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If they didn’t realize it before, investors around the globe have quickly found that collapsing oil prices negatively impact sectors beyond energy, and far of this pain is being felt within the infrastructure, equipment and services spaces.
These segments from the market benefited immensely from surging development in unconventional resources plays such as the Alberta Montney and Texas Eagle Ford, as well as relatively easy access to cheap capital in recent years.
Investors piled in because of the attractive yields and consistent dividend hikes many of these stocks offered. Of course, things have changed.
“The collapse of commodity prices has established numerous stresses on producers and infrastructure companies,” Paul Lechem, an analyst at CIBC World Markets, told clients.
He noted the most vulnerable companies are individuals with high levels of direct commodity exposure, high dividend payout ratios, and limited free cash to finance growth internally.
“The dividend growth story for many from the energy infrastructure companies is increasingly in doubt,” Lechem warned.
Kinder Morgan Inc.’s 75 per cent dividend cut, which allowed it to narrowly avoid a credit rating downgrade, is one prime example of the sector’s woes.
Williams Cos. Inc. wasn’t in a position to escape that fate, as its high leverage and other challenges saw it downgraded to non-investment grade.
Times truly are tough for Canadian players, but Lechem believes the prospects are superior to for their U.S. counterparts. That’s in large part because of their lower dividend payout ratios, strong counterparties, lower direct commodity exposure and stronger credit ratings.
In terms of commodity exposure, the analyst noted that Canada’s regulated utilities for example Algonquin Power & Utilities Corp., Emera Inc., Fortis Inc. and Hydro One Inc. fall at the low end of the risk spectrum.
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Pipeline companies like Enbridge Inc., Inter Pipeline Ltd., Spectra Energy Corp. and TransCanada Corp. are considered more dangerous, with power companies such as Capital Power Corp., Northland Power Inc., TransAlta Renewables Inc. and TransAlta Corp. weighing the higher end from the risk scale.
Capex reductions within the oil sector paint a good picture of methods depressed activity is really.
J.P. Morgan’s survey of actual spending plans points to a 23 percent year-over-year decline for exploration and production companies globally in 2016.
This follows a 21 per cent pullback in 2015, implying 2016 will see a roughly 60 per cent decline in the peak in 2014.
Independent U.S. E&Ps are leading the way in terms of cuts, coming in at 53 percent year-over-year, but they’ve managed to reduce oil production by only nine percent.
The Middle East and North Africa region is set to make the smallest capex cuts at about 10 per cent in 2016, while reductions in Canada are expected to be about 30 per cent.
“A halving of U.S. independent capex budget cuts in 2016 represents an unwinding of over ten years of spending growth to levels last observed in 2003,” J.P. Morgan analyst Sean Meakim said in a research note. “Meanwhile, E&P requires another round of capital efficiency imply not only more pain in 2016, but greater risk towards the timing and degree of an eventual recovery in activity.”
While Meakim recommended that investors use rallies to lower their positions, he did highlight some areas of relative safety, where value can be found for investors.
The analyst suggested leaning towards high quality and large companies, with Schlumberger Ltd. and Halliburton Co. top picks among large caps due to their strong execution and balance sheets, and fairly sustainable free cash flow profiles – a rarity in the energy space today.
Among small , mid caps, the analyst likes MRC Global Inc., Nabors Industries Ltd., Superior Energy Services Inc. and Tetra Technologies Inc.
