Fixed Income Viewpoint
Pipelines – April 2014
Sector Rating: Market Perform Relative Value
to its peers given its business mix, underpinned by its cost- of-service oil sands transpor- tation segment.
Risks
External – Development of pipeline infrastructure is de- pendent upon government and aboriginal support, the long-term attractiveness of oil and natural gas prices and economic viability of resource plays.
M&A – We are not concerned
with M&A risk (large-sized transactions) over the short
term given the sheer size of
the sector’s organic growth initiatives.
5-Year: 10-Year: 30-Year:
Market Perform Market Perform Market Perform
Spread View – During Q1/14, the Pipeline sector outperformed from a broad perspective as a result of a 26 bps tightening in long Canada’s given the naturally long duration of the sector. The FTSE TMX Canada Universe Corporate Bond Index nar- rowed by 9 bps (2.95% total return), with the short, mid and long buckets moving in by 9 bps (1.39%), 14 bps (3.85%), and 9 bps (6.06%), respectively. By comparison, Energy – Pipelines narrowed by 6 bps (3.87%) from a broad perspective, moving in by 4 bps (1.34%) in the short bucket, 5 bps (3.69%) in mids, and 7 bps (5.70%) in longs. We are maintaining our Market Perform rating for the sector given the positive market signals for energy infrastructure as a result of commodity price dislocations. Underpinning these development initiatives is an overwhelm- ing demand from producers for flexible energy transportation capacity, as evidenced by the current commercially secured project backlog, which is quickly approaching $100 billion and showing no signs of slowing down in 2014. In addition, we expect continued development with respect to LNG export initiatives in British Columbia and the corresponding pipeline/ processing/power infrastructure required.
Credit Curve – During the year, the Pipeline 2s-5s curve flat- tened by 1 bp to 21 bps, the 5s-10s curve steepened by 1 bp to 36 bps, and the 10s-30s curve flattened by 9 bps to 32 bps. In light of the relative steepness, we see better value in the middle part of the curve.
Sector Value – We highlight the relative value opportunities available in owning the midstream/energy infrastructure issu- ers. 2013 was a pivotal year for the midstream entities in our coverage universe given the significant progress made with respect to de-risking development portfolios and securing com- mercial arrangements for additional infrastructure projects. At the heart of these initiatives is the focus on fee-for-service and cost-of-service cash flows, which bodes well for long-term industry fundamentals.
Recommendation
Top Picks – We believe Enbridge Inc. bonds look inexpensive relative to TransCanada, especially in the belly of the curve. In the midstream space our top pick is Inter Pipeline Ltd. We believe the company warrants a premium valuation relative
Mark Laing, CPA, CA, CFA
Regulatory – The increasing use of negotiated settlements has reduced regulatory risk; however, permitting for large-scale pipelines has become a more arduous process.
Trading Liquidity – We believe the Pipeline sector exhibits aver- age trading liquidity in the Canadian bond market. Enbridge Pipelines, Enbridge Inc. and TransCanada Pipelines provide the greatest liquidity.
New Issuance – During 2014, we estimate Canadian dollar is- suance in the Pipeline sector will be approximately $5.6 billion vs. $2.7 billion of issuance in 2013.
Other – In order to achieve targeted growth rates, Pipeline is- suers must deliver projects on time and on budget. Moreover, they must effectively mitigate cost pressures and continue to plan and solicit customer interest in new oil pipeline and natural gas processing and transmission opportunities.
Credit Profile
Sector Financials – As large-scale projects come on line, the Pipeline sector is on track to improve its key financial metrics, which should remain supportive of credit ratings.
Sector Fundamentals – Demand for pipeline and energy infra- structure continues to reach peak levels, especially for NGL infrastructure and crude oil transportation assets.
Credit Ratings – There were no rating changes in the pipeline sector in Q1/14.
BMO Nesbitt Burns Inc. mark.laing@bmo.com (416) 359-4601