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3 yield plays with enduring appeal

Glenn Freeman  |  07 Apr 2020Text size  Decrease  Increase  |  
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The solid credit ratings and lower risk of utility and listed property stocks AGL Energy, Spark Infrastructure, Ausnet and BWP Trust makes them particularly appealing now, says Morningstar.

"They're trading at share prices that are between 10 per cent and 20 per cent below our fair value. They're not going to make a huge profit…but it's certainly a lot safer than trying to catch some of the falling knives out there," says Morningstar senior equity analyst Adrian Atkins.

He says some so-called defensive stocks will see their revenues "smashed" because of the coronavirus lockdown - a risk that was on no-one’s threat radar before January.

"If the coronavirus lockdown goes on for three months then it's no big deal, but if it goes on for nine months, then I question whether some of them can meet their covenants," Atkins says.

Covenants are limits for certain credit metrics banks set on companies before extending loans to them.

Among utilities companies, Atkins says share prices are already down 40 per cent in some cases, but they might still have further to fall.

Origin is at greatest risk among utilities researched by Morningstar Australia, because of its large LNG export business. These prices are closely linked with oil prices, with Brent crude prices down about 50 per cent since January.

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But the following are his safest picks from the stocks he covers:

AGL Energy (ASX: AGL)

Economic Moat: Narrow | Morningstar Rating: 4-star

AGL is an Australian retailer of electricity, gas, solar and renewable energy services to homes and businesses. Atkins says AGL's earnings remain safe during the coronavirus lockdown, because it has more exposure to consumers than manufacturing. 

"AGL has a bit of volatility in its earnings, because if manufacturing shuts down then that's going to mean less electricity demand," Atkins says.

"But most of the company's money is made from households."

Atkins also highlights the company's healthy balance sheet, with a very low net debt-to-earnings before interest, tax, depreciation and amortisation ratio of about 1.7 times.

"Earnings are defensive, cash flows relatively strong and financial leverage is conservative. Mostly franked dividends are comfortably covered by operating cash flow."

The power retailer's cash holdings were also helped when it walked away from a potential $3 billion acquisition of telecommunications company Vocus in June.

yield plays

Spark Infrastructure (ASX: SKI)

Economic Moat: None | Morningstar Rating: 4-star

Spark and Ausnet both share similar characteristics in both being regulated utilities, which means government body the Australian Energy Regulator sets the margin they are allowed to earn.

Spark is an electricity distribution company, owning 49 per cent of three networks: CitiPower and Powercor in Victoria and SA Power Networks in South Australia. It also owns 15 per cent of electricity transmission network TransGrid.

It has higher debt on its books than AGL, with a net debt-to-EBITDA score of 6.3 expected for FY2020, but its earnings are regarded as defensive – reflected in its A-minus rating from the major credit agencies.

And its earnings don't face a major hit during the coronavirus shutdown, because it is a regulated utility.

"Every five years there's a regulatory reset - but that's a 'known known'. We know they are going to get lower revenue over the next two or three years, but that's nothing to do with coronavirus," Atkins says.

Spark's profits are next due to be reviewed by the Australian Energy Market Operator in the middle of 2021.

Atkins says that lower power consumption since mid-February this year matters for AGL, but not Spark and Ausnet because of the government control of their revenue. It's also why the return on equity isn't huge, but it's stable.

"The regulator says' you don’t' have any risk that's why you deserve a 5 per cent return on equity. And in this environment, that's probably not too bad," he says.

Atkins expects regulatory changes to hit profits over the shorter term, as the tariffs electricity companies are allowed to charge are reviewed every five years by the Australian Energy Market Operator.

"SAPN is the first to suffer new, lower regulated returns from mid-2020, followed by VPN in January 2021. TransGrid's returns are locked in for another 3.5 years," he says.

Atkins expects weaker dividend growth for a few years from 2021, but is more upbeat over the longer term as bond yields improve.

This is important because the government tariff adjustments are linked directly to the 10-year bond yield, which hit record lows in mid-2019.

Ausnet (ASX: AST)

Economic Moat: None | Morningstar Rating: 3-star

AusNet owns three electricity and gas networks in Victoria - two electricity grid networks and a gas distribution network.

The utility delivers a solid dividend yield of around 6 per cent, buoyed by a solid stream of regulated revenue, says Atkins.

"But there could be a risk to dividends from 2022 following the next regulatory reset," Atkins says.

It also relies heavily on debt funding – with a net debt-to-EBITDA of 7.1 forecast for FY2020 – and the recent turbulence in global credit markets raises risk.

"But the firm is in good financial health, with a solid balance sheet and two strong large shareholders in Singapore Power and State Grid of China, who are likely to offer financial support if conditions deteriorate."

BWP Trust (ASX: BWP)

Economic Moat: Narrow | Morningstar Rating: 3-star

Listed property companies are also favoured as defensive stocks because the bulk of their earnings come from long-term commercial rents.

Real estate investment trust BWP Trust (ASX: BWP) holds a portfolio of 75 properties, and 66 of these are Bunnings businesses.

Atkins downgraded his fair value estimate for BWP by 3 per cent to $3.60 after taking over research on the company. But the company's narrow moat rating and medium fair value uncertainty rating are unchanged.

"There's a lot to like about BWP in the current uncertain climate, including a strong key tenant in Bunnings Warehouse, which contributes 90 per cent of rental income, and low gearing of 18 per cent," he says.

It has a forecast net-debt to EBITDA ratio of 2.6 for FY2020.


is senior editor for Morningstar Australia

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