National BankConcurrently, Mr. Kenny adjusted his cost of capital assumptions for other Canadian pipeline, utility and energy infrastructure stocks in his coverage universe to align with the revised interest rate forecast from National Bank’s Economics & Strategy Group, noting “economic data continues to swirl above the equity investment landscape, supporting a renewed bias towards further near-term rate hikes to curb sticky inflation. “Despite the GCAN 10-year rate moving up above 4.0 per cent recently, our esteemed colleagues are calling for 100 basis points in rate cuts north of the border through 2024, with the 10- year GCAN rate coming down to 3.65 per cent by Q4/24 and landing at 3.5 per cent by Q3/25,” he said in a note. “As such, we have increased our long-term GCAN 10-year assumption embedded in our cost of capital assumptions across our coverage universe to 3.5 per cent (was 3.0 per cent).”
“Recall, every 50 bps increase to our long-term 10-year GCAN benchmark assumption results in a 10 per cent valuation impact to our Pipeline & Utilities valuations and a 5-per-cent impact across our Midstream & Alberta Power names.”
That led Mr. Kenny to drop his target prices by an average of 8 per cent on Thursday.
“A company’s ability to convert EBITDA into cash on a sustainable basis, which can then be used to fund organic growth prospects (after paying dividends of course), has emerged as a focal point for investors as the current yield curve continues to weigh on valuations — i.e., conceding the end of the ‘free money’ era, and putting the spotlight on a company’s internally funded organic growth outlook,” he said. “That said, with energy infrastructure companies having prioritized the rightsizing of leverage ratios and improving their cash flow quality profiles in recent years, our coverage universe is blessed with robust discretionary free cash flow generation available for funding organic growth.
“We calculate an average internally funded AFFO growth rate over the next five years of 8 per cent, which is on top of the average current dividend yield of 6 per cent, implying an attractive mid-teens total return profile without assuming any multiple expansion/ recovery on the valuation front. When comparing 2024 EV/EBITDA valuation metrics versus our five-year implied internally funded AFFO growth rates, we highlight Outperform-rated SES, CPX, TA, SPB, GEI and ALA as representing the most attractive investment opportunities for value-based investors.”
His changes are:
- AltaGas Ltd. ( “outperform”) to $31 from $33. Average: $31.86.