Page 2 Viewpoint
Over the past quarter, 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. During Q1/14, the FTSE TMX Canada Universe Corporate Bond Index narrowed 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 overwhelming demand from pro- ducers 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 de- velopment with respect to LNG export initiatives in British Columbia and the corresponding pipeline/processing/power infrastructure required.
While we believe total returns for large Pipeline issuers could be hindered by a heavy issuance calendar in 2014 coupled with a rising interest rate environment, we highlight the relative value opportunities available in owning the midstream/energy infra- structure issuers. 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 commercial arrangements for additional infrastruc- ture 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.
Top Picks: From a relative value perspective, we believe En- bridge Inc. bonds look inexpensive relative to TransCanada, es- pecially in the belly of the curve. In our view, Enbridge remains well positioned to build the pipeline infrastructure required to address ongoing crude oil transportation constraints and price differentials in North America. In addition, we take notice of the ongoing capital program, which will increase investments held at the Enbridge Inc. level.
Enbridge Pipelines is our top fundamental investment recom- mendation among the large Canadian Pipeline issuers due to the combination of strong cash flow generation, solid manage- ment team, and manageable financing needs in 2014.
In the midstream/energy infrastructure space our top pick is Inter Pipeline Ltd. We believe the company warrants a premium valuation relative to Pembina and AltaGas due to its business mix, underpinned by its cost-of-service oil sands transporta- tion segment. For context, Inter Pipeline has recently traded
Fixed Income Quarterly—Pipelines
Chart 1: 10-Year Indicative Pipeline Spreads 600 bps
500 bps 400 bps 300 bps 200 bps 100 bps
Alliance Pipeline Limited Partnership
Enbridge Inc.
Enbridge Pipelines TransCanada Pipelines Westcoast Energy
0 bps
Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13
Source: BMO Capital Markets
as much as 20 bps through Pembina in the middle part of the credit curve vs. 9 bps currently.
Historically, we have recommended investors own other mid- stream/energy infrastructure issuers (AltaGas, Inter Pipeline, Pembina) over Westcoast Energy; however, we take notice of the substantial narrowing of Westcoast’s premium valuation relative to peers. For example, on an indicative basis, Westcoast 10s now trade 3-20 bps through AltaGas, Inter Pipeline and Pembina, compared to 25-45 bps in early 2013.
We recommend holding a Market Weight position in Enbridge Income Fund bonds; however, we highlight the name as a great “higher beta” option amongst the midstream/energy infrastructure issuers. Going forward, we expect the fund to continue to diversify and grow, removing reliance on any particular assets (i.e., Alliance Pipeline). A majority of these growth opportunities will likely come from Enbridge Inc., which remains a majority owner and strong sponsor of the fund. In the event another drop-down transaction is completed in the near term (of similar size to years past), incremental debt issuance will be required. This will likely increase outstanding debt to approximately $2 billion, which should bode well for liquidity.
Key Themes
New Issuance – Enbridge Inc. was the only active domestic pipeline issuer during Q1/14, successfully issuing $1.53 billion of fixed and floating rate notes. Of note, Pembina wasted little time coming to the market in Q2/14 via its $600 million un- secured 30-year offering in early April. For 2014, we estimate the pipeline sector will issue approximately $5.6 billion (Table 2). The companies with the largest undertakings remaining in 2014 include TransCanada Pipelines, Inter Pipeline Ltd. and Enbridge Pipelines Inc. We estimate these entities will issue