The investment case for planes, trains and automobiles

My drive into the Sydney CBD was a stop-start crawl of around 45 minutes in pre-COVID times – I’m now often parking the car 20 minutes after leaving. But the trip was even quicker at the height of our brief lockdown, when most of us were bunkered down at home.

Traffic jams are making a comeback. While unwelcome in many ways, they’re a sign of returning normalcy. And it supports the points made below by Tim Humphreys from Ausbil Investment Management and Gerald Stack from Magellan Financial Group: toll roads are on the move again. Roads are bouncing back faster than other modes of transport, particularly planes and airports.

Motorways are bouncing back faster than other forms of transport infrastructure.

This leads Humphreys to suggest regulators may slightly loosen the thumbscrews on airport operators in future – with a flow-on effect to Ausbil’s toll road exposures. Taking a different angle, Magellan’s Stack takes a stab at when airports might return to pre-COVID valuations and what this means his fund’s aviation holdings.

Changing things up further, 4D Infrastructure's Sarah Shaw hits the hustings to explain how the impending US election will affect North America’s overall growth – and why infrastructure may well be the only thing Trump and Biden ever agree on. She also reveals how her team has adjusted its exposure to essential services assets as a pandemic recovery trundles into view.

How has the outlook for infrastructure changed over the course of 2020, and how have you changed your exposures as a result?

COVID's fantastic elastic effect

Tim Humphreys, Ausbil Investment Management

There have been several major developments during the course of 2020, a year which has seen major change in most aspects of life. The following are the three key shifts we think matter.

The impact of COVID-19 on transport. The pandemic has had a profound impact on transportation assets such as toll roads and airports. Clearly, airports were never priced for the possibility of zero-traffic. COVID-19 means that, moving forward, these assets will be valued with zero volume as a credible assumption within the range of potential patronage scenarios. As a result, it is likely that overall valuations become more elastic, making these assets slightly riskier investments than before the pandemic.

The counterargument is that once a vaccine is available, air traffic and profitability will recover within a few years. This recovery is also contingent on toll roads and airports adapting their operations, cost bases and capex spend for the new environment. It’s also quite possible regulators will allow airports to price for higher returns in the future, to allow for the increased pandemic risk they face.

The rise of ESG investing. Integration of environmental, social and governance themes in portfolios is now the bare minimum for listed infrastructure investing. ESG – which impacts not just the appetite of investors for securing assets, but also the designers, builders and operators of these assets in order to secure approvals and funding – has become one of the hottest step-shifts in investing. We are seeing some knee-jerk reactions due to ESG considerations and many assets trading almost entirely on this theme, creating a “green at any price” phenomenon. 

Ausbil has always had ESG strongly embedded in its infrastructure process, and we feel that gives us a distinct advantage in being able to sort the hype from the reality. The bottom line is that you cannot build high-quality listed infrastructure portfolios without having ESG at the heart of your process ­– but it is important to maintain a disciplined valuation approach.

The energy transition. We believe the pandemic has changed two fundamental psychological positions in our world, and much faster than expected:

1. COVID-19 has changed how people feel about the world and their environment because of how ugly it can get when things are out of hand.

2. the pandemic is providing governments with broad, palatable bipartisan policy platforms that appeal to our collective desire for a cleaner world, with the added benefit of high-profile renewable energy projects that offer stimulus and jobs to the economy.

The accelerating shift from fossil fuels to renewables – wind and solar, batteries, green hydrogen and offshore wind farms – is an exciting area for us as investors. And this transition is happening even faster now than we anticipated 12 months ago.

But the shift towards a renewable economy has deep long-term ramifications for some of the industries in which we invest, such as pipelines, gas and electric utilities. We have been positioning ourselves towards the renewables that we believe will inevitably be the longer-term winners.

Planes, trains and automobiles bounce back

Gerald Stack, head of infrastructure and portfolio manager, Magellan Financial Group

The outlook for infrastructure differs for the various segments of the infrastructure universe. But overall, we define this as comprising:

1. regulated utilities – companies that own networks that provide energy and water to communities and are subject to price regulation, and
2. transport infrastructure – companies involved in the transport of people, goods and data across communities.

For regulated utilities, the financial performance and the outlook have been largely unaffected by COVID-19 and the pandemic’s associated lockdowns and other restrictions. Increased residential demand for regulated utilities largely offset the fall in service demand that commercial and industrial providers typically experienced.

There have been other effects, such as an increase in bad debts. But regulated utilities have generally been able to reduce costs or agree with regulators to spread the impact of these unexpected events over multiple years. As a result, regulated utilities have largely stuck to their previously issued earnings guidance for the year and have not changed their outlook. In response, we view the recent share price weakness in the sector as an opportunity and have increased our allocation accordingly.

Airports, toll roads, railroads and communications infrastructure are some of the primary assets we include within the segment. The first two of these – airports and toll roads – were most heavily affected by the pandemic. Both involve the physical movement of people, and so lockdowns led to a significant negative impact upon their operational and financial performance.

But we expect both airports and toll roads to recover. Many toll roads have already staged significant recoveries in traffic volumes as lockdowns have eased and people have begun to move around their communities again.

Airports are likely to take much longer and indeed IATA, the global association of the world’s airlines, has forecast it will be 2024 before global passenger volumes return to pre-pandemic levels. The recovery path for aviation activity remains highly uncertain. While we believe aeronautical travel will recover, we have reduced the portfolio’s exposure to airports.

We expect traffic on toll roads to recover more quickly than passenger levels at airports. Over recent months we’ve already seen traffic levels improve significantly in line with improving health outcomes and easing of quarantine restrictions. We have made no material changes to our toll road exposure.

Similarly, we haven’t really changed our allocation to railroads. Freight volumes have now largely recovered, despite seeing significant volume declines in the early stages of the pandemic.

And our allocation to communications infrastructure has also not changed materially, as the segment continues to benefit from secular growth in the levels of communications data being broadcast across communications networks. The pandemic has not changed this trend.

Trump, Biden shine light on infrastructure

Sarah Shaw, 4D Infrastructure

COVID-19 and the upcoming US presidential election are the two big global factors of 2020.

The pandemic has pushed the international economy into recession and hit global equity markets. Listed infrastructure has certainly not been immune to this value erosion. This price volatility could continue for a while yet, until it becomes clearer that health authorities everywhere are getting on top of the outbreak.

But it is important to note that infrastructure is a very long duration asset, an investment horizon of between five and 10 years. Once we move past the worst effects of the virus and the world economy stabilises, infrastructure in all its forms will be integral to recovery and a return “situation normal”. There is no global growth recovery without roads, railways, pipelines, power networks, communications, ports and airports.

The US presidential election is now just days away (on 3 November), and one of the very few policy areas the two candidates agree on is the need to invest in US infrastructure. While this public sector investment may not immediately provide new investment opportunities for private investors, it does lay the groundwork and points toward a big boost to US economic growth.

In terms of opportunities, we’re currently spoilt for choice. We see significant value emerging across the entire infrastructure universe as a result of the March equity market collapse. Our portfolio remains diversified, with a strong bias to attractively valued, high quality names with solid balance sheets and superior management teams.

We have increased our exposure to essential services, which has in turn boosted the earnings stability and yield of the portfolio. But we’ve also retained exposure to oversold user pay assets such as airports, which we expect will bounce sharply on news of a vaccine or opening of borders.

We believe the long-term infrastructure investment thematic is actually enhanced by the current pandemic – and there are a few reasons for this:

• Government stimulus programs are fast-tracking infrastructure investment.
• Stretched government balance sheets will see a greater reliance on private sector capital.
• A “lower for longer” interest rate environment supports infrastructure investment and valuations.

We currently have a very unique sector buying opportunity, and we are capitalising on this.

In conclusion

Many smart people have pored over the economic effects of the pandemic, and the second- and third-order effects on listed companies and their shareholders. But there’s always another angle. 

The way we move around the world – or don’t, at the moment – has been shaken up, as anyone who’s visited an airport lately can attest. Airline travel will return, just as peak hour congestion on motorways is coming back. But the changing risk parameters for regulated assets like airports and telecommunication providers may ultimately have long-lasting effects on their business models and share price valuations – something each of the above portfolio managers is banking on.

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