Standard and Poors has released a study looking at the (in)consistency in company definition of distributable cash by income trusts or funds in Canada. It’s not news if you follow the TrustInvestor studies or articles, but a useful contribution to public understanding in any case.

Link to their Stability Ratings web site for a copy of “Canadian Income Funds And The Perceptions Of Distributable Cash: Part I of 2”. The document is found down the page among news reports in the Industry Studies and Commentary section.

Their findings are not news to members of TrustInvestors or subscribers to our iTrustReport. We’ve repeatedly explored the high degree of inconsistency in definition of distributable cash and the implications it has for using Payout ratios as a significant indicator of trust quality.

But the study is useful to further explore the degree and extent to which this can subvert an attempt to measure the viability of a company.  And it’s a different take on the kind of concerns repeatedly expressed by Toronto-based forensic accountant, Al Rosen.

The S&P analysts, Kevin Hibbert and Ronald Charbon, are using words that generate news coverage.  They say “financial reporting among Canadian income funds leaves much to be desired...[with the] distributable-cash calculation plagued with distortion and information risks that, if left unattended, will undoubtedly result in misinformed investor decisions.”

Most significant in their work, S&P looked at nearly four dozen large income trusts and found that nearly half used different names to describe the generation and availability of cash for return through distributions to unitholders.  Most worrisome was their view that one in ten trusts in their study “had cash generated and available for distribution that was lower than what was reported..and insufficient to cover distributions over a two-to three-year period.”

We note that S&P is paid by income trusts to undertake stability ratings.  Companies value the appearance of being open to ratings by them because they are used by investors for purposes of valuing securities issued by the trusts.  Standard and Poors has, quite naturally therefore, refused to identify those relatively few trusts that their study found to be most “distorting” cash reports.

Optimists could say that the S&P findings really mean that financial reporting is better in quality than many might expect.  More than half the companies in the S&P study were found to be using relatively consistent descriptions of distributable cash. And roughly 9 of 10 companies provide data that can be useful to investors.

The information gaps that have been confirmed with this study, puts S&P ratings analysts, investors and other industry participants at a disadvantage in terms of our ability to make informed decisions.  An S&P spokeswoman is quoted by Canadian Press as saying, however, that the key message from the study is that “investors need to make more informed decisions.”

Of course, the TrustInvestor would agree with that conclusion, noting that it’s a challenge. And our iTrustReport is one resource to support informed data-driven investment. So we look forward to the follow-up report from the S&P.