By Paul Rickard

One of the key investment themes over the last couple of months has been investors switching out of interest rate sensitive stocks. This has come as global markets have started to factor in a rise in US interest rates, as evidenced by rising bond yields, a stronger US dollar, and weaker gold price.

In Australia, comments from the new RBA Governor Philip Lowe that “inflation remains quite low ... and is expected to remain the case for some time”, supported by remarks from Treasurer Scott Morrison, have led some economists to conclude that the RBA cash rate at 1.5% may be as low as it goes. The interest rate cycle is bottoming.

On the markets, stocks that have done really well from lower interest rates have been sold off - in particular, the so-called ‘expensive defensives’.

These stocks, which essentially have annuity style revenue streams, have been massive winners from falling interest rates due to yield compression as investors sought relatively secure returns and at the same time, struggled to find stocks that can grow their revenue.

But all this has changed.

Following a loss of 5.2% in August, the utilities sector of the S&P/ASX 200 lost 3.3% in September. So far this month, it is down by 3.7%, with its year-to-date return of 5.24% now below that of the broader market’s 7.05%. Real estate, which is mainly the listed property trusts, slipped 4.0% in September and is down by 3.7% in October. Year-to-date gains have been trimmed to 8.84%.

So, are the ‘expensive defensives’ now moving into buy territory? We will try to answer this question by reviewing the prospects of 3 popular stocks - Transurban, Sydney Airport and Scentre.

Transurban (TCL)

Toll road operator Transurban has enjoyed a stellar run over the last few years. One of the strongest performing stocks across the entire ASX, it peaked on 1 August at $12.67 and has now pulled back to $10.62, a fall from the high of 16.2%.

Transurban has guided to a distribution of 50.5c per unit in FY17, up by 11% from the 45.5c it paid in FY16. For FY18, the brokers forecast a distribution increase again of about 10% to 55.7c per unit. This puts Transurban on a prospective yield of 4.8% for FY17 and 5.2% for FY18. Transurban distributions are partly franked at around 15.0%.

According to FNArena, the brokers see upside in Transurban. The consensus target price of $12.24 is 15.3% higher than the current price. There are four buys and three neutrals, with most brokers citing a strong growth profile. Gearing is down to just over 33%.

Macquarie recently noted that Transurban “offered a compelling valuation, with the yield of 4.6% (now 4.8%) sitting 2.5% above the Government bond rate (still a margin of 2.5%)”.

Sydney Airport (SYD)

Sydney Airport peaked at $7.62 on 1 August and has fallen back to $6.48, a drop of 15.0%. 

Passenger numbers continue to grow, with 27.4m passengers moving through the airport during the first eight months of the year, up 6.3% on the comparable period in 2015. International arrivals and departures are up by 9.5%, with Chinese nationals now ranking as the second biggest group. Year to date, visits from Chinese nationals are up by 18.8%.

Sydney Airport has forecast a total distribution of 31c for FY16, up 21.5% on its 2015 distribution (it balances on 31 December). The brokers forecast that this will grow to 33.4c in FY17, a growth rate of 7.7%. This puts Sydney Airport on a forecast distribution yield of 4.8% for FY16, and 5.2% for FY17. Distributions are unfranked.

The brokers are, in the main, positive about Sydney Airport, with four buys, two neutrals and one sell. Credit Suisse has a sell, saying that Sydney Airport may be challenged to maintain double digit distribution growth, and feels that there is better value in Transurban.

The consensus target price is $7.37, a 13.7% premium to the last trading price. 

Scentre Group

Scentre Group (formerly Westfield Retail Trust and the Australian development operations of Westfield Group) is Australia’s largest listed real estate company. With 40 shopping centres in Australia and New Zealand, it has assets under management of $43.3bn, including 16 of the top 25 shopping centres in Australia by annual sales. Scentre’s share price peaked at $5.42 on 29 July, and has since fallen to $4.51, a drop of 16.8%. 

Scentre also balances on 31 December and has guided to a total distribution of 21.3c for FY16, up 2% on FY15. For FY17, the brokers forecast a distribution of 22.0c. This puts Scentre on a forecast distribution yield of 4.7% for FY16 and 4.9% for FY17. Distributions are unfranked.

The brokers are somewhat negative on Scentre. According to FNArena, there is one buy, two neutrals and three sells. The consensus target price is $4.68, a 3.7% premium to yesterday’s closing price.

Scentre Group is geared at 33%. As at 30 June, net tangible asset backing per share was $3.44 per security, which means that Scentre is currently trading at a 31% premium to its NTA.

Bottom Line

The direction of bond rates will ultimately have a big impact on these stocks, and if they rise rapidly, all will be under pressure. Of the three, I think you can rule out Scentre Group (in fact, I think the whole property trust sector is unattractive), so far too early to even consider for 'the buy zone'.

There is value in Transurban and Sydney.

Both of these stocks have demonstrated an ability to grow revenue (and distributions), and while the distribution yields are only marginally attractive, they are also very secure. With events still to unfold in the US with the election and the timing of the Fed’s move to raise interest rates, my guess is that time is on your side. Momentum swings tend to go on longer than expected, so you can afford to be a little choosy. But, worth putting on the buy list.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.