In This Week’s JMRD Market Observer
- The JMRD Market Observer Turns Eight Years Old
- Independent Power Producers: Costs are declining, capital is flowing and our IPPs remain attractive. What’s not to like?
- Fed Policy Monitor – Fed says case for rate hike has strengthened
- FNB Capital Asset Management – Under the Microscope
- Terry Fox Run
- JMRD Basket Corner
- Retirement Corner
- Reads of the Week
- Economic Calendar
- Earnings Report
The JMRD Market Observer Turns Eight Years Old
It only seems like yesterday but this week marks the 8th anniversary of the first edition of the weekly JMRD Market Observer. We’ve come a long way since the early days and a lot of the additions and improvements are the result of feedback we have received from many of you. We try to provide a little something for everybody each week and we hope we have lived up to this goal. As always, we encourage you to continue sending feedback and look forward to another eight years (and more) of keeping you informed.
Power Producers: Costs are declining, capital is flowing and our IPPs remain attractive. What’s not to like?
Northland Power and Innergex Renewable are owned in JMRD’s baskets.
Renewable power costs continue to trend lower
Last week, Vattenfall (Swedish utility) was awarded two offshore wind contracts in the North Sea at €60/MWh, 17% lower than the previous record for the Borssele I and II projects set by DONG Energy in July. This week, a bid for solar in Abu Dhabi came in at 2.42¢/kWh, breaking the record of 2.91¢/kWh set in August. The bid was submitted by a consortium of JinkoSolar (Chinese manufacturer) and Marubeni (Japanese developer). Lower costs are being driven by technology, but also by lower cost of capital and more competition. Lower costs could also increase the size of the opportunity for renewables.
Capital from private markets continues to stream into infrastructure
With low interest rates, Canadians groups like CPP, CDP, BCIMC and others are leading the way with private capital investments into infrastructure. Earlier this week, a consortium, including OMERS, won a 50-year lease for Australia’s busiest container port for US$7.3 bln. Recently, a Brookfield-led consortium acquired a 90% stake in the natural gas pipeline network of Petrobras for US$5.2 bln. In July, Brookfield Asset Management (BAM) raised US$14 bln for its third infrastructure fund. Capital flows into infrastructure increase competition for assets and could push IPPs towards finding partners. We believe that NPI is in the process of exploring options like this.
IPP valuations attractive relative to private markets and utilities
Valuations of the IPPs in our sector are attractive on implied equity discount rates, compared with private markets and larger utilities which can trade at below 6%. Our IPP sector is currently trading in a range of 5.8-8.4% on contracted cash flows or 6.9-9.2% when growth is included. Yield spreads stand at about 4% to the Canada 10-year, versus a long-term average of about 3%. We believe that developers that can find excess returns for growth initiatives should receive premium valuations. Our highest total return estimates are for INE, BLX and AXY, but most remain attractive. (Full report attached) IPP
Fed Policy Monitor – Fed says case for rate hike has strengthened
As widely expected, the Federal Reserve left monetary policy unchanged at its September meeting. The fed funds rate remains between 0.25% (lower bound) and 0.50% (upper bound). The Fed was encouraged by continued strengthening of the labour market and a pick-up in economic activity after a difficult first half. However, inflation remains low and investment is soft. Near-term risks to the economic outlook “appear roughly balanced”. The FOMC said the case for an increase in the federal funds rate has strengthened but it decided, for the time being, to wait for further evidence of continued progress toward its objectives. The ranks of dissenters grew in September as Esther George was joined by Loretta Mester (another hawk) and Eric Rosengren (a one-time dove). All those folks wanted a rate hike to 0.50-0.75%.
Fed’s new projections: The central tendency forecast for GDP growth (Q4/Q4) was lowered to 1.7 to 1.9% for 2016 (versus 1.9 to 2.0% previously), and left unchanged for 2017 and 2018. The central tendency projections for the unemployment rate were raise slightly for this year to 4.7-4.9% and left roughly unchanged for 2017 and 2018. PCE core inflation forecasts were left largely unchanged. For the first time, the Fed presented 2019 forecasts which put Q4/Q4 GDP growth at 1.7-2.0%, the unemployment rate at 4.4-4.8% (i.e. similar to 2018) and the PCE core inflation at 1.9-2.0% (i.e. also similar to 2018).
The dot plots show how participants feel about the pace of policy firming going forward. Participants now expect only one rate hike this year according to median forecasts. The long-run level of the nominal fed funds rate has been lowered again to 2.50-3.75% (from 2.75-3.75% last June). Back in June, seven FOMC participants expected the long-run or neutral rate to be above 3%. That view is now held by only two participants, i.e. the large majority of FOMC participants (fourteen to be exact) see rates between 2.5 and 3% in the long run. That range is expected by most to be reached by 2019.
Press conference: Fed Chair Yellen reiterated in the press conference that every meeting is “live” and she expects rates to go up before year-end. The FOMC is generally pleased with how the U.S. economy is doing because there is evidence of stronger expansion. The labour market is also stronger and attracting more people from outside the labour force. But the Fed decided to wait for more evidence of progress. There are no apparent pressures on utilization, meaning the economy has room to grow without overheating. She said inflation remains below target but the Fed expects it to return to 2% in the next two to three years. Projections show the continuation of soft GDP growth in part due to productivity growth which is expected to remain low. While she acknowledged risks of waiting too long to normalize policy, she thought there was little risk of the Fed falling behind the curve. As such, she was confident the Fed would be able to raise rates only gradually. While acknowledging risks of asset bubbles, the Fed didn’t seem concerned at this point. The Chair said that asset valuations are not out of line with historical norms.
Bottom line: The Fed said the case for a rate increase has strengthened but it nonetheless decided to err on the side of caution and wait “for the time being”. While the labour market is strong, the Fed thinks more progress can be achieved as to allow wage growth to pick up and give itself a better chance of eventually hitting its 2% inflation target. Median forecasts of FOMC participants show just one rate hike slated for this year, two hikes in 2017 and three hikes in 2018 and another three in 2019. We continue to expect this year’s sole rate increase to be in December rather than at November’s meeting which is just a few days before the elections. The drop in the long-run neutral rate should not be surprising considering the decline in the economy’s potential. That just means Fed rate hikes will be very gradual, with rates peaking at a very low level. (Full report attached)
FNB Capital Asset Management – Under the Microscope
FNB Capital, based in Montreal, is the firm that manages the Multiple Asset Class (MAC) Basket, a Basket that the JMRD team has used in clients’ accounts for many years and one that we have highlighted in past Market Observers. Michel Falk and Ralph Hartmann are the two principals who oversee this Basket, which is an actively managed portfolio of Exchange Traded Funds (ETFs). In fact, the acronym “FNB” stands for ETF, but in French – Fonds Negocier en Bourse. We have attached what we think is some very interesting commentary on their views about volatility and risk, similar views to which The JMRD Team subscribes. (Full report attached). FNB Capital
Terry Fox Run
JMRD Team member, Paul and his family, participated again in their local Terry Fox run last Sunday. Paul’s family organized this run for many years and are happy to see it continue on. Paul tried a new challenge and did 20 km but was heard this week in the office saying “never again” as he limped down the hall.
JMRD Basket Corner
Brookfield Asset Management (BAM.a) – Brazil’s state-run oil company Petroleo Brasileiro SA agreed to sell 90 percent of its natural gas pipeline unit for $5.2 billion to a group of investors led by Canada’s Brookfield Asset Management Inc, the companies said on Friday. The Brookfield-led group agreed to pay $4.34 billion upon closing the deal and the remaining $850 million in five years, they said. The consortium includes sovereign wealth funds CIC Capital Corp of China and GIC Private Ltd. of Singapore.
WSP Global (WSP) – WSP investor day: Outlook unchanged; with infrastructure spending on the horizon, directional outlook looks good: we have published an in-depth report (link here) detailing the significant increase in infra spending not just in Canada but also likely in the US and the UK. WSP hosted its investor day today and the 3 geographies (Canada / US / UK) represent 60% of company’s topline; with Nordics’ outlook remaining robust (Sweden/Norway/Denmark – all-in 12% of employee base), the directional outlook remains positive for the company. We do expect the organic growth momentum to be in 1.5% range in 2016E but the rate of growth should pick up over the coming 2 years buttressed by less negative growth in Canada (due to oil & gas; specifically WSP is looking for flat organic growth in Canada in 2017E) and smaller negative Middle East contribution. Importantly, Australia is also seeing an infrastructure upturn. This geography is critical in making the PB transaction a home run as at the time of the acquisition the EBITDA drag amounted to slightly negative (while at the peak in 2011 it was POSITIVE US$47.5mln); now AUS is in a positive territory, showing improved execution (due to management change around 15 months ago and better market backdrop predominantly driven by infrastructure projects). (Full report attached) WSP
All-Cap Growth Basket
Constellation Software (CSU) – Constellation previously had made a cash offer of £1.05 per ordinary share for Bond not already owned by it or by persons acting in concert with it. Constellation has made a revised cash offer, through a wholly owned subsidiary, for Bond that the CSI Group does not currently own, at a price of £1.15.5 per ordinary share. The Revised Offer values the existing ordinary share capital of Bond at approximately £48.7 million. Bond is an international software company based in the U.K.
Uni-Select (UNS) – Henry Buckley, President and CEO of Uni-Select, discusses the outlook of the automotive aftermarket industry and how his company plans to stay ahead of the competition. (Part 1) (Part 2)
U.S. Growth Basket
Facebook (FB) – Big ad buyers and marketers are upset with Facebook Inc. after learning the tech giant vastly overestimated average viewing time for video ads on its platform for two years, according to people familiar with the situation. Several weeks ago, Facebook disclosed in a post on its “Advertiser Help Center” that its metric for the average time users spent watching videos was artificially inflated because it was only factoring in video views of more than three seconds. The company said it was introducing a new metric to fix the problem. Some ad agency executives who were also informed by Facebook about the change started digging deeper, prompting Facebook to give them a more detailed account, one of the people familiar with the situation said. Ad buying agency Publicis Media was told by Facebook that the earlier counting method likely overestimated average time spent watching videos by between 60% and 80%, according to a late August letter Publicis Media sent to clients that was reviewed by The Wall Street Journal
Reads of the Week
- “National becomes first bank in North America to win approval to issue yuan bonds in China” (Financial Post)
- “National Bank of Canada joins the ranks of zero coupon issuers, raises €750 million” (Financial Post)
Monday September 26th – None
Tuesday September 27th – Critical Outcome Technologies, Nike
Wednesday September 28th – Blackberry
Thursday September 29th – PepsiCo, Uranium Participation Corp.
Friday September 30th – None
Monday September 26th – US New Home Sales
Tuesday September 27th – US Consumer Confidence Index, US Case-Shiller Home Price Index
Wednesday September 28th – US Durable Goods Orders
Thursday September 29th – US Initial Jobless Claims, US GDP, US Pending Home Sales
Friday September 30th – Canada Industrial Production and GDP; US Chicago ISM Index
Have a good weekend!