Income Report / Income Report; Fade not follow the current pullback in global interest rates (ALX, SYD, AIA, TCL, SKI)

By Market Matters 30 May 18

Income Report; Fade not follow the current pullback in global interest rates (ALX, SYD, AIA, TCL, SKI)

Market Matters Income Report 30th May 2018

Alert but not yet alarmed was the key takeaway from last week’s Income Report however looking at the Bloomberg headlines this morning / today it seems the market has become more alarmed than alert – or at least bond traders in Italy have as shown in the AM report today! Overnight the market has come under pressure, largely caused by the failed Italian coalition increasing the prospects of fresh elections in their Autumn, plus a potentially scary EU referendum. Investors are concerned that Italy may ultimately vote to leave the EU, which following the UK would be a major nail in the coffin of the Eurozone. Stocks were hit reasonably hard overseas led lower by financial stocks however most action was in the bond market.

Australian stocks are trading lower at time of writing (12.42pm), with the Financials tracking their overseas counterparts and feeling most pain, while the interest rate sensitive stocks / sectors are doing best – Utilities are trading up on the session.

In today’s note we’ll look at yield  stocks that are typically targeted for income investment, particularly relevant given the short term pullback in US Bond yields - the US 10 year yield moving from a recent high above 3.10% down to 2.81% overnight. This has implications for certain areas of the market.

US 10-year bond yields chart

In terms of the MM Income Portfolio over the past week,  the portfolio was down (-0.14%) while the ASX 200 was off by (-0.47%). Overall,  the portfolio is up 4.77% since inception (5/7/17) versus it’s benchmark (RBA cash rate +4% - equates to 4.94%).  Cash still sits at 5.5%, however we expect some amendment to cash levels and overall composition of the portfolio in the near future. To view all activity on the Income Portfolio – click here

Fade not follow the current pullback in global interest rates

Some of the traditional ‘yield play’ stocks have popped in recent weeks courtesy of falling US interest rates plus some corporate activity in a number of the ‘yield’ sectors – property has been the standout while infrastructure has also done well. At Market Matters we’ve been negative a number of these interest rate sensitive sectors however has that view changed? Today we’ll look at infrastructure stocks.

Infrastructure

The top infrastructure stocks listed in Australia are toll road operator Transurban (TCL), Airport operators Sydney Airports (SYD) and  Auckland International Airport (AIA), electricity distribution company Spark Infrastructure (SKI) and Atlas Arteria Group (ALX) which is the old global infrastructure developer, operator and investor Macquarie Atlas. We’re hearing a lot about new infrastructure investment globally and history will show that infrastructure investments provide strong, long term, stable returns if managed well.

However, infrastructure companies carry significant amounts of debt, and this was a major concern during the GFC when credit markets more or less froze – refinancing maturing debt was simply off the table and some companies globally were driven to the wall. While not suffering the same fate as some, Sydney Airports for example was carrying significant debt and market concerns pushed the airport operator to a low of $1.29 in March 2009, before commencing an almost uninterrupted rally to above $7.34 today as credit became available, central banks bought bonds and global interest rates collapsed.

The bond-like characteristics of infrastructure stocks attracted many investors that would traditionally have bought fixed-income assets pushing up the price of these stocks. Now we have an environment where interest rates are rising which puts pressure on bond prices, or the prices of assets that are priced like a bond – infrastructure stocks are clear examples.

Looking at the performance over the past 12 months of the 5 stocks above (before dividends) shows some varying results, however overall, the sector has been weaker than the market as interest rates have risen – a trend we think will continue.

1 Atlas Arteia (ALX); The one exception has been a strong performance by Atlas Arteria (ALX) – a company that develops and operates toll roads overseas with interests in 2 concessions in France, one in Germany and the Dulles Greenway is in the United States which it has 100% interest in  – all good assets that have driven good returns.

This company has good momentum in earnings and from a valuation perspective is ‘cheaper’ than its other listed peers.

The trend of ALX remains strong and if held we could simply run stops below $6.20 and enjoy any further upside.

Atlas Arteria (ALX) Chart

2 Sydney Airports (SYD); SYD is in great shape operationally however it is still carrying significant debt. Funding is currently cheap and they’ve managed their maturity profile well. That said – a simple look at the long term chart of SYD shows signs of stalling – indecision is now in play and the huge rally in share price is being questioned, largely a result of rising interest rates and the expectation of more to come.  

We’re negative SYD with an ideal sell zone of ~$7.50 quickly approaching which would target a move back to ~$6

Sydney Airports (SYD) Chart

3 Auckland International Airport (AIA); a company with the same pressures as SYD however it’s cheaper and looks more bullish from a technical standpoint. Although it seems a contradictory call, we are bullish AIA targeting a retest of previous highs – around ~20% from current levels. For the sophisticated investor, a pairs trade could be considered. Sell SYD and BUY AIA however this will create a negative yield differential and would therefore rely on price movement for its return.   

We could buy AIA targeting ~$7.50

Auckland International Airport (AIA) Chart

4 Transurban (TCL); rising global interest rates coupled with the likelihood of a growing development pipeline and Transurban could be hit from two sides. As it stands, Transurban has an ~$11bn development pipeline, with the potential for this to grow significantly, e.g. Wesconnex at around $16.8bn, North East Link at $16.5bn and Maryland in the US  around US$9.0b – this could mean that dividend growth is lower than is currently factored in (given requirement to spend on growth).

We are negative Transurban (TCL) at current levels targeting a move down to $10 i.e ~20% lower

Transurban (TCL) Chart

5 Spark Infrastructure (SKI); hard to get excited about Spark and we continue to think that it will grind lower from current levels.  

We are negative SKI at current levels targeting a move down to $2 i.e ~10% lower

Spark Infrastructure (SKI) Chart

Conclusion (s)

We are overall negative infrastructure stocks in a rising interest rate environment.
We are particularly negative SYD, TCL and SKI
We are mildly bullish AIA and ALX however acknowledge overall sector headwinds

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

Disclaimer

All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 30/05/2018. 12.42PM 

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