Pipeline and utilities shares susceptible to swings in Bond yields
The recent spike in bond yields has meant trouble for Canadian pipeline and utilities stocks. Companies such as Enbridge Inc., TransCanada Corp. and Northland Power Inc. are down roughly 10% or more since late May as 10-year government bond yields have surged to more than 2.5% from below 2%. The upward move sets up two likely scenarios: Either rates continue to head higher as the U.S. Federal Reserve begins to remove stimulus in the long end of the yield curve (and Canadian yields follow), or 10-year government of Canada rates settle in the 2% to 2.5% range. In the first scenario, in which 10-year rates head to 3%, RBC Capital Markets analyst Robert Kwan thinks most of the Canadian energy infrastructure sector could see share price declines of 20% to 25% (including the recent slide), with additional weakness if yields move materially higher than that level. Mr. Kwan expects every 100 basis point backup in long rates to produce a downside of 10% to 15%. However, he thinks the initial move would be more violent than that range. “The relationship would be expected to hold until 10-year government of Canada rates reach 6%, after which we would expect the stocks to reach ‘floor’ valuations,” the analyst said in a note to clients. In the second scenario, in which rates stabilize in the 2% to 2.5% range, Mr. Kwan believes energy infrastructure stocks could easily recover their recent losses and potentially even expand valuations. He pointed to Emera Inc., Fortis Inc., Atco Ltd. and Canadian Utilities Ltd. as companies that should see higher earnings if rates rise. Mr. Kwan’s base case is for rates to stabilize.