Developed economies face the challenge of renewing their ageing infrastructure assets at the same time as delivering new projects fit for successive generations. This will be a significant multi-year theme that supports and stimulates economic activity.
This Perspective describes the important role infrastructure plays in developed economies and discusses why investing in infrastructure companies is an attractive strategy. The paper cites Australia, the US and Western Europe as examples of the most sophisticated infrastructure markets. These markets face the ongoing challenges of renewing their existing infrastructure assets, much of which was constructed several decades ago.
A country’s infrastructure base not only helps it to operate effectively, but it encourages economic growth, in turn creating demand for even more infrastructure capacity. This interplay is particularly relevant today in many developed markets. Notably, global infrastructure equities have outperformed global equities over the last 10 years, as Chart 1 shows, even during extremely volatile market conditions.
Developed economies are delivering some of the most advanced infrastructure projects ever constructed. One the largest European projects today, the £15 billion Crossrail project will connect central London and its western and eastern suburbs with a rapid rail service. In the US, the development of shale oil and gas fields is directly benefitting various US infrastructure industries and supporting a broader reindustrialisation of the US economy via lower-cost energy and raw materials. Indeed, the US energy revolution is helping the country to become a leading exporter of natural gas – reversing decades of dependency on imports. Australia is investing in new-generation infrastructure including roads, rail and energy, funded partly by its new ports privatisation programme and by encouraging private capital to co-finance major projects.
The global infrastructure securities universe grew from a total market capitalisation of $595 billion in 2002 to more than $2.3 trillion by the end of 2013.1
*The Dow Jones Brookfield Global Infrastructure Index includes companies domiciled globally that qualify as ‘pure-play’ infrastructure companies whose primary business is to own and operate infrastructure assets. These activities generally generate long-term stable cash flows. Index components are required to have more than 70% of cash flows derived from infrastructure lines of business. The index intends to measure all sectors of the infrastructure market.
Infrastructure encompasses a range of facilities, services and installations that are needed for a fully functioning, economically productive society. Infrastructure assets can be either economic or social:
There is considerable scope for the private sector to partner with the public sector by investing in and operating a wide range of infrastructure assets. Although the public sector has traditionally been viewed as the natural provider of infrastructure, the private sector is playing an increasingly active role by providing private capital as well as management and operational expertise.
The public-private partnership (PPP) structure – also known as P3 in the US – has resulted in risk/reward sharing by the public and private sectors. Australia, the UK and the Netherlands have been leading proponents of PPPs; these transactions have financed numerous nationally important projects including toll roads, high-speed rail, schools and hospitals. Facing massive infrastructure renewal challenges, various US states are adopting PPP/P3 legislation to repair and maintain crumbling infrastructure assets. Private sector participation in social infrastructure is often in the form of PPPs, such as the UK’s school and hospital building programmes.
Chart 2 shows the private sector’s responsibility in an infrastructure project increases in line with its financial stake, with privatisation being the fullest form of private ownership. The private sector is attracted to infrastructure opportunities because they tend to have pricing power due to inelastic demand; maintain quasi-monopolistic positions due to high barriers to entry; benefit from economies of scale because of high fixed costs and low variable costs, and benefit from price and/or economic regulation.
While taxes are an important source of infrastructure funding in OECD countries, their ageing populations result in shrinking wages and reduced tax receipts. The impact of lower tax receipts may be eased by increases in the labour participation rate, immigration, productivity and the balance between income- and consumption-based tax revenues. However, public budgets are likely to be insufficient to bridge the infrastructure funding gap in developed economies.
As demand for infrastructure improvements continues to grow in developed economies, the flow of deals has the potential to generate attractive and stable returns throughout business and economic cycles. Although infrastructure is inherently a long-term and stable income-producing asset class, there is abundant liquidity when investing in infrastructure equities and the total returns can be attractive, especially during market downturns.
Chart 3 shows that from July 2008 to June 2013 listed infrastructure had a 0.82 and 0.83 correlations with stocks and real estate, respectively, and much lower correlations with bonds and commodities. As well as offering some diversification benefits, returns are attractive. Over the 10 years to August 2013, the risk-adjusted returns for global infrastructure equities were more favourable than global equities (see Table 1).
In a low-yield and volatile world, investing in infrastructure companies has grown in appeal for some other key reasons. First, the relatively high yields offered by infrastructure stocks can help investors diversify their income streams and meet their yield targets. Moreover, the stable earnings that many infrastructure assets can generate, thanks to low competition, long-term contracts and resilience to economic conditions, typically provides defensive characteristics that help to mitigate portfolio risk via lower beta than the market. Investing in companies making pure-play infrastructure investments offers a degree of asset liability matching for investors with long-term liabilities. Lastly, infrastructure can help to protect against inflation via income and capital growth.2
“I prefer to invest in developed market infrastructure via listed investment companies that access the asset class through a number of opportunities including PPPs. Relying on experienced third-parties that have solid track records of investing in infrastructure can deliver very attractive returns.”
Eugene Philalithis, Portfolio Manager, Fidelity Solutions
Infrastructure assets’ risk-return profiles vary considerably by sector, geography and over time. This means that an investment strategy focused on researching infrastructure equities can identify value-add opportunities and avoid high-risk exposures.
By investing in infrastructure equities, investors not only benefit from good liquidity but also gain immediate exposure to infrastructure company revenues at a lower cost than more illiquid investment strategies. Listed infrastructure companies are also attractive to active managers because governance requirements mean companies have to be transparent. This information can help investors achieve an upside from managing complexities such as political and regulatory risks.
The developed economies of Australia, the US and Western Europe offer ample opportunities for private companies to participate in economic and social infrastructure.
"Sydney Airport, an investment trust which owns and operates the Sydney Kingsford-Smith Airport, benefits from its monopoly advantage and strong passenger volumes, particularly from China and increased low-cost carrier capacity from Asia. The company generates strong incremental rates of return and has a track record of redeploying capital profitably. This has been achieved by improving airport configuration and capacity utilisation on the aeronautical side as well as improving non-aeronautical services like retail and parking.”
Pak Luan Yeoh, Portfolio Manager, Asia Pacific Equities
Infrastructure in Australia tops the political and economic agendas. So much so that prime minister Tony Abbott successfully campaigned for political office last year on the promise of becoming ‘the infrastructure prime minister’. With a 23+ million population, the vast majority of whom live in Australia’s coastal cities and towns, there is robust demand for new infrastructure capacity. Almost 90% of Australia’s population live in urban areas, making it one of the world’s most urbanised countries despite its expansive landmass.3
The infrastructure pressure points are the country’s roads and public transport systems, but parts of the energy industry also need to replace ageing assets. Although the country’s independent agency, Infrastructure Australia, assesses the economic viability of projects, sourcing public and private funding is as contentious as it is in other countries.
Australia’s infrastructure construction programme is expected to be funded by a number of privatisations and PPPs, according to our analysts. While the federal government committed $36 billion to transport projects in the six years to 2014, it believes there needs to be dramatic increases in spending going forward.4
Last year, the New South Wales state government boosted its infrastructure programme considerably by signing 99-year leases of Port Kembla and Port Botany with a A$5 billion winning bid from the consortium called the NSW Ports. The deal was valued based on a lofty multiple of 25 times earnings. The consortium is made up of leading investors in the unlisted infrastructure market: Industry Funds Management, Australian Super and Tawreed Investments, a subsidiary of the Abu Dhabi Investment Authority. The leases have netted A$4 billion to Restart NSW, the state’s infrastructure fund, which will be partly used to fund projects like the WestConnex motorway, which is one of the state’s largest infrastructure projects.
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“The US shale energy-producing states are benefiting from a trickle-down phenomenon that will result in capex growth in industrial construction. We can see this in the strong level of road building in Texas and other states to renew ageing infrastructure and provide new capacity. Martin Marietta is the second largest producer of construction aggregates in the US and will benefit from higher prices of construction materials as demand builds. Eagle Materials is boosted by higher cement prices where supply growth is limited and also from its ongoing frac sand business build-out.”
Pete Kaye, Portfolio Manager, US Equities
Our analysts in Sydney say there is likely to be successive port privatisations or concession agreements as states seek to monetise state-owned infrastructure assets to fund new roads and transport projects. Australia has many general and specialised port terminals that manage the export of good and commodities. Some states are expected to favour their greenfield (new) infrastructure projects being funded through PPP structures. There is also some discussion about the possibility of issuing infrastructure bonds.
The private sector in Australia has delivered a marked increase in infrastructure construction by dollar value over the last 10 years (see Chart 4), notably by the private sector. Investing in companies like Leighton Holdings and Lend Lease, which have track records of winning contracts to construct Australia’s roads, ports and universities, is a good route to investing in the country’s infrastructure industries.
While various roads and rail systems are due to be upgraded, other infrastructure projects, such as a second airport for Sydney, are still far from being decided. The federal government and the NSW government – both Liberal Party administrations – disagree about the project: the NSW state believes there are more pressing projects to invest in so the airport is not a priority. This benefits Sydney Airport, which handled more than 35 million passengers in 2011 and has ample spare capacity without expanding the airport partly thanks to airlines operating larger-size aircraft.
The US invested heavily in infrastructure as the country boomed in the post-WW2 era, but much of its infrastructure urgently needs to be replaced and additional capacity needs to be added to meet the growing needs of the economy. Thanks to the US shale and oil and gas production, however, a number of states will fund their infrastructure projects by using the tax revenues from the shale fields in their territories.
The reindustrialisation of the wider US economy, which directly and indirectly supports infrastructure companies, is directly benefiting from the lower cost of gas, which is priced at almost one-quarter of 2008 US prices and much cheaper than prices in Europe and Japan (See Chart 5).
“MasTec is an interesting US infrastructure play as it provides essential engineering and construction facilities for electrical transmission, oil and natural gas pipelines, renewable energy and wireless networks.”
Chris Moore, Portfolio Manager, Global Equities
US states with shale gas supplies are in strong positions to invest the new wave of gas-fired power generation. Federal legislation is also set to phase out the oldest coal plants from 2015, so this will likely hasten the gas turbine cycle. GE is expected to be a strong beneficiary of this trend as a leading manufacturer of gas turbines. The biggest driver of the stock going forward, our analysts say, will be the gas turbine cycle, which is at a trough at present at about 30% of its early-2000 peak. However, given the cost advantages of gas fired power, there should be a pick-up in orders for gas-powered turbines in 2015, our analysts believe.
Although a lot of the investments in the US shale industry have focused on upstream assets, investors are encouragingly now making more downstream investments too. These include LNG export facilities, petrochemical plants and refineries, some of which have been converted from their original use as oil and gas import facilities.
Engineering and construction companies will play an important part in rebuilding the country’s ageing assets, including bridges, railways and other transport infrastructure, oil & gas pipelines for the shale industry, and power generation facilities. Caterpillar is a good way to play the US infrastructure build-out given its machines are heavily used in roads and building works. Danaher sells a lot of equipment to telecoms companies for testing. Honeywell and Eaton are selling into the non-residential construction industry, including the oil & gas space. Pipeline contractor MasTec lays the pipes in the oil & gas industries and also works for telecom companies like AT&T laying carbon fibre and other wireless infrastructure.
The US rail industry is a large beneficiary of US shale, which has more than offset a reduction in coal-related transport that has fallen off in recent years. Rail companies have been in demand to ship production supplies and materials to the shale fields. They are also transporting oil and gas from the shale wells to the distribution networks, as fixed-line pipelines have yet to be completed. It is this transport cost that has caused the gas price to increase over the last couple of years from trough levels (Chart 5). Norfolk Southern and Union Pacific are directly benefiting from shale-related transport demand.
While states such North Dakota, Louisiana, Texas and Pennsylvania can use shale-generated tax dollars to pay for infrastructure projects, others do not have this tax revenue stream. The PPP/P3 regime in the US is state-specific, but the need for private capital and development partners is countrywide. However, the infrastructure industry is highly fragmented, which means there are ample opportunities for the private sector throughout the infrastructure ecosystem. The expected pick-up in US infrastructure developments is likely to benefit many companies, including large European developers such as ACS, Hoctieff and Skanska. They have extensive international experience of developing infrastructure projects.
To secure a stable flow of infrastructure projects going forward, the US needs a long-term federal highways bill in place and not short-term patches to its Transportation Infrastructure Finance and Innovation Act (TIFIA). Also, there are calls to increase the federal ‘gas tax’, which funds about $85 billion or 30% of the US transport sector’s annual budget.5 Various US states have already addressed some of the funding gap. Virginia has replaced its gas tax with a sales tax to fund major improvements across the state. In Pennsylvania, a law came into effect in early 2014 that will inject billions of dollars into improvements to the state’s highways, bridges and mass-transit systems. Maryland, Vermont and Massachusetts are raising their gas taxes to adequately fund maintenance of their roads and bridges.
Despite signs of a broadening European economic recovery, government finances and project affordability are key issues across the region. Europe is also managing the added pressures of an ageing infrastructure stock, so a key challenge is how to renew existing assets without stretching public finances to breaking point.
Infrastructure projects are key priorities for the European Union because they help to stimulate growth through investing in better transport and road connections, for example, and support improved social cohesion with investment in education, health and utilities. The European Investment Bank (EIB), which can lend up to 50% of a project cost with low-cost capital (the bank is AAA-rated) alongside private funding, has extended €200 billion to infrastructure projects in Europe since 2009 (see Table 3). Transport and energy & renewables projects have received the lion’s share of the funding in this timeframe. While the EIB co-finances many projects, others are funded wholly by the public or private sectors in Europe.
In social infrastructure, for example, there have been PPP deals to build schools and hospitals, mainly in the Netherlands and the UK where PPP legislation is well established. The rest of Europe lags in PPP activity because of a lack of supportive legal framework. PPP deals can also be politically motivated. The market in the UK has been quiet for the last 18 months, but there could be a flurry of activity ahead of the May 2015 general election in the UK. Fresh project activity in the UK PPP market could benefit companies such as Skanska and Balfour Beatty.
Europe is home to some of the most established, good-quality infrastructure companies, giving investors access to strongly performing stocks that make regular dividend payments. These include Fraport, which operates Frankfurt Airport in Germany, and Vienna Airport, as well as French concessions and construction companies Eiffage and Vinci.
In the developed economies of Australia, the US and Western Europe there is a strong need to replace ageing and crumbling infrastructure. Investing in infrastructure companies in developed markets not only generates attractive risk-adjusted total returns when compared with the wider equity market, but the breadth of infrastructure stocks presents excellent investment and diversification opportunities for active managers.
1 Bloomberg and AMP Capital. Data from 31 December 2002 to 32 December 2013.
2 The case for global listed infrastructure, Colonial First State Investments.
3 Urban population data, The World Bank Group, 2013.
4 Infrastructure Finance and Funding Reform Report, Department of Infrastructure and Regional Development, Australia.
5 A Federal Gas Tax for the Future, Institute of Taxation and Economic Policy, US, September 2013,