Written By: David Crawford
David Crawford of Nordea Asset Management UK expresses confidence in the outlook for listed infrastructure over the next few years, as this asset class displays earnings resilience and stable cash flows
Last year, during the height of the pandemic, equity markets embraced companies embodying the “new economy” – businesses such as Peloton, Netflix and Zoom. Far less attention was paid to the “essential economy – water, gas and electric utilities. But in 2021, it looks like Listed Infrastructure will get a booster shot of new investment. Infrastructure companies form the backbone of every economy, and as the world transitions toward clean energy, government policies are accelerating investments in this asset class – in particular, the upgrading of ageing infrastructure assets.
The big shift occurring in the US under the new administration led by Joe Biden is a prime example of how the asset class is set to benefit in 2021 and beyond. During the presidential campaign, candidate Biden unveiled a $2 trillion infrastructure plan – concentrating on roads, rails and bridges, developing zero-emission transport and electric car infrastructure.
The “blue wave” election result will likely usher in huge infrastructure spending, tax credits and subsidies for clean energy – while new appointments are strengthening the Environmental Protection Agency, the energy regulator. These new measures will accelerate the ongoing phase-out of coal plants and increase renewable development over the next decade.
But this is not just a US story, with additional strong commitments in Europe, China and Japan. To meet the 2050 net-zero carbon goal, forecasts suggest $740 billion of global capital expenditure is required annually – up from prior estimates of $400 billion. These capital-intensive investments can be financed at historically low funding costs.
Strong sector dynamics
Listed infrastructure spreads across a variety of sectors – such as communications, midstream energy, utilities and transportation. These companies are supported by recent tailwinds and long-term dynamics.
Existing infrastructure assets already require ongoing investment – to enhance safety, reliability and efficiency. This consistent organic growth is reinforced by the recent initiatives targeting infrastructure upgrades. For example, the clean energy transition should invigorate ageing network assets, as it requires significant investment in the network and electric grid. Annual investments are forecast to increase by 50% from 2020-2030, which will translate into attractive earnings and dividends.
For many infrastructure companies, decarbonisation has become a major theme, particularly for utilities. Many still own old and costly coal-fired power plants, which have the potential to be replaced by increasingly cheaper renewables. Innovation is also driving investment opportunities in battery storage, smart meters, and network efficiency.
More generally, the continued rollout of Covid-19 vaccines should support the outlook for the more traffic- or volume-exposed businesses – such as toll roads, passenger rail companies and midstream companies. We also remain positive on the data growth theme, which remains secularly and structurally supported by increased digitalisation and the internet of things.
Valuation and ESG drivers
After a year where infrastructure performance disconnected from fundamentals, we now see four primary drivers of the asset class:
Firstly, global listed infrastructure trailed global equities by 20% last year, with the relative EBITDA multiple de-rating to levels last seen in the aftermath of the global financial crisis.
Secondly, while corporate bond yields have been compressing in recent years, listed infrastructure dividend yields have remained firm. The relative yield spread between global infrastructure and credit is now well above its long-term average.
Thirdly, infrastructure assets in the listed markets are trading at 20% plus discounts to private market values.
Finally, infrastructure companies generate positive social, environmental and economic impacts – such as contributing to greenhouse gas emissions reduction, the revitalisation of disenfranchised areas and improving access to services. Listed infrastructure underpins many of the 17 UN Sustainable Development Goals, and ESG fund flows are increasingly seeking investments in themes key to the asset class – such as decarbonisation and clean water.
Attractive relative value opportunity – the triple discount
Listed infrastructure has a history of downside protection and outperformance when equity market volatility increases. However, this was not the case in 2020, with the pandemic challenging certain economically-sensitive areas within the space – despite the majority of the essential sectors within infrastructure reporting relatively stable earnings since the onset of Covid-19.
For example, airports were the largest laggards, with many companies having to cut dividends in the face of the unprecedented 80-90% declines in traffic volumes. Midstream companies were also impacted by the sharp decline in fuels related to travel, as well as reduced broader economic activity.
As a result, the global listed infrastructure space now displays a triple discount:
- Compared to listed equity markets: Relative to global equities, global listed infrastructure stands at a 5% discount to global equities, versus a long-term 10% premium. Even as the market has been fixated on other areas of the equity market, listed infrastructure has displayed earnings resilience and stable cash flows.
- Compared to private markets: Infrastructure assets in the listed markets are trading at 20% plus discounts to private market values. This gap is supported by a plethora of private market capital waiting to be invested, which distorts asset valuations. The M&A potential for listed assets should also not be ignored, as the listed space increasingly appeals to institutional investors – particularly given the discounted valuations and scarce availability of similar assets in private markets.
- Compared to the bond market: while corporate bond yields have been compressing in recent years, listed infrastructure dividend yields have remained firm. The relative yield spread between global infrastructure and credit sits well above its long-term average.
Protection against the reflation trade
Infrastructure has characteristics that should enable the assets to perform well in the longer term. A little over 80% of the assets the companies in our universe own have explicit or implicit mechanisms to pass inflation on to the end user through tolls or tariffs. And this would offset a lot of the impacts of the accompanying rise in bond yields that one would expect to see if inflation were to pick up.
There is often an assumption made that listed infrastructure’s strong performance relative to general equities over the last 20 years must have been driven by falling bond yields. However, the strong long-term track record of listed infrastructure has been due to a faster rate of underlying earnings growth versus general equities, and is not due to an expansion in P/E or EV/EBITDA multiples relative to general equities.
This makes us very confident about the outlook for the asset class over the next several years almost irrespective of the path of inflation and bond yields.
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