Utilities rebound as rates hold steady

Utility and infrastructure stocks tend to lag the broader stock market when interest rates are rising.

That is because these companies have high borrowing needs and as rates rise, the cost of servicing their debt rises. Their dividends also compete with bonds and other fixed-income options, so as rates rise, the dividends become less attractive relatively.

Utility, telecom and Real Estate Investment Trusts (REITS) have rebounded in 2019, along with the broader market, as global central banks have signaled interest rate increases are on hold. Their dividends have become more attractive relative to bonds and worries about rising debt servicing costs have eased.

BCE, Canada’s largest telecom company, (TSX:BCE) is up 11.63% year-to-date and its $3.17 annual dividend is yielding 5.27% at current prices. TransCanada Corp.,  (TSX:TRP), one the largest Canadian pipeline companies, is up 31.96% year-to-date. Its $3 dividend yields 4.66% at current prices.

The S&P/TSX Capped Utilities index made up of 16 power producers stocks is 15.58% higher year to date.

The U.S. Federal Reserve has indicated a flatter path for interest rates that matches its new ‘patient’ policy. That means none or maybe one increase this year. Rates may be cut if the global economy slows down. The European Central Bank has indicated it will not raise rates until mid-2020. In March, it announced a new round of quantitative easing.

Building power plants, generating electricity and building pipelines is expensive and the size and scale of the projects mean the projects take a long time to complete.

Because of this, many utilities are monopolies, or near monopolies. So, revenues are guaranteed and prices paid for the services often include inflation-linked increases. The steady cash flows mean dividends in all conditions and regular increases as cash flow grows.

This means these companies offer stability in turbulent times.

There’s nothing sexy about pipeline or telecom companies.  But they are the economy’s equivalent of plumbing – hidden from sight, but serving a vital purpose that is largely unnoticed until it goes missing.

Investments in this sector are unlikely to yield large short-term gains, but they are the underlying systems we depend on to improve productivity and stimulate growth.  In good times or bad, we all use a phone and need electricity or natural gas to heat our homes.

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