Fixed Income Viewpoint
Infrastructure – April 2014
Sector Rating: Market Perform Relative Value
5-Year: Market Perform 10-Year: Market Perform 30-Year: Market Perform
Spread View – We are maintaining our Market Perform sector recommendation for Infrastructure – Transportation given our expectation for range-bound yields over the near term and our belief that investors will prefer product with greater spread in that environment. So far during 2014, Infrastructure – Trans- portation performed roughly in line with the market on both a spread and total return basis in each of the three maturity buckets for the corporate segment of the FTSE TMX Canada Universe Bond Index, although sector spreads were relatively soft in the Mid and Long buckets.
On a broad basis, however, Infrastructure – Transportation actually outperformed the corporate component of the index by just over a full percentage point during Q1/14, posting a total return of 4.22%. This outperformance was entirely predi- cated upon the relatively longer duration of the Infrastructure – Transportation sector, which was more than sufficient to offset its more meagre performance in each segment of the curve. With modest upward pressure expected to persist on long-dated GoC yields now that the U.S. Fed has commenced tapering, the longer duration of the Infrastructure sector rela- tive to the index will likely serve as somewhat of an albatross, even though we do believe yields will be relatively range-bound over the near term.
From a spread perspective, we expect that a paucity of new issue supply from the sector in the coming years will keep spreads reasonably well behaved. Following a decade of considerable primary market activity from the sector, there are relatively few projects currently under construction that require new financing. In addition, there is little in the way of refinancing requirements for 2014 and into 2015, unless some issuers decide to opportunistically take advantage of the market’s historically low rates. Thus, although sector spreads trade tight on an absolute spread basis to provies, we believe there is room for further compression due to this lack of sup- ply. Also, we believe it is possible spreads for some issuers in the Infrastructure sector may eventually trade on top of, or through, certain provinces.
Credit Curve – Despite relative steepness along the 2s-5s seg- ment, which makes the short part of the Infrastructure curve look more attractive, we believe the long end of the Infra- structure curve is more likely to outperform due to the higher quality it offers versus other sectors in the current uncertain
global environment, as well as demonstrated periodic investor skittishness towards higher beta in that part of the curve. We also believe lack of supply and demand for high quality long-dated product will play a role.
Sector Value – Our preferred
issuer in the Infrastructure
sector remains 407 Inter-
national, or more specific-
ally, 407 bonds issued under
the older covenant struc-
ture. Part of our justification
is predicated upon relative
valuation, wherein GTAA
currently trades three basis
points through 407 across the curve. Historically, this relation- ship has seen GTAA trade well back of 407. While we laud GTAA’s annual traffic performance during 2013, the airport authority’s compressing margins juxtapose starkly to 407. 407 has demonstrated the ability to generate strong and consistent revenue growth, despite a moderate traffic performance, due to annual toll rate increases and the high inelasticity of demand for the highway.
Recommendation
Top Pick – We prefer 407 International in the short and middle parts of the curve as GTAA spreads versus 407 are now at the tighter end of the historical range. In the longer area of the curve, however, we believe a predominance of 407 bonds with the newer covenant structure will weigh on performance, and thus expect GTAA to outperform.
Risks
External – Most issuers in the sector face above-average geo- political risk, as well as the effect of currency risk on trans- border traffic movements and health risks that lead to travel advisories. The impact of rising fuel costs shows commodity price risk.
M&A – We do not expect any ownership structure changes in the near term.
Regulatory – Stricter security at the U.S. border has dampened traffic. Also, most issuers are governed by federal or provincial legislation, which may be modified, but we do not expect chan- ges that would materially alter their rate-setting ability.
Jason Parker, CFA
BMO Nesbitt Burns Inc. jason.parker@bmo.com (416) 359-5410