The Bull Market No One is Talking About

The financial world didn’t get its relief yesterday. The bailout plan and any accompanying reprieve just weren’t in the cards. The Dow tumbled and investors rushed to the exits.

I’m not going to harp on the bad news again, I’m sure you’ve heard it all by now. That’s because opportunity is knocking right now.

I will say the bailout plan, or some form of it, will be formalized and approved. Too many politicians have too much riding on it. And then all will go back to normal…for a few days.

We could even get a nice bounce in the markets following the new (and therefore better?) bailout plan that eventually gets approved. If by some miracle the door is slammed shut on banking problems by a swipe of the pen, the next door will open. I’m afraid, what is behind the next door is a lot uglier: the economy.

That’s what really matters here. The economy…it’s always the economy. When bailout euphoria hit the markets a few weeks ago, we focused on what matters most. Although the U.S. is technically not in a recession yet, we’re headed for one. The looming recession is reducing demand for everything, profits are getting squeezed, and some very smart money is quietly buying some highly undervalued stocks. And we can buy right along with them.

In fact, the big money shopping spree has quietly sparked a mini bull market that no one is talking about. Some of these companies have watched their share prices increase 20% to 50% in just the last few weeks. It’s takeover time and I expect plenty more takeovers for these ultra-safe, high-dividend paying stocks over the next few months.

Right now it seems almost no companies (or their share prices) are immune from the downturn. But some very big money is taking a completely different view. Over the past few weeks Canadian income trusts have become private equity darlings and the trend is only getting stronger.

The Canadian government didn’t help matters either. It declared the special tax breaks afforded to shareholders of income trusts would be eliminated in 2010. This announcement took the income trust holders by surprise and sent the value of them plummeting between 30% and 50% in a day. Most have fallen further since. But now they’re starting to roar back to life.

You see, most income trusts are not in terribly exciting industries. They’re not going to develop the next Blackberry, make a run at Google’s market share, or anything of the sort. They are, however, some of the most basic businesses that will survive the worst of economic times.

Some leading income trusts have sound businesses in tuna processing, lumber shipping, grain silo operation, and food shrink-wrapping. Not even close to any great cocktail party conversations starters.

That’s the beauty of them though. They are not complicated businesses. Most of them have positive cash flows and demand for their products and services, profits, and their dividends grow like clockwork. They are some of the safest businesses you can be in. And safety will be getting a premium as a recession looms and bear market continues. That’s why the big money is moving to safety in a big way. It’s already started.

Over the past few weeks we’ve watched a few income trusts get bought out. The buying spree is laying the foundation for a bull market in income trusts. In most cases, investors had the opportunity to take an average profit of 37% overnight. For example:

Teranet Income Fund (TSX:TN.UN) manages Ontario’s Electronic Land Registration System (ELRS). The ELRS is the database of all the registration information for every piece of land in Ontario. That’s a lot of data when you consider Ontario is three times the size of Montana.

Despite the size, ELRS has all of the historical records for the past 200 years stored electronically. It is used regularly by lawyers, real estate agents, and the government. Every time a house is sold, some timberland changes hands, or any other land-based transaction, it all has to be processed through ELRS.

Teranet operates the whole thing. It has a monopoly on it. And it charges a small fee for every user. Granted, it’s not an overly exciting business, but it’s sustainable, safe, and generates lots of free cash flow.

That’s what has attracted a hostile takeover bid from Borealis Infrastructure Management. Before the bid Teranet shares were trading around $8 with a hefty 10% yield. Borealis has offered $11 per share, good for a gain of 37%. (Note: Teranet management is fighting the buyout because they think Teranet is worth even more. They just might get it too.)

Sleep Country Canada Income Fund (TSX:Z.UN) – operates a chain of mattress stores. It has 160 total stores in Canada and 46 in Arizona. Again, selling mattresses isn’t the most exciting business, but it’s sustainable, profitable, and has plenty of cash flow.

Sleep Country rewards its shareholders too. The mattress seller pays out a little over 12 cents per share in dividends each month. In August, when income trusts were at their lows, that would have worked out to about an 8% annual yield. That’s a pretty appealing yield any way you look at it.

Individual investors weren’t the only ones that found the safety and high dividend of Sleep Country appealing. A few days after the company reported a 9.4% increase in sales and 7.2% profit in the past year, private equity launched its buyout bid.

Birch Hill Equity Partners and Westerkirk Capital jointly placed a bid for Sleep Country. Before the bid shares were only trading for about $16. Last week, the deal was closed and every shareholder sold out at $22 per share, good for a 37% gain.

Connors Brothers Income Fund (TSX:CBF.UN) – is a fish-packing outfit. This company is best known for its Clover Leaf and Bumble Bee tuna brands. The market downturn may be dragging demand down for a lot of things, but it’s not hurting tuna sales.

Despite a big problem with bad meat in one of its facilities over the summer which sent shares tumbling to about $2 a piece, Connors Brothers has been able to recover. Through it all Connors Brothers is still making its regular dividend payment of 6.67 cents per share each month. That works out to a yield of about 12% as of Thursday’s closing price of a little over $6.

Doesn’t sound too bad, does it?

I didn’t think so. Neither did the analysts at private equity firm, Centre Partners Management. They found $6.23 a share to be so cheap for Connors Brothers they offered $8.50 each for all of them. That’s a premium of 36%.

Connors Brothers was just another takeout of a beaten down income fund business selling at fire sale prices. All three of these takeovers have been put together in just the past few weeks. The average premium has been 37%. This is the start of a trend that isn’t likely to go away anytime soon.

Income trusts have been unfairly beaten down and are as cheap as ever. They offer incredibly high yields (between 6% and 14% in most cases), are some of the safest investments you can make, and have very simple businesses that will survive a long recession.

To be honest, I’m not going to tell you which one is next to be taken over. I don’t know. But I do know there will be a next one, and a next one, and a next one.

When it comes to most income trusts at these price levels, the worst case scenario is you’ll have to collect some pretty high monthly dividend checks while you wait for the big payday.

Considering the record volatility in the markets over the past few days and what’s likely to unfold over the next few months, that’s not a bad situation to be in right now if you ask me.

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