Big business seen as income trust driver

(June 13, 2003) A growing number of big businesses are issuing income trusts, pushing this sector forward. But watch out for rising interest rates that threaten to take a bite out of performance, says Brian Petersen, head of the income trust group at RBC Capital Markets.

Speaking at the Canadian Institute’s second annual Income Trust Summit yesterday in Toronto, Petersen gave his forecast for the income trust market in the year ahead.

Last year, the Canadian income trust market grew to $55 billion compared with just $15 billion in 1998. Income trusts now account for 8% of the market capitalization on the Toronto Stock Exchange and with big business getting into the income trust market, Petersen sees their presence in Canadian equity markets continuing to grow. “We’ve seen a 35% compounded annual growth rate over the last three years,” he said. “With $10 to $15 billion a year in new equity, I don’t think a $100 million market capitalization is out of the question for income trusts.” And if they’re indexed, he said, it could be even more.

Business trusts currently represent 25% of the trust market and big-name companies like Bell are helping to boost their profile and credibility with investors. Petersen points out that the prevailing concern that “real management don’t run trusts” is being countered by the number of “significant” companies in Canada taking divisions public through income trusts. He says that’s beginning to bolster the reputation of the industry among investors — and businesses looking to raise capital in a cost-effective way.

Indeed, the type of business using the asset class structure has also changed from resource- and commodity-based companies in the oil and gas sectors to a much broader representation of industries. “The trust market is now a stock-pickers’ market,” said Petersen. “There are numerous types of businesses, different risk-reward characteristics.”

Petersen also points to baby boomers retiring and an environment of low-yielding bonds as drivers for future strong performance of income trusts. And with $6 billion a year of distributions created by income trusts, he believes there’s still a massive source of underlying demand to support continued growth.

New limited liability legislation in Ontario might also give income trusts a boost with institutional investors, believes Petersen, who thinks pension funds could now turn to this market for growth to offset poor equity market performance.

However, so far this year initial public offering (IPO) activity is down slightly from 2002. Does that mean income trust activity is trailing off or are we just taking a breather? Petersen says it’s still an active year and that activity will remain strong. But there are some economic indicators investors are wise to monitor.

In particular, income trusts are typically sensitive to interest rate changes. Rising interest rates and a pick-up in the economy might mean bad news. Moreover, a resulting dip in commodity prices might not be great for energy-based trusts. However, the growth in business trust sector that could be the real driver in the coming months. While trusts are traditionally sensitive to rate hikes and a stronger economy, Petersen points out that business trusts are based on underlying businesses that will do better when the economy picks up: “This business trust sector is really going to be the growth engine going forward as far as new IPOs on the market.”

Caroline Cakebread is a Toronto-based investment writer.

(06/13/03)