CA - Can The Canadian Utilities Sector Continue To Power Ahead Of The Broader Market?

2023-05-31 20:34:00 ET

Summary

• Why Canadian utilities stocks are outperforming the TSX.
• Potential market tailwinds that could support utility stocks.
• The potential impact of inflation on utility stocks.

The Canadian utility sector has outperformed the S&P/TSX Composite so far this year. Marisa Jones, Utilities Credit Analyst at TD Asset Management, tells Greg Bonnell why she believes certain market tailwinds could help to keep that momentum going in coming quarters.

Transcript

Greg Bonnell: While the market leadership we've seen from the big tech firms out of the US has been hogging the spotlight, Canadian utilities have been quietly outperforming on this side of the border. Joining us now to discuss, Marisa Jones, utility credit analyst at TD Asset Management. Marisa, great to have you back on the program.

Marisa Jones: Thanks for having me here. Thank you.

Greg Bonnell: So it was interesting when you brought this up when we were having a chat yesterday, but what do you want to chat on the show -- I was taking a look at the utilities, and indeed they have outperformed the TSX Composite index. What's happening in this space?

Marisa Jones: Well, there's a number of things. If you look back at the first quarter, the utility sector here in Canada was a bit of a laggard in Q4 last year, so coming into this quarter, there was a bit of a trade looking for safety, security, which, of course, the utilities offer.

And secondly, I would say that there were a number of utilities that outperformed in the quarter that had been the ones that had been lagging in Q4 due to specific situations.

Greg Bonnell: OK, so that was what was behind this. Of course, what investors are also concerned about is what do we have in front of us, what do we have ahead of us? How is utility shaping up for the rest of the year?

Marisa Jones: Sure thing. I think that the utilities are well positioned to continue performing strongly, so what we have -- our outlook for inflation continues to be a headwind for most of the companies in Canada, in North America, generally speaking, but the utilities offer a real return.

So, what I mean by that is that inflation rates are passed through the cost of capital and the expenses for the utilities onto the ultimate ratepayer, so it offers a bit of a protection for the investor against any inflation headwinds, which we continue to expect.

Furthermore, I think there's a lot of medium- to longer-term tailwinds behind the sector, and we can touch on that if you wanted, namely policy support and regulation that is supportive of greening the grid of increasing electricity demand and support of the system here in Canada.

Greg Bonnell: Now the Canadian federal budget, this seems like ancient history, although only several weeks ago. At the same time, though, the measures in there, obviously, can have effects on various industries going forward. So as the media spotlight goes away from the Federal budget, you're still seeing things in there that relate to the utility space. What are they?

Marisa Jones: Well, it was very interesting because I saw the Canadian federal budget as a response to what we saw last summer in the US. That was the Inflation Reduction Act. So, in the IRA in the US, there was a lot -- of course, they tried to deal with inflation and with jobs, but there is a lot in that bill in the US supporting renewables and clean generation and building on home territory, so bringing the supply chain back to the US.

So in Canada, to keep up with that, the Canadian federal budget also included different tax measures, tax credits for manufacturing of clean energy. So the whole supply chain for clean energy will be able to receive tax credits going forward. So that is supportive.

There's also different support mechanisms for investments in terms of building renewables, a lot of tax support there. It's the whole energy supply, so it's more so the power generation than I would say the regulated utility side. So not as much for distribution and transmission.

But of course, if you have a build out in support of the power generation side, the regulated utilities that I largely cover.

Greg Bonnell: You have to generate the power, then you have to find out--

Marisa Jones: You have to --

Greg Bonnell: You got to get it to the people. Get it ahead of --

Marisa Jones: Distribute it, yeah, so it's very supportive, I think.

Greg Bonnell: I wanted to talk to you about the inflation thing because last time we were on, we talked about this. You mentioned it briefly, and of course, you talked about the ability of these regulated utilities to pass through those inflationary pressures, and in the end, we bear them as users of those utilities. Is there political risk in that in times when the government will say, well, we want to ease your pain from these higher costs, and then people will say, well, what about my energy bill?

Marisa Jones: A very good point, and that's something we've been watching very carefully. So there is the balance between the capital investment needed for the utilities on many fronts, the inflation impact on the cost side, and then the balance between affordability, so customers.

So the regulated utilities have a responsibility to serve the territory that it's based in. That's its obligation, and for that on the regulated side, they're expected to get a fair rate of return. That's how the utility space works here in Canada and globally.

So when you have inflation rising, there is that fear that, yes, they're allowed to capture that and pass it through to the end ratepayer, but if they can't afford that, there's a lot of risk of political interference.

Largely what we've seen in North America is that the government has said in different jurisdictions, we recognize this is an issue, so the government in different -- we've seen in some of the states, that they've actually stepped in and started giving relief programs to customers that can't afford these rising costs on their bills.

I do watch to see if there is political interference. Typically, there's none that will actually impact the regulated utilities, but we did see one instance in Nova Scotia in the fall, and this resulted in some -- you would see the stock price declined, the rating agencies took punitive actions against Nova Scotia Power ( EMRAF ).

It was more that the dollar impact to the utility was not that significant in the end, but the fact that the political interference was there was deemed a risk and a negative.

Greg Bonnell: I imagine a lot of our viewers are going to be looking at the utilities space today as we talk about it from an equity perspective. Of course, you're a credit analyst. Are sort of equity investors and someone like you looking at credit, sort of looking for the same things out of a company? I think when you start doing your homework and digging into the balance sheet, are you sort of looking for the same things?

Marisa Jones: Very much so, and I'd say specifically now as you're mentioning, the costs are rising. We're watching the impact on cash flows. And for utility spaces in particular, and to some extent the pipelines midstream companies as well, the impact on the ability to pay a dividend could be affected if the credit ratings are at risk of being downgraded. The ability to grow could be impacted as well. So I'm, from a credit perspective, cautious of the risk to the downside, but right now, I think our interests are very much aligned with how equity investors are looking at the companies too.

Original Post

For further details see: