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Harry Koza

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A mighty wind

Harry Koza

TORONTO (GlobeinvestorGOLD) — Income Trusts. Everywhere I turn these days, all I see or hear in the domestic financial media is trusts. The feds have their shorts in a knot about all that "lost" tax revenue, and seem hell-bent on doing something hugely stupid to knee-cap the sector any day. They could, of course, do the obvious thing and eliminate the regressive double taxation of dividends that helped create the trust phenomenon in the first place, but don't hold your breath waiting for that to happen. Mind you, the political cost of wiping out the only decent income-producing investment for hundreds of thousands of voters (millions of voters when you add in the pension funds that also hold trusts) is so high that the Martin government will likely stick to what it does best, and just dither about the issue, maybe promising new trust guidelines, oh, any day now, much like they've done with bank merger rules.

In the meantime, trust prices are starting to show the kind of volatility normally reserved for dot.com startups, and a pall of impending doom has hit the sector, compounded when S&P started backpedaling on putting trusts into the stock index.

That's all got me kind of interested. I still own units of 44 different income trusts, one of them a trust of trusts. Some of them have been beat up a little bit in the past week or so, and a couple of them are even under water a little, but most of the ones I hold are still way higher in price than when I bought them, are still faithfully pumping out the distributions every month, which adds up to a fairly tidy sum. I've been accumulating cash in my RRSP as a result, but I haven't come up with a lot of bright ideas about where to put it to work. I'm already long oil and gas and drill services, and have been since the turn of the millennium, and current share prices in the sector are, frankly, unprepossessing, so I've been reluctant to add more exposure.

Current bond yields suck, to put it bluntly. Trusts are darn near the only thing out there that offers any decent yield in it, and their prices have been pushed into the ozone as well. So the recent pullback in the general level of trust prices could be a buying opportunity.

One of the power trusts I own (and I own virtually all of them) is the Clean Power Income Fund. It is trading much lower than my cost at the moment, but at current prices (just under $6 a unit), is cranking out a running yield of 11.76 per cent. That's the kind of yield I like.

Clean Power is a trust that I still like, despite its recent problems. Last November, the trust cut its annual distributions from 95 cents to 70 cents a unit due to currency losses and problems gearing up output at its land-fill gas generation projects in the US. The unit price dropped from around nine bucks down to six, and it's gone sideways since then.

I've bought a little more on the dips, and am thinking about buying some more again. Here's why.

Clean Power has 42 renewable energy projects across North America, pumping out 1.6 Billion KWH per year from 347 MW of environmentally friendly technologies. It is the first income fund to be certified under Canada's Environmental Choice(M) Program.

By the end of the year, the 50 per cent owned 20 MW Grand Manan windpower project in New Brunswick will come online. By April 2006, the 99 MW Erie Shores wind farm will also be on line, bringing total output to around 450 MW. That's a lot of juice, all of it sold under long-term contracts with provincial and state utilities. And all of it produced from fuel that costs, basically, zip. Unlike natural gas-fired co-gen plants, Clean Power doesn't care how high natural gas prices go — they get their fuel from garbage, or the wind.

Most of their operational problems last year stemmed from the Arbor Hills, Michigan land-fill gas recovery operation. They've replaced the management team, spent money on maintenance and upgrades, and a capacity expansion will be completed in Q4, adding to the facility's overall production and cash flow. By 2006, the gas recovery operation should be back at normal levels, with lower costs, and contributing US$9 to US$10 million a year in cash flow. They've also hedged their currency exposure, at least for 2006, which should eliminate their losses on that front.

Back in August, DBRS cut Clean Power's debt rating to BB(High) with stable trend, from BBB(low) with negative trend. They also confirmed the trust units at STA-3 (low ) (on a scale of 1 to 7). The rating agency figures that the Erie Shores wind farm will be accretive to distributions, and, along with the improvements in the landfill gas recovery operations, will enable the trust to generate enough distributable cash to cover its distributions for the first time since its inception.

That's a little scary. DBRS says "since inception, the Fund has not generated sufficient cash available for distribution to cover its distributions, mainly due to lower-than-expected output and higher-than-expected maintenance costs at its landfill gas facilities."

Still, that could be about to change. Clean Power is a fairly speculative trust at this point, but it seems to have gotten a grip on its problems and may have turned the corner, plus, that 11.75 per cent yield is danged attractive for a power trust. At current levels, it may be worth a look.

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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