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Three drivers of attractive infrastructure opportunities

Infrastructure has become a hot topic in recent months. Donald Trump has promised a US$1 trillion infrastructure investment programme, while in Indonesia immediately to our north, the Joko Widodo administration has committed to a doubling of infrastructure spending in 2017 compared with 2014.

Locally, the national political debate is escalating on the adequacy of South Australian and east coast electricity generation capacity, and how we might meet any shortfall. The latest plan from Prime Minister Malcolm Turnbull explores a $2 billion expansion of the Snowy Hydro Scheme.

Increased investment in infrastructure is long overdue. This is true in both developed and emerging economies, and has become increasingly acute over the past 30 to 40 years. In the United States, for example, the recently released 2017 Infrastructure Report Card from the American Society of Civil Engineers (ASCE) gave America’s infrastructure an overall score of D+, stating:

“… our nation is at a crossroads. Deteriorating infrastructure is impeding our ability to compete in the thriving global economy, and improvements are necessary to ensure our country is built for the future”.

ASCE estimates US$4.6 trillion is needed in US infrastructure investment between now and 2025, of which they estimate approximately US$2.5 trillion is funded, leaving a massive funding gap.

The main factors driving the need for investment

Three main factors drive the escalating need for infrastructure investment around the world:

1. Long-term chronic underspend

A 2015 study by the B20 (the business arm of the G20) estimated that by 2030 approximately US$60-70 trillion will need to be spent on infrastructure around the world just to keep up with demand. It believes only US$45 trillion will be funded, leaving a gap of US$15-20 trillion.

This spend is largely to bring existing assets up to standard and keep pace with growth, and would offer little expansion in the infrastructure stock.

2. A growing middle class, especially in emerging economies

The growth of a substantial middle class in emerging markets will demand not only more but better infrastructure to complement their improved living standards and increased disposable income.

3. Governments with limited funding capacity

Historically governments have been the primary provider of national infrastructure. However, in the post-GFC world, many governments are running substantial fiscal deficits and have fragile, highly geared, national balance sheets. Their ability to invest in public sector infrastructure is highly constrained. In fact, the demand to improve infrastructure comes at a time when governments’ funding ability is at its weakest in a longtime.

Enter the private investor

Infrastructure assets possess a number of attractive investment characteristics including:

  • long dated, resilient and visible cash flows
  • regulated or contracted earnings streams
  • monopolistic market position or high barriers to entry
  • attractive potential yield
  • inflation hedge within the business
  • low maintenance capital spend
  • largely fixed operating cost base
  • low volatility of earnings.

These characteristics are ideally suited to both the listed and unlisted infrastructure markets where the quality and predictability of earnings are highly valued. The public, or listed, market also offers liquidity which allows entry into or exit from an investment more easily than in the unlisted market.

A current example in NSW is the State Government privatising its electricity assets with the proceeds to be recycled into new infrastructure investment. The Government is entering long-term leases of the energy businesses Transgrid, Ausgrid and Endeavour. The major purchasers of these assets have been superannuation and unlisted infrastructure funds, with some involvement from listed market investors.

Given the popularity of infrastructure assets amongst unlisted investors, demand currently far outstrips supply, meaning that investors in an unlisted fund can be waiting on the sidelines for some time before a suitable asset is secured by their fund, and their cash deployed for investment.

Regulated v user-pay assets

An important definition in the world of infrastructure investing is the distinction between regulated and user-pay assets.

Regulated assets are the typical essential service utility such as gas, electricity and water companies. Given the natural monopoly position they enjoy, a free market economy will typically ‘regulate’ the returns they can earn and rates they charge customers.

In contrast, user-pay assets, such as airports, ports and toll roads, typically operate under the governance of a ‘concession deed’ with a government authority. It is this deed that determines the scope and scale of the business emanating from it.

This distinction offers a different investment profile. In the current environment of strong global growth, user-pay assets should do relatively better as they are better positioned to immediately benefit from increased demand and pass through any inflationary pressures. Alternatively, in an environment of sluggish global growth and falling interest rates, regulated utilities would be preferred as their defensive, safe haven characteristics become more highly valued by investors.

The global listed infrastructure market will grow rapidly over coming decades, along with its unlisted cousin. Public equity markets will form a crucial component in the funding solution for how the world meets its acute and rapidly growing infrastructure needs.

 

Greg Goodsell is Global Equity Strategist at 4D Infrastructure, a Bennelong boutique. This article is general information that does not consider the circumstances of any individual.


 

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