3 infrastructure ideas to power your portfolio

Water has always been fundamental to life, and electricity isn’t far behind as a staple of modern existence. Reliable internet access is creeping ever-higher on the list of essentials within the developed world, as we’ve been reminded during the pandemic lockdowns of 2020.

These themes underpin many of the most defensive listed assets available to retail investors. And they also cropped up when the following infrastructure fund managers were asked to reveal a favourite stock.

In this wire, a trio of fund managers make their respective cases for holding North America’s largest water utility; a Florida, US-based clean power firm with super-reliable cashflow; and a Spanish telecom operator. They also outline a few sectors they outright avoid and explain why.

Responses were provided by:

• Gerald Stack, Head of Infrastructure and Portfolio Manager, Magellan Financial Group
• Tim Humphreys, Head of Global Listed Infrastructure, Ausbil Investment Management
• Sarah Shaw, Chief Investment Officer, 4D Infrastructure

3 reasons to love this liquid asset

Gerald Stack, Magellan Financial Group

American Water Works, the largest listed water utility in the US, views the problems with the US’s water and wastewater systems as an opportunity to expand while earning higher returns for investors from what is a low-risk industry.

The core of the company’s operations is the regulated business of providing metered water services to about 1,600 communities across 16 states in the USA, each of which has a different regulator. This regulated business brings in a weighted return of 9.8% from its regulated activities and expects to replace nearly 3,200 kilometres of mains and pipes over the next five years.

As American Water has typically replaced only about 0.8% of its pipeline network a year (which, in industry jargon, translates to a 130-year replacement cycle), the company has a vast opportunity to invest in its network to ensure robust growth in regulatory revenue in coming years.

American Water’s second prong is to expand through takeovers. The company plans to spend up to US$1.2 billion on acquisitions between 2020 and 2024 – and there are plenty of targets because only 16% of the US’s water systems and just 2% of the wastewater systems are investor-owned.

The third prong is that management is focused on running American Water more efficiently. Management intends to reduce expenses to 31.3% of revenue by 2024, down from 35% in 2019 and from 46.1% in 2010. The company is cutting its cost-to-income ratio by adopting technology, improving supply systems and by scrutinising costs.

These three prongs have helped American Water record compounded growth rate of 10% in dividend payments and average annual revenue growth of 3% over the last five years. We expect they will also help the company deliver the reliable, predictable and growing earnings streams investors expect from infrastructure and utility assets.

Assets that don’t make the cut

We exclude assets whose earnings and cashflows are directly affected by competition, commodity prices (such as the oil price), and significant sovereign risk.

Based on this approach, companies that derive more than 25% of earnings from construction, merchant power generation and car parks are excluded. Magellan also avoids companies that derive more than 25% of earnings from Chinese or Russian domiciled assets, because we aren’t confident that the rights of companies in these countries are protected by the legal system. It is important to note that we’re not assessing these assets as poor investments. But their long-term earnings and cashflows don’t meet the level of reliability that we believe investors want from infrastructure.

A perfect marriage of clean power, cashflows

Tim Humphreys, Ausbil Investment Management

Without offering financial advice, we’re most interested in the US company, NextEra (NYSE: NEE) because of its long-running renewable energy theme. The company is a blend of a regulated electric utility with very favourable regulation in Florida, and the world’s largest generator of electricity from renewable sources. It firmly straddles the safe and long predictable cash flows of a regulated utility, with the huge cash flow growth potential from the unstoppable displacement of fossil fuels with renewables.

In terms of renewable energy, NextEra is far and away the market leader in the US, no other firm comes close in the mix of ambition and funding capacity for new investment. Now that renewable energy is increasingly cheaper than fossil fuel generation, NextEra is able to go into states in the US and offer regulators an alternative renewable replacement for fossil fuel generation at state-level energy supply volumes, not just small percentages of the grid loads. As renewables continue to increase in demand and volume share, and the US inevitably moves towards a zero-carbon economy, NextEra will play a central role.

Even under a coal-loving President, this year Arevia Power had the largest ever solar farm approved in US history, the Gemini Project in Nevada. Under the Democrats, a move towards carbon-free electricity generation by 2035 would also significantly improve their long-term outlook. Under either a Republican or Democratic government, NextEra is positioned to continue growing for many years to come as is the role of renewables in the overall energy complex.

No to emerging markets, price sensitivity

We explicitly and fundamentally avoid anything with sensitivity to commodities, prices and demand. This means we exclude midstream assets that have commodity or volume exposure, and assets that are very sensitive to the overall global GDP cycle, such as ports.

We also limit exposure to emerging markets, as we think the layers of risk – including political, economic and legal – increases uncertainty at the expense of the long-term predictability we look for in genuine essential infrastructure assets.

Tailwinds are favouring telco

Sarah Shaw, 4D Infrastructure

Attractive fundamentals, long-term thematics, the COVID-19 response and depressed stock prices represent a unique buying opportunity for listed infrastructure as a whole. But Cellnex Telecom, the largest independent mobile tower company in Europe – and our largest portfolio position – is a name we’re particularly excited about.

The company’s visionary management team is capitalising well on significant structural opportunities in creating value for shareholders. Its key structural tailwinds include:

• Mobile telephone companies are incentivised to co-locate equipment on towers as operating costs are reduced through sharing of leasing costs, power, and operations and maintenance. For the tower operator this co-location increases tenancy ratios, providing significant organic growth opportunities.
• Most European mobile telephone companies built their own tower networks (in the 1980s and 1990s) and are today actively looking to recycle capital into new growth initiatives such as fixed wireless and 5G via the sale of their mobile tower assets. This has already provided Cellnex with opportunities to accelerate growth in its asset base, and will continue to do so.
• Due to increasing demand for mobile telephony data, Cellnex can sign long-dated inflation-linked contracts – usually spanning 20 years or more – providing strong and visible earnings growth over the long run.

Tower assets offer true infrastructure exposure, and we believe Cellnex offers an incredible combination of quality, value and opportunity.

The emerging markets opportunity

In terms of longer-term themes that we find particularly interesting, I would highlight the:

• huge global need for infrastructure investment, both replacement and new;
• emergence of the middle class in EMs, which offers a huge opportunity with infrastructure both a driver and a first beneficiary of improved living standards;
• global population growth but with changing demographics – the West is getting older, but much of the East younger (for example India, Indonesia, the Philippines); and
• energy transition underway – climate change concerns have raised a number of environmental challenges which underpin the need for even more spend on infrastructure.

In terms of assets we avoid – if a company or asset doesn’t meet our strict definition of infrastructure it’s excluded from our universe. Our country analysis can also highlight regions that we don’t feel are acceptable investment destinations at that point in time. If this is the case, we won’t invest in assets in that country until the situation improves.

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