Solid business results and economic stimulus packages are creating exciting opportunities in infrastructure
While private equity and bond investors have had a clear understanding of infrastructure as an asset class for some years now, infrastructure is still a relatively new topic for equity investors. The relatively stable business results of many infrastructure firms and the extensive packages of economic stimuli, totalling more than $1,700bn to date around the world, should encourage investors to remain on the lookout for suitable investment ideas within this sector.
With regard to the general definition of the infrastructure universe from an equity investor’s perspective, we believe it makes good sense to focus on owners and operators of essential infrastructure facilities. These are companies that provide indispensable services such as electricity, water supply and waste disposal as well as oil and gas pipelines, railways, shipping ports, airports and toll roads.
The key premise here is the business performance of such infrastructure firms tends to be driven by monopoly-like market positions, income streams secured over the long term by regulatory or contractual means, partial protection against inflation and largely inelastic demand due to the nature of the services in question. These fundamental advantages of infrastructure firms remain intact even when times are hard for the economy as a whole.
A good example is the Italian company Atlantia. It controls around 60% of Italy’s toll motorway network – over 3,500km of roads and four million users per day. The company has a conservative balance sheet with a defensive road portfolio that is relatively insensitive to economic growth. Atlantia was heavily oversold in 2008 because of concerns about the impact on traffic of a higher oil price and a weaker economy. However, concerns proved to be unfounded, with the slowdown being only marginal and short term. Traffic fell by only approximately 2.4% during H1 2009, and was up year on year in Q3 2009.
Another example, this time of a more economically sensitive company, is Hamburger Hafen und Logistik (HHFA), a German port and logistics operator based in the port of Hamburg. It has a competitive advantage based on its location and a strong strategic position, with efficient container terminals and high-performance transport systems. Since the container traffic growth is more leveraged to economic conditions, HHFA was sold heavily on expectations that world trade would suffer as the economic outlook deteriorated. Container volumes have fallen sharply, but in our opinion they will recover. HHFA is now seeing the first signs of volume stabilisation (albeit at low levels) post the downturn. The share price is recovering as the market unwinds its extremely bearish outlook and moves to focus on fundamentals and the shares’ attractive valuation.
Aeroports de Paris (ADP) is the second-largest airport group in Europe, and another more economically sensitive company. ADP has characteristics we like: a strong strategic position and it operates in market with high barriers to entry. Furthermore, Paris is the number one tourist destination in the world. ADP’s share price fell sharply in 2008 amid concerns over record high oil prices and the economic slowdown. However, ADP’s passenger traffic was resilient to the economic downturn – down only 6.4% in H1 2009 and EBITDA was +4.5%. The oversold share price is recovering strongly, supporting our belief that share prices move to reflect fundamental valuations over time.
The share prices of infrastructure companies that own and/or operate assets perceived to have variable user demand came under pressure in late 2008, as illustrated by these examples, because investors expected lower usage levels and therefore lower profitability as a result of the sharp economic deterioration. The market focused on the mostly weaker toll road, air traffic and seaport volume data during this period, which overshadowed the historical resilience of these assets as well as factors such as the benefit for toll roads and airports of the significantly lower oil price as it fell from its July 2008 peak. While there has been some reduction in the patronage of user demand assets, infrastructure remains far less cyclical than many other investment sectors.
An interesting factor strengthening the case for infrastructure investing is the stimulus packages many governments have put together to boost their economies. These are creating new opportunities for infrastructure firms in particular, since a considerable portion of the government stimulus packages is set to flow into infrastructure projects, which are likely to be handled by established operators in the various infrastructure industries. The share to be spent on infrastructure is especially large in the US and China. In the US, for example, almost two thirds of the $787bn (e615bn) economic package passed in February is earmarked for infrastructure investments. These will focus on highways and bridges in urgent need of renovation and on modernising schools and hospitals – on a scale not seen since the New Deal in the 1930s.
China, too, intends to invest the lion’s share of its stimulus package in infrastructure. Some 75% of the $585bn total will be spent on infrastructure projects and on rebuilding the region in the southwestern part of the country that was devastated by an earthquake. Even Germany’s package has a programme of public investment at its core. Around a third of the budget for its second economic programme, which exceeds e50bn, will go towards infrastructure work including renovating schools and universities.
Most of these huge investment programmes will take effect in 2010, and can open up new prospects for infrastructure companies. Rapidly rising public debt levels are leading to increased privatisation pressure in many countries, which could create further opportunities for infrastructure corporations over the medium term. Government stimulus packages fall a long way short of covering the need for infrastructure investments worldwide. The World Bank estimates investments of roughly $1.6tn will be needed over the next five years in the US alone. The Organisation for Economic Cooperation and Development (OECD), meanwhile, is calling for further infrastructure programmes and fast-acting measures.
Equity markets have bounced strongly from oversold levels earlier this year, but it remains to be seen whether markets have rallied ahead of the economic and earnings recovery in some sectors. As expected, infrastructure earnings have been more resilient than many other sectors, and current valuations for listed infrastructure stocks do not appear stretched based on our earnings forecasts. Many owners and operators of essential infrastructure facilities are continuing to deliver sound operational performance and earnings transparency, in keeping with their essential service nature and ability to withstand weak economic conditions. While markets have rallied strongly since March, we believe the infrastructure sector is still providing absolute and relative return opportunities.
Dirk Kubisch, product specialist equities, Swiss & Global Asset Management
