Here a Trust, There a Trust (Part One)

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In today’s mouthwatering feast:


  • Market Guy Mailbag
    • Shoppers Drug Mart Optimum Program
  • Feature: Here a Trust, There a Trust (Part One)

Market Guy Mailbag

Julie in Kanata wanted to mention a customer loyalty plan that she uses. It’s the Shoppers Drug Mart Optimum Program and it rewards you with points on almost every purchase made in the store. When points are redeemed, customers receive a discount on their purchases ranging from 20% to 100%. Unfortunately there is a maximum of $75 per redemption, but it usually takes a while to hit that target anyway. “We’ve used it to get free diapers and lots of stuff,” she told me.

Earlier this year saw the launch of the CIBC Shoppers Optimum Visa card that allows you to collect points on purchases at other stores. Plus, if you’re at Shoppers and use the Optimum Visa card along with your regular Optimum card, you’ll receive 50% more points than usual. Free stuff gets me drooling like Homer Simpson at an all-u-can-eat buffet. Thanks, Julie.

Feature: Here a Trust, There a Trust (Part One)

The year was 1996:

• Caroline in The City, Boston Common, and The Single Guy were among TV’s highest rated shows. Civilization has since recovered.

• The Yankees were just beginning their run as The Evil Empire, defeating the Braves 4-2 to take the World Series. Civilization has not since recovered.

• I began a new policy of avoiding movie previews. All the commercials for the biggest hit of the year, Independence Day, ruined the best parts of the movie.

• Dolly the sheep was cloned. They can clone mammals, but there is no Arby’s in Ottawa. How far have we really come?

• And I was still living in my parent’s basement. The following year saw an end to that.

But for me, the most important moment of 1996 was something entirely different. One morning, I came up from the basement and started to read an investment newsletter that had just arrived at the house. In amongst the various predictions and analyses was a modest blurb on income trusts. Nothing would ever be the same again.

It seems as though your interest in trusts has been piqued. I’ve received a substantial amount of mail on the subject, with common questions being:


  • What exactly is an income trust?
  • Is the trust market overvalued?
  • What trusts do you own?
  • Do you know of any good websites for researching trusts?

As always with The Market Guy, ask and ye shall receive. I’ve developed a three-part series to deal with these and many other trust-related questions. In part one I’ll provide an introduction to income trusts and some of the most important things to consider. Parts two and three will deal with the different types of trusts and how I’m spending my money. I’ll also talk about some of the events that are looming on the horizon that will affect the entire sector. For those of you interested in more information, I’ll make sure to offer a few suggestions on where to head.

Trusts as equities

I’d like to start with the most important point of the series: Income trusts are equities, not fixed income products. Expecting them to be as safe as GIC’s or government bonds just isn’t realistic. Like many other equity investments, income trusts trade on the Toronto Stock Exchange and have become very, very popular since the bursting (and partial re-inflation) of the tech bubble. There are well over 100 trusts from which to choose and the market capitalization has topped $60 billion. These trusts are involved in a variety of sectors including pipelines, utilities, infrastructure plays, real estate, long life resources, conventional oil and gas, and a host of other businesses. Generally these are very slow growing businesses that generate a steady stream of income for unitholders. Many of the trusts are small caps and therefore, there can be issues of liquidity when it comes to trading the units. Many times I’ve encountered a wide spread between the bid and ask, or not enough shares available for much of a trade. However, I’ve never encountered this problem with the larger, more liquid trusts.

Trusts do have a number of features that make them unique among equity investments. In order to appreciate these differences, we need to talk about cash and corporate structure. Although I don’t really enjoy talking about corporate structure, I sure do love talking about cash. In fact, a column on trusts is just as exciting for me as reading Penthouse Forum is to a teenaged guy.

To borrow from Economics 101, companies generate cash when they sell their products. Every company hopes to have more cash than it needs to cover expenses. That is, they want to be cash flow positive. Ah, but what to do with that extra cash? They might decide to buy back their own stock, finance a project, reduce debt, or fund acquisitions. Or they can get me all excited by distributing some of the cash to the stockholders, via a dividend. An income trust (more accurately referred to as an income fund, but I’ll stick with trust for now) focuses on the latter by distributing much of the excess cash flow to the unitholders. Some funds offer their payouts every quarter, but most do it monthly. Personally, I’m addicted to the monthly payouts. Each cash injection reminds me of Renton shooting up in Trainspotting…ah, the euphoria of a perfect day.


Like all good things, the perfect day must come to an end and this day ends when you have to pay taxes on the distribution. You see, the trust doesn’t have to pay corporate taxes on the income that is distributed. Rather, the burden is shifted to the unitholders. However, this is done in a relatively tax-friendly way. Typically, each distribution consists of two components: a fully taxable portion and a tax deferred portion. The fully taxable part is usually declared as other income on your tax return. With the deferred portion, you don’t have to pay taxes until you sell the holding. Even better, the tax people regard these deferred portions as a return of capital, to be treated as capital gains. This is fine to me because capital gains are the most tax efficient way to make money…better than dividends, better than interest, and definitely better than employment income.

Not all yields are created equal

Remember the Market Guy mantra: give me the cash….ohm. Say it. Sing it, if you prefer. When it comes to the income trust market, cash is king. How much should I expect to receive in distributions from Trust A this year? Divide that number by the unit price and the result is the yield. Trusts with very stable distributions tend to have yields in the mid to high single digits, while the more volatile payouts can result in yields reaching the mid to high teens. Of course this changes with interest rates. As a general rule, a high yield should be regarded with skepticism. Either there are substantial risks associated with the company, the sector, or the payout is less than stable. Also, make sure to know the difference between trailing yield, current yield, and projected yield. The trailing yield is usually based on the previous 12 months of distributions. Current yield uses what the company should pay out this year (or per annum based on the current monthlies). Projected yield uses what the company is likely to pay out in some future time period (say next year). The differences are important, especially if the payout is a moving target.

Payout ratios

Many investors have a nasty habit of focusing only on yield. However, you don’t want the trust paying out more money than it is taking in or using debt to artificially pump up the distributions. Therefore, it’s important to look for the payout ratio. This is the percentage of cash available for distribution that is actually distributed. The rule of thumb is that if a trust is distributing more than 90% of the flow, this is very aggressive. With a number of highly publicized distribution cuts and even cancellations, the market seems to be paying more attention to this metric. Investors seem to be impressed with conservative payouts because these are more easily sustained over time. Besides, being conservative also helps to improve the balance sheet of the trust and reduce the volatility of the distributions (and by extension, the unit price). For me, the payout ratio is the single most important statistic in the trust universe.

Stability ratings

To assist in the process, Standard and Poor’s and the Dominion Bond Rating Service have both developed ratings of distribution stability. For example, S&P uses a 7-point scale, with SR-1 denoting high stability and SR-7 indicating low stability. These ratings are accessible through Income Trust Centre. Just head to the section titledIncome Fund Ratings. I like browsing through the various reports because they help me learn more about each company. All of this information is free, although you have to register to gain access to the S&P ratings.

I’m very excited about the rest of the series because I’ll have a chance to mention some specific companies. Here’s a teaser: what do phone books, garbage, shopping malls, and pipes full of oil have in common?

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. During the power outage he marked papers by candlelight. Seek your illumination


That’s Vegas, Baby!

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Following each edition I receive a considerable amount of mail. Predictably, some columns generate more of a response than others. The recent Money Gripes edition produced by far the most reaction from readers. Oddly enough, most of the correspondence didn’t pertain to matters of money. Instead, the comments referred to a single line that I offered at the end of the column: “I’m going to Vegas.” Since then, I’ve received everything from travel tips, questions about our hotel arrangements, requests that I place bets on your behalf, and various comments from those who’ve already been to the town that Bugsy built. All right, I’m game. So with that I present a few thoughts on Vegas, money, and the corporations that contributed to our travel experience.

As United Airlines flight 417 was descending into Vegas (and notice I write Vegas and not Las Vegas…how many towns can lose half their name and still be twice as cool?), the first thing that captures your attention is the Stratosphere Tower at the north end of the Strip. As you come in closer your eyes start scanning south and you encounter a series of very large hotels, each with a decidedly European flavour (The Venetian, Paris, Bellagio, Caesar’s Palace). Among other figures that don’t seem to go together, you see a pyramid (Luxor), four striking black towers arranged in an X pattern (MGM Grand), a monstrous castle with different coloured peaks (Excalibur), two shiny, golden towers (Mandalay Bay) and a compressed version of the New York City skyline (New York New York). That’s quite an assortment, but something is missing. Hmmm. How about a $28 million ½ scale replica of the Eiffel Tower? Done. It’s only a matter of time before they build a 2000 foot statue of Arnold Schwarzenegger in his Terminator outfit, put 6000 rooms in it and call it The Governor. In any event, we descended into what looked like an absolutely huge theme park. And park thy name is Id.

Once you get to the Strip, it quickly becomes apparent that Vegas is a town without many rules. Want to drink in public at 10am in front of the cops? No problem. You’re 14-years old and want to pass out prostitution pamphlets that have pictures of nude women with “I can be in your room in 20 minutes” as the caption? No problem. You’re at McDonalds and want extra dipping sauce for your chicken nuggets? Well, that’s going to be a problem. This is the only rule that we came across. Each McDonalds (MCD on the NYSE) has a very clear sauce policy that is prominently displayed on a sign beside the cash. Six nuggets, one sauce. They also have a maple syrup policy. Let’s review: Public drunkenness? No problem. Prostitution? No problem. Extra dipping sauce? Big problem. Maybe you get an extra sauce if you come in drunk and with a prostitute. That’s Vegas.

The Three Kings and Beyond

This isn’t your grandfather’s Vegas or even your father’s Vegas. In fact if you haven’t been there in a few years, it may not even be the place you remember. Much of the south Strip has been completely rebuilt over the past 5-10 years, with old classic hotels and casinos being replaced with themed mega-resort complexes. Ownership of these places is highly concentrated, with 70% of the rooms controlled by three companies: MGM Mirage (MGG on the NYSE), Mandalay Resort Group (MBG on the NYSE) and Park Place Entertainment (PPE on the NYSE). We stayed at the MGM Grand, a behemoth of a place. Here are a few tidbits: It has over 5000 rooms, 8000 employees, and the casino covers the same area as 4 football fields. There are plenty of $500 slots, a 17,000 seat arena, 3 night clubs, a lion habitat, a television research centre, a shopping mall, 5 swimming pools, and 13 restaurants plus a food court. All in the hotel. That’s Vegas.

Betting on wagering

Surely such large places generate considerable cash flow and should be regarded as investment opportunities. Although Vegas is still the pantheon of gaming, there is stiff competition for the gambling dollar. To understand the sector, you need to consider what’s going on in places such as New Jersey, Mississippi, Illinois, Missouri, etc. In fact, nearly half of the states have legalized forms of gambling. “Racinos,” or racetracks that offer slot machines, are especially popular and have also made an appearance in Canada. To further diversify their revenue stream, many companies have found a lucrative market for riverboat gambling. Harrah’s Entertainment (HET on the NYSE) and Argosy Gaming (AGY on the NYSE) are among the participants in this area, with riverboats on the Ohio, Missouri, and Mississippi rivers. However, there are pitfalls to operating outside traditional gaming markets such as Nevada and New Jersey. Many non-traditional markets have seen an increase or are likely to see an increase in gaming taxes. With state governments in serious financial trouble, this is one way of raising money without ruffling too many feathers. But that’s not Vegas.

That’s why several companies, such as Mandalay Resort Group, have decided to focus almost exclusively on their traditional markets. President Glenn Schaeffer recently noted that 70-80% of his company’s revenue comes from the Vegas strip. There are challenges, however. Although still growing, demand for rooms has slowed considerably since the late 1990’s. The major operators are keenly aware of the dynamics of supply and demand, with room supply expected to grow at only 1.5% per annum over the next few years. Many large projects are on hold until the demand picture warrants new construction. The Vegas operators are also worried about the recent expansion of Nevada-style slots and table games on California Native reservations. With nearly 30% of Vegas tourists coming from the Golden State, these worries sound justified.

Another pitfall involves the reliance on huge, theme resorts. “In the casino business, even a billion-dollar property can head towards obsolescence nearly the moment it opens, if the next big thing opens down the street” (Motley Fool, 2003). Hard to argue with that. Park Place Entertainment (they run Caesar’s Palace, Bally’s, The Flamingo, The Hilton, among others) notes that 71% of their revenue comes from gaming, with the remainder from hotel, food, and entertainment. However, it’s the lure of the hotel that gets people into a specific casino in the first place. It’s not cheap to build these places, and the balance sheets seem to reveal a fair amount of debt.

In any event, several gaming companies have recently initiated cash dividends. Mandalay Resort Group has decided to pay $0.92 for a current yield of 2.6%, while Harrah’s will pay out $1.20, representing a 2.8% yield. This compares with the 1.7% yield on the S&P 500. I like cash.

Also on the plus side, heavy governmental regulation can be good from a corporate governance standpoint. So if you have images of shady casino operators and mob alliances, best to consult a textbook of Vegas history…or watch Scorcese’s Casino. Good movie. We expect great things from DeNiro and Pesci. But Don Rickles really nailed it.

If you aren’t interested in the bricks and mortar of the hotel and casino business, another investment option is International Game Technology (IGT on the NYSE). This company develops gaming products, such as slot machines. I just visited their website and came across “Kenny Rogers, The Gambler Video Slots” as one of their “hot products for 2003.” Insert your own joke here.

Canadian gaming

There are a number of ways to play the gaming sector in Canada. Magna International (MG.A on the TSX), primarily known for its auto parts business and highly paid Stronach family, is also in the racetrack business. Pending shareholder approval, Magna plans to spin off their track and property businesses to shareholders. The vote will take place on August 19th.

The only pure casino play in Canada is Gateway Casinos Income Fund (GCI.UN on the TSX). This income fund owns several casinos in Alberta and British Columbia, including the Palace Casino located inside West Edmonton Mall. It currently yields over 9% with annual distributions pegged at $1.20.

Finally, Cryptologic (CRY on the TSX) develops and licenses an online casino software product called WagerLogic. This allows gamers to visit a virtual casino, participate in multi-player games, and chat with other gamers. You knew it would eventually come to this.

Random thoughts on Vegas

• It is the only place I’ve been to that measures its drinks in units of length, not volume. Yes, for $13 you can have the frozen, fruity fun that is Margaritas by the Yard. Only in Vegas does a yard equal 48 ounces. You need to know this.

• Nothing beats seeing a good show in Vegas. We took in a George Carlin set at the MGM. Is there a sharper comedic mind? At this point of his career, you’d think Carlin would become a singles hitter. Yet he keeps knocking it out of the park.

• What’s it like to be a high school student in Vegas? Or a student at UNLV?

• The Strip is fascinating and looks absolutely beautiful when lit up at night. There are plenty of things to see and do, and we spent a considerable amount of time just touring the resorts. Bring comfy shoes and be prepared to shell out for lots of bottled water, especially if traveling in the summer. Heat without humidity…what a concept.

• Market Gal was disappointed by the lack of Elvis sightings. However, we did see Vegas cheese on stage at the Plaza. Imagine two 50-year old Japanese men in weathered grey suits and red ascots playing classic rock on their silver guitars, singing with a full accent. At that point I was convinced someone had slipped a little something extra into my drink. Even better, the audience seemed to be taking it seriously. Am I making this up? The fact that I’m even wondering reminds me that it’s Vegas.

• There is nothing quite like traveling on bankrupt airlines. I suppose traveling on solvent airlines comes pretty close. In terms of service, United Airlines seems to be handling the situation more effectively than Air Canada (AC on the TSX…for now). After arriving at Pearson, the Air Canada plane had to remain on the tarmac for over 30 minutes because no grounds crews were available. After another half-hour in customs, our bags didn’t hit the carousel for 45 minutes. No baggage handlers were around. You’ve never seen a more disturbing panic than an elderly Brit still waiting for her luggage and her connection to Heathrow is leaving in 5 minutes…from another terminal. We overheard an Air Canada official blame CEO Robert Milton, to which a passenger replied, “Milton’s the excuse, not the reason.” One passenger threw his coffee on the floor and several airport and Air Canada officials held a scrum over the spill debating who should go find a custodian. After they couldn’t resolve anything, an Air Canada lady placed chairs around the spill and complained that she couldn’t find anyone to clean it up. She even complained to those of us still waiting for our baggage. Obviously they don’t administer a social intelligence quiz to prospective employees. Psychologists would have a field day at the airport. No problems with United. It wasn’t their fault that I lost my cell phone at the gate in Denver. I should mention that I used to train crisis counselors in how to deal with suicidal people and I never broke a sweat. Leave behind a cell phone and the thoughts of being charged for calls I didn’t make had me squirming like a ten year old on the last day of school. Market Gal wanted to have me sedated.

• We used 800 film for most of our pictures. Apparently 800 film is fine for tripod work or if you’re at a Nascar race. Needless to say we don’t have very good pictures. Our friend Steph said, “if you used 800, as long as it was Fuji and not Kodak.” We used Kodak, of course. Apparently I’m the only person who didn’t know this. Why wasn’t I informed? Why didn’t I learn this in school? I spent thousands of hours and tens of thousands of dollars in our institutions of higher learning and yet I still don’t know how to take acceptable holiday photos.

• Just in case there was any doubt about my being a full-fledged, card-carrying member of the geek society, I thoroughly enjoyed the Star Trek Experience at the Hilton. Walking on the bridge of the Enterprise, watchingMarket Gal get all nervous around a couple of Klingons, and having my picture taken with that Nomad device from the original series were exceptionally cool moments. Well worth $25.

• A few years ago they blew up the Sands Hotel (Frank Sinatra’s stomping grounds during the 60’s) and constructed a resort complex inspired by Venice. Up sprung The Venetian. Among its many amenities are gondola rides that take you on a canal that runs inside the hotel. There are shops and café’s located alongside. We decided to take a ride and I had an informative discussion with the gondolier. I asked him what the locals do for entertainment. Breaking out of a false Italian accent, he stated, “we gamble.” He told me that “69% of local residents gamble at least 3 times a week. It’s a real problem.” He confessed that it would be a problem for him “except for the fact that I have no money.” Although I couldn’t confirm the 69% figure, it is quite clear that local residents are gambling in very high numbers. Station Casinos (STN on the NYSE) has constructed several gaming houses in the Las Vegas suburbs to cater to local demand. Las Vegas is the fastest-growing city in the United States and appears to be attracting a high number of retirees, the demographic class that visits casinos the most. In fact, 40% of those moving to Vegas are retired. The sad reality is that many of these people have a serious, diagnosable gambling problem. According to The National Gambling Impact Study Commission, 15% to 30% of casino revenue may come from pathological gamblers. Having spent only a few days in the town, I’m surprised everyone doesn’t have a gambling problem…and ADHD. That’s Vegas.

• When told of our experiences at the Venetian, Dick in Edmonton asks, “Isn’t that opulent?” Yes. It’s also ridiculous, but in a fun sort of way. Remember on The Simpson’s when Homer designed that completely over-the-top car? Vegas is that car. This helps me illustrate a little something about how perception can be altered by the Vegas vibe. A buddy going to Vegas is like a buddy having a nasty girlfriend. In both scenarios he spends way too much money, eventually ends up drinking before lunch, and as the days wear on, he starts looking more and more like Abe Vigoda. Everyone else knows he’s crazy, but to the buddy, everything seems perfectly normal. That’s Vegas.

Overall, Vegas is vibrant, exciting, exhausting, and like no other. Coming home too quickly will give you a case of the psychological bends. That’s a bet I’m willing to make.

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. If you invest in any of the aforementioned companies, some say you are investing in sin. It’s never a sin to invest in