What happened
Shares of NextEra Energy Partners(NYSE: NEP), Tellurian(NYSE: TEL), and Medical Properties Trust(NYSE: MPW) sank today, falling 7%, 9.5%, and 4.1%, respectively, in today's trading.
NextEra Partners is a renewable energy yieldco, Tellurian is attempting to build a giant liquid natural gas export facility, and Medical Properties Trust is a real estate investment trust that owns hospitals globally.
At first, these three stocks don't seem to have all that much in common. But what they do have in common is an extreme sensitivity to interest rates, as each depends on a low cost of capital for their business models to work.
Unfortunately, that cost of capital was moving higher today, reversing the easing seen over the past few days.
So what
Today saw a rise in long-term U.S. Treasury Bond yields, reversing the last few days of declines following the big run-up in yields seen over the past six months or so.
Investors might think that the rise in yields had to do with this morning's inflation report, but that report actually was fairly tame, neither much hotter nor cooler than expected, depending on which elements one wanted to focus on.
Rather, yields surged and stocks plummeted around mid-day, likely due to the results of a Treasury Bond auction released today around that time. When those results were released, there appeared to be tepid demand for the newly issued bonds. This is in spite of long-term bond yields recently reaching 17-year highs.
It appears demand is still low for long-term U.S. Treasury bonds, and this can be for a number of reasons. The Federal Reserve is no longer buying bonds amid its quantitative tightening, and large banks are also retreating from the market, as they are dealing with duration risk problems stemming from the rapid rise in yields over the last 18 months. But whatever the case, long-term bonds are now much higher than a mere few months ago.
Since all corporate debt is typically priced off of U.S. Treasuries, that raises the cost of capital for all companies. And that's not good news if your entire business model depends on raising reasonably priced capital.
Image source: Getty Images.
NextEra is a captive yieldco set up to buy renewable power projects from NextEra Energy(NYSE: NEE) and others, with the goal of paying out a rising dividend. But since most of its profits go to shareholder payouts, it has to continue issuing equity and debt to fund new acquisitions. Now that the cost of capital has gone up, however, its share price has plunged, leaving it too low to issue new stock to fund purchases. So, its business model is "stuck," currently.
Meanwhile, Tellurian has a severe need of funds, as it's attempting to build out its massive Driftwood LNG export terminal in Louisiana. The big problem here is that Tellurian began construction before it had all of its funding lined up, and just before interest rates began their climb over the past two years. And the project is projected to cost $14.5 billion, all-in.
Unfortunately, when yields go up, so does the cost of equity, so Tellurian may have to raise equity at a lower price than it otherwise would have, potentially limiting the returns on the project, which management still forecasts will be in operation by 2027. Rising long-term yields also lower the value of future earnings, the further out they are. So, the fact that profits won't even start coming in until after 2027 also lowers the value of those future cash flows to would-be investors.
Finally, Medical Properties Trust has had a series of escalating problems, largely stemming from the rising cost of capital. In order to protect its balance sheet, Medical Properties recently decided to sell some of its owned properties in Australia to pay down its debt, and those sales just closed yesterday. That unfortunately also required cutting its dividend to unitholders in the process.
Now what
Dividend stocks can be very tempting for investors seeking a consistent payout. But investors should also take care to really investigate what's behind the "output" of dividend yields to see if they are sustainable. As we're seeing with dividend-paying NEP and MPW, a quick change in bond yields can disrupt their entire business models, leading to payout cuts, or a lower price on fears of potential cuts.
And investors should also be careful of investing in any stock that is still dependent on outside capital, such as Tellurian. One never knows what the capital markets will do, so if that near-term funding element is out of a company's control, it may be best to stay away from it, no matter how interesting the company's future looks.
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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends NextEra Energy. The Motley Fool has a disclosure policy.
