Across all infrastructure sectors, we think that the short-term share price reaction was largely an overreaction compared to the true long-term impact on the value of these companies.
The subsequent partial rebound of equities has been impressive, but it is fair to say that quality infrastructure remains undervalued. We haven’t seen this kind of valuation in infrastructure assets since the GFC, a real opportunity to shape our portfolio towards greater quality, at prices that position many of these assets to outperform in the decade to come.
Regardless of whether there are U or V-shaped recoveries, this is an opportunity to accumulate infrastructure companies with a significant margin of safety to their underlying value.
Some sectors have been resilient and others less
We have seen a bifurcation in performance across infrastructure sectors, with communications and utilities outperforming, and transport and energy underperforming.
The commonly accepted stability in utilities, and their revenue streams, played out as companies like water, gas and electricity utilities outperformed relative to both global equities and diversified infrastructure.
For many gas, electricity and water utilities, the revenue line is decoupled (relatively protected) from rises or falls in usage in order to maintain a stable and predictable revenue stream for the company. For example, in electricity, typically if usage falls below assumed levels, tariffs adjust upwards in future periods, such that the contracted revenue for the utility remains relatively unchanged.
COVID-19, with its sudden shift to work from home, and high-tech usage in isolation, also saw communications like data and telecom towers outperform.
However, vanishing traffic from the world’s toll roads, and the cessation of air travel, slowing in ports and across other transport hubs have seen the largest sector sell-downs, with transportation falling the most of all sectors.
The COVID-19 demand-side shock, and the impact of lockdown measures on population behaviour meant that we saw patronage assets like the transport, toll roads and airports sectors take an unprecedented hit.
While global airport shares have bounced hard off their March lows, we believe a cautious approach to airport investing is still warranted, though interesting investment opportunities are emerging. The challenge with airports is that there still remains a wide range of possible outcomes in terms of the recovery of air travel even as countries look to progressively open up to domestic and international air travel. The worst case, but still plausible scenario, is of a very slow recovery and some structural change to air travel could have a more material impact on value, balance sheets and gearing. For example, we believe that there is potential for a permanent and structural reduction in corporate air travel resulting from COVID-19. Given the wide range of potential scenarios, balance sheet strength is very important in terms of assessing an airport investment.
Similarly to airports, the patronage of toll roads collapsed during the COVID-19 lockdowns, however, because they can still operate with social distancing, as lockdowns have been lifted, we have seen a sharp recovery in traffic back to levels not too dissimilar to pre-COVID levels. Moreover, given recent trends, there is a case for toll road traffic to overshoot previous levels if people remain cautious about how they travel to work from a social distancing perspective.
Energy infrastructure is split between those long-haul pipelines (where we invest), with very long contracts that, for all intents and purposes, look like a regulated utility; and midstream companies (where we don’t invest) that are closer to the wellhead, and have a lot more sensitivity to volume and to price. Both types of company have been sold down together, creating a fantastic opportunity to acquire infrastructure assets, like high-quality long-haul pipelines, at a significant margin of safety to their true underlying value.
The impact of working remotely on communications
Communications infrastructure largely outperformed from both the underlying stability of its cash flows, and sentiment buying of technology and technology-related companies in the wake of COVID-19. Driving the performance of communications is the growth in mobile data. More data was created in the last three years than in the prior history of the world. The transition from 4G to 5G requires higher volume and denser networks of mobile phone towers. This drives the mobile phone operators’ needs to secure long-term contracts on more mobile phone towers in a mutually reinforcing network effect. For this reason, mobile phone tower companies have been very strong.
Investors like infrastructure because of its lower volatility and higher free cash
For us, everything that matters for investing in infrastructure ultimately converges on cash flow. The more confident a company is about their cash flow, the more they are going to pay out in dividends. With infrastructure companies, not only do we have confidence that the long-term cash flows are there, you also have growth embedded in these revenue streams, offering defensive growth characteristics.
When you think about the change in the macro-environment over the last decade, but even more recently with COVID-19, and how supportive that change has been for the infrastructure asset class, it is just extraordinary. We have seen interest rates move to even lower levels, for even longer, and global growth expectations ratchet down. A relatively low growth, low-interest rate, and low inflationary environment is very supportive of infrastructure investing given its long-term cash flows, growth profile and competitive yields.
In this context, quality infrastructure companies have been smacked down by 20 per cent, or more in some instances, and you are getting a dividend yield of around 4 per cent. This is a compelling opportunity for any investor looking for a defensive investment, with secular growth opportunities and an attractive dividend yield component.
Tim Humphreys, head of global infrastructure, Ausbil
