income trusts, because they are the most bond-like of all income trusts, and thus the most sensitive to fluctuations in interest rates. A lot of people must be taking that advice to heart, because the unit price of both of these funds has taken a header.

But that's exactly why I like these (and other) power trusts. They have the most stable cash flows of any type of income trust, and with their long-term fixed-price contracts for their output, and essentially fixed operating costs, they are indeed downright bond-like in their predictability — barring random Acts of God such as rivers suddenly drying up, of course.

Normally, to earn a 9 per cent yield on a bond, you've got to go beyond triple-A and A ratings, beyond investment grade, out to the sporty end of the credit spectrum, out where companies have the kinds of credit rating letters that would give you conniptions if your kids came home from school with them on their report cards. So to me, earning a 9 per cent running yield on essentially an investment-grade utility credit is a no brainer.

Now, there is a chance that while you're up at the cottage this summer, terrorizing the neighbours on your Sea-Doo and feeding new generations of mosquitoes, Mr. Greenspan may raise U.S. interest rates, and, as every one knows, rising rates mean that bond prices fall, and so do the prices of quasi-bond-like instruments such as electricity income trusts. But the bond market has already priced in at least four of the next three interest rate hikes.

Bring on the rate hikes

So what if the Fed raises rates by 25 basis points, or even 100? If you're earning 9 per cent, and overnight rates go from 1 per cent to 1.25 per cent, or even to 2 per cent — there's no need to call for the Prozac. Many power trusts have dividend reinvestment plans so you can compound your income by buying cheaper units if prices fall further, plus, you're still earning 9 per cent or more. Besides, the Fed wants short rates to rise, not long ones. Mr. Greenspan and his minions want the yield curve to flatten, lest the US residential housing boom be slowed by rising mortgage rates.

There are a number of ways the Fed can do this: stop auctioning 10-year notes and increase the amounts of 2, 3 and 5-year auctions; issue more maturities of TIPS (inflation-adjusted bonds); buy 10-year bonds and other long-dated bonds in the open market. More likely, though, is a summer tour of Fed heads, spreading Dovish sentiment across the land.

Meanwhile, with the US economy picking up some momentum, Canada will also see a boost in demand for our products, which will help keep demand for power high. So will a long hot summer, come to think of it. Gee, like we never have one of those.

I'm not saying you should run right out and buy these trusts now. I haven't. I already own units in a half dozen power trusts — hydro, co-gen, biomass, green power — so I have plenty of exposure to the sector already. But Boralex and Innergex are two that I think are worth watching. I've been thinking about them for a while now, but a few months back they were only yielding around 7 per cent, while my other power trust holdings I bought at 9-per-cent or 10-per-cent yields. And while prices may drop further on power trusts in general, that will just make them more attractive.

You may want to wait for higher yields, and certainly these puppies will be pretty volatile with rising interest rates, but I think the market's nervousness about interest rates is a little overdone, and both these trusts look cheap at current prices. Sure, interest rates may rise by 100 basis points over the next year or so, but these power trusts have already backed up 200 basis points. You could do worse. You could have bought Descartes Systems at near $4 in March and have lost half over your money already.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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