Is the yield play over? Focus to shift to dividend quality and growth
* We expect the yield theme to change: We differentiate between dividend quality & growth versus bond yield correlation
In response to a changing macro environment (gradually rising bond yields, improving growth), our strategists believe the focus on yield will change, to areas of the market which offer reasonable yield with growth. In this report, we differentiate between utilities which offer sustainable yield and DPS growth vs. those with high bond correlation and low-quality DPS.
* We highlight Buy-rated Gas Nat, IBE, Suez Env and Hera which combine DPS quality/growth and upside to consensus 2016E DPS
We highlight these four stocks which screen well based on yield, dividend growth, FCF cover, balance sheet headroom and upside to consensus DPS forecasts. For all four stocks, we are above consensus at both EPS and DPS. For IBE and Gas Nat, our DPS forecasts also reflect an increase in the DPS payout which we believe will be driven by balance sheet headroom.
* We see risks for bond proxy stocks with low-quality dividends and high EPS sensitivity to rising rates: EDP (Sell) and REN (Neutral)
EDP has had one of the highest correlations with bond yields in the utilities sector. Rising bond yields may increase the focus on EDP’s balance sheet which we believe is stretched relative to management targets. In terms of DPS, we see downside to 2016E consensus and no growth into 2017. EDP is among those stocks with the greatest EPS exposure to rising interest rates longer term. We also highlight REN, where we expect flat DPS (in line with company guidance), reflecting a lack of balance sheet headroom.
* EPS risk from rising rates only marginal on a 2-3 year view, more material longer term: EDP, EDPR, Acciona, EGP, Enel exposed
As the majority of the debt is fixed with a long duration, we estimate the impact of rising rates to be limited on a 2-3 year view. Longer term, the impact is more material, with around one-third of the sector having a gearing of at least 10% on EPS to a 100 bp move across debt. Those with among the greatest exposure are EDPR, Acciona, EDP, EGP and Enel.
* E.ON: We see 100% upside to ‘16E consensus DPS due to demerger
We see the greatest upside to consensus DPS forecasts (90% for 2016E) from E.ON (CL-Buy) where we believe the demerger provides for a DPS reset. Our 2016E forecast for DPS to double to €1 implies a yield of 8%.