Safest High Yield Stocks to Buy On the Next Dip

Part 1: Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF)

While stocks are overpriced at this time, and that the current rally lacks justification, we also believe that this is the time to be preparing a list of stocks to buy when they pull back. There are many others, but time limits your humble author to just one for now.

Why Stocks are Overvalued

Our reasons include:

1. The rally was essentially based on bad results beating worse estimates, not any real signs of improving business. Slowing decline does not necessarily mean imminent improvement, especially considering that the fundamental causes of the current crisis have not materially improved. These include:

1. Declining consumer demand fed by a long term soft job market, declining real wages and hours worked.
2. A financial sector that is still unable to profit from ongoing operations, and that has been beating low earnings estimates by unsustainable means such as one-time asset sales or high risk trading.

1. The dollar is likely to lose value over the coming years, and that trend will counteract consumer attempts to save. Why? The dollar is burdened by excessive supply and debt that is likely to inflate and devalue it relative to certain other key currencies and all commodities. Washington has little choice. As Fed Chairman Bernanke told us recently in his testimony before Congress, the US economy will be too weak to withstand withdrawal of stimulus measures until there is job growth. The US is too dependent on consumer spending to sustain a recovery without sustained improvement in consumer incomes.

Why CDPYF Should Be on Your Shopping List

The reasons include:

Solid Performance Under Adverse Conditions

They are actually growing operations despite the worst economic and credit environment in decades.

• Posted solid first quarter results, as revenue rose 5.2 percent, net operating income increased 3.4 percent and distributable income moved higher by 2.5 percent.

• The balance sheet got stronger as debt interest rose to 2.07 from 1.98 in 2008. In addition, some 95 percent of the mortgages that back the REIT’s properties are federally insured, enabling management to consistently refinance them at a cost lower than conventional mortgages.

• Rents rose 2.3 percent and occupancy, though down slightly, was still enviable at 97.3 percent, with a good chunk of the vacancies due to the REIT’s policy of kicking out unreliable tenants.

Strategic Focus on Quality Properties and Regional Diversification

• The company has a relentless focus on property and tenant quality, evidenced by its ability to raise rents and avoid hefty bad debt expense.

• Another is regional diversification, tempered by a concentration on Canada’s most stable markets. Energy dependent Alberta, for example, contributes only 7 percent of net operating income, while far more stable Ontario is 69 percent. The overall property mix is, therefore, not tied to any particular demographic. Nor is it leveraged to new development, as the REIT’s primary expansion has occurred through acquisitions.

Financial Strength to Exploit Best Future Growth Opportunities

The solid balance sheet, access to low-cost funding, a wide knowledge of Canadian markets and reliable cash flow are all critical strengths for such successful growth. And while tight credit markets and the weak economy have kept growth plans on the conservative side, management is certainly poised and prepared to tack them up a notch or two. Opportunities include the growing demand for upscale senior housing and accommodating wealthy immigrants who continue to come to the country, many from emerging Asia to British Columbia, where the REIT has recently expanded.

High Yield in CAD: The stock yields around 8% and is valued in CAD, a healthier currency than the USD and most other currencies. It's underlying economy is among the healthiest and had not required massive QE that would undermine the CAD's value, it has commodities that the few growing economies need, and it's banks do not require massive bailouts. This is a critical consideration for those lacking CAD exposure

Why Not

Here are the main risks.

Not Immune from Overall Sector Weakness

The increase in portfolio-wide vacancies over the past year is a clear sign Canadian Apartment is by no means immune from economic ups and downs. Weakness has been most pronounced in areas of most recent expansion, such as British Columbia and Alberta. Management’s prior forecast of stabilized rents in those provinces has proven optimistic, as competitors have dropped rents and forced the REIT to come down as well.

In addition, operations in Ontario, which has also seen rising costs such as for increased recycling standards and energy, have also been less profitable. And while high-end apartment rents have generally held steady, lower-end unit rents have been falling. While this REIT focuses on the high end, overall market weakness could ultimately hurt the entire market. Just like subprime foreclosures ultimately also hurt high end home prices, the same overall slack demand could ultimately weaken upper scale rental prices.

A deepening of Canada’s recession could well worsen these trends and cut

more deeply into cash flow.

Very Thin Trading Volume

With a three month average trading volume of under 2000 shares a day (often trading under 1000 shares per day), this one can be volatile, and is not suited for anyone but buy and hold investors who do not need to worry about needing to get out fast.

Conclusion: Rewards Outweigh Risks, But Wait for Market Pullback

Fortunately, things will have to get a lot worse to really threaten the payout, which was covered even in the traditionally weak winter quarter when energy costs can bite hard into apartment REIT profits.

The REIT has also been able to offset some of the overall economy’s

weakness by effectively controlling debt and operating costs, such as energy. That effort could be intensified in coming months, if Ontario regulators act to establish rules allowing a resumption of smart metering growth.

If there is a drawback to owning Canadian Apartment Properties it’s management’s exceptionally conservative approach to its distribution, which hasn’t been increased since November 2003. But at well over 8 percent and safe, it’s far superior to anything on this side of the border.

Better still, these dividends are treated as a qualified dividend in the US as well, a further advantage over its counterparts in Canada, which mostly pay out in ordinary income.

Buy Canadian Apartment Properties REIT for steady, high income and some growth, but only on dips between 10-11 USD per share or less. While shares currently trade above 12, the thin volume can make this one volatile when markets get negative.

Disclosure: The author may hold positions in the above instruments.