MENU

Transurban Group & Sydney Airport Holdings Pty Ltd: Will rising rates sink these bond proxies?

The U.S Federal Reserve has indicated it will raise interest rates three times in 2018, following three rate hikes in 2017.

Short-term bond yields risen in anticipation of higher interest rates, decreasing the yield premium that some equities offer.

The shrinking yield premium may be a concern for investors in so-called bond proxy stocks; large, well-established companies with reliable earnings protected by high barriers to entry.

The prices of such stocks have been bid up significantly over the past few years as investors seek consistent yield in a low interest rate environment.

However, bond proxies may experience selling pressure now that major overseas economies are improving, and market commentators are also predicting an Australian rate rise later this year.

Infrastructure stocks can be heavily indebted due to the substantial cost of acquiring large assets like toll roads, and this is another factor to consider when rates rise. For example the companies may encounter higher interest expenses and costs to raise additional debt.

Below are two ASX-listed companies that have seen their share prices appreciate strongly over the last three years, but may not do as well in 2018 due to the expectation of higher interest rates.

Transurban Group (ASX: TCL) owns and operates toll roads around Melbourne, Sydney, Brisbane and Washington D.C. The company’s shares have risen 33% since January 2015, though the current price is down almost 9% over the last month.

Transurban uses a large amount of debt to finance its operations, including borrowings of more than $13 billion as of 30 June 2017, equating to a debt to equity ratio of 3.

At its current share price, Transurban has a trailing price to earnings (P/E) ratio of 100 and yields about 4.50%, partially franked.

Sydney Airport Holdings Pty Ltd (ASX: SYD) shares are up 37.5% from three years ago and currently trade on a trailing P/E ratio of 46. The company also relies heavily on debt, with more than $8 billion of interest-bearing liabilities and a debt to equity ratio of 13.

Sydney Airport’s earnings for the six months to 30 June 2017 rose 4.4% compared to the previous corresponding period. While this a good result, it’s difficult to justify the company’s lofty valuation on a P/E basis.

Shares in Sydney Airport are down 8% over the past month and pay an unfranked dividend of around 5%.

Foolish takeaway

Transurban and Sydney Airport are both great businesses with defensive assets that generate large cash flows. It’s precisely these characteristics that have attracted yield-seeking investors, however I believe the shares may be fully priced at current levels.

Even when buying shares in great companies for the long-term, investors must still pay attention to fundamentals to ensure they are paying a fair price for expected returns.

OUR #1 dividend pick to grow your wealth over the new financial year is revealed for FREE here!

Financial year 2018 is here and The Motley Fool's dividend detective Andrew Page has revealed his must buy dividend share to grow your wealth in 2018.

You might not know this market leader's name, but it's rapidly expanding into a highly profitable niche market here in Australia. Even better, the shares boast a strong, fully franked dividend that should balloon in the years to come. In other words, we're looking at the holy grail of incredible long-term growth potential AND income you can watch accruing in your account in real time!

Simply click here to grab your FREE copy of this up-to-the-minute research report on our #1 dividend share recommendation now.

Motley Fool contributor Ian Crane has no financial interest in any company mentioned. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited. The Motley Fool Australia has recommended Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.