‘Huge opportunity’ to find mispriced infrastructure assets
With the push towards decarbonization, ultra-low bond yields and rising inflation, the role of an adviser is becoming more and more challenging. The investment paradigm has changed for both the adviser and investor. Gone are the days when a substantial portion of an investor’s portfolio was buried in high-interest term deposits virtually risk-free. These days, yields aren’t rising anytime soon and risks are almost everywhere.
There are, however, a few pockets of opportunity, where new trends such as climate change concerns have led to ageing utilities requiring significant upgrades. This has brought about a renewed focus on essential infrastructure assets that provide the backbone for economic and social activity. These include electricity transmission and distribution lines, ports, rail and roads, communication lines, and data networks.
Because these assets are deemed essential, they carry low risk and often provide investors with stable and secure cash flows. Looking at it from an asset allocation perspective, essential infrastructure gives downside protection and diversification benefits from an otherwise high-risk equities portfolio. The other big plus is that essential infrastructure assets are resilient in most economic environments, bar a pandemic.
Nevertheless, we spoke with Ausbil following a national adviser workshop series it held covering global listed infrastructure (GLI). One of the pressing issues the team came across was rising interest rates and inflation being a major concern for investors.
The team responds to these questions by stating “whilst the discount rate used in valuations goes up with interest rates, revenues should increase to offset this, as long as interest rates are rising due to increased economic activity. Inflation protection is expressed most in Essential Infrastructure – often explicitly built into concession tariffs or regulation.”
While infrastructure companies carry substantial debt, most of it is fixed and long-term. And often an unlisted acquirer will increase the debt as they have a higher debt appetite than listed investors.
Many investors are concerned that essential infrastructure is expensive and trading at lofty levels.
Ausbil dispels this common thought, saying, “Our top-down valuation tool is showing a “neutral” valuation currently – this is the cheapest level since 2011/12. Our conservative, bottom-up IRR is showing expected returns of about 8.5%p.a. and a normalised yield of about 3.5%; a nice blend of income and growth. Some areas are expensive, but some are cheap (e.g., European airports and toll roads).”
And you don’t need to look far to see recent examples of high demand for essential infrastructure despite valuations. “High premiums bid for SYD, AST, SKI suggest that there is a material disconnect between the listed share prices and the valuations being ascribed by sophisticated long-term infrastructure investors. Infrastructure assets are in demand – infrastructure’s characteristics are desirable and great from a long-term asset liability matching perspective.”
Ausbil believes there is a “valuation arbitrage between the listed market valuation techniques (largely short-term multiples) and sophisticated unlisted investors such as Future Fund, Brookfield, UniSuper etc, which use multi-decade cash flow models, similar to our valuation methodology.”
The push to decarbonisation is the next big transition; a once-in-a-generation opportunity where energy is transitioning to predominantly renewable energy generation. It is now the cheapest electricity generation solution, according to some analyses, which will create winners and losers.
Ausbil is positioned with the companies it thinks will be long-term winners. It says, “Utilities that are transitioning their fleet from fossil fuels to renewables present a huge opportunity that is unrecognised by most investors. ESG considerations are only going to increase in importance, and ESG momentum is a great way to play this.”
What is the COVID recovery opportunity?
Ausbil says travel, toll roads and airports are the recovery opportunity, having been hit hard during the pandemic. The team says, “Most European toll road traffic is now above 2019 pre-Covid levels but share prices are well below 2019 levels. Air traffic will likely recover during 2022, so that 2023 will be a clean year and the bid for Sydney Airport (by a consortium of Australian firms IFM Investors, QSuper and AustralianSuper and US-based Global Infrastructure Partners) is an example of how sophisticated long-term investors are looking through 2021 and 2022 and focussing on the long-term trends in air travel.”
Essential infrastructure as an asset class has the perfect qualities any retiree would want in their portfolio. It’s defensive, with visible and predictable cashflows; it has downside protection; and it preserves capital. Ausbil says, “The income aspect represents about 40% of the total return, once yields normalise next year.”
To sum it up, Ausbil says:“listed infrastructure is a young and an inefficient asset class. It employs very technical valuation methodologies and requires a lot of experience to avoid the pitfalls of long-term modelling. Infrastructure, e.g. utilities, tends to be a structural underweight for most generalist managers, as they chase higher-beta stocks to outperform an index. Therefore, this is potentially a huge opportunity for mispricing, and therefore active management. You want to put active dollars to work where there is the biggest opportunity, and essential infrastructure sits in that sweet spot for all the above reasons.”