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Why infrastructure appeals to investors: 3 reasons and 3 stocks

Glenn Freeman  |  02 Mar 2017Text size  Decrease  Increase  |  

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Infrastructure is a popular theme among retail investors and governments alike, with the former attracted by consistency and defensive characteristics, and the latter by voter appeal.

 

Government spokespeople often refer to infrastructure in broad terms, referring to everything from bridges and gas pipelines, through to power stations, telecommunications cabling and roads--see, for example, US President Donald Trump's State of the Union address earlier this week.

"The word infrastructure gets splashed around as a broad term. We are talking quite specifically about those companies in the business of providing essential services ... we're not talking about the building of bridges and pipelines," says Tim Keegan, head of SMSF and self-directed wealth, AMP Capital.

AMP's infrastructure funds invest in established companies which "typically operate in monopolistic environments, or are government-backed in one form or another, with long-term leases, or government contracts".

Self-managed super fund (SMSF) trustees have typically had a strong focus on direct equities, along with exposures to cash and term deposits.

"But they're challenged at both ends at the moment. You've got term deposit rates that are low, and a level of volatility in equity markets that they're not comfortable with," Keegan says.

"From a risk-adjusted perspective, this asset class is incredibly attractive ... [and] makes a lot of sense as a diversification play."

Some of the reasons for the appeal of infrastructure assets to retail investors are:

1) Attractive, consistent returns

Infrastructure offers the potential for attractive, consistent returns through market cycles. This is because infrastructure assets are often critical elements of everyday society--such as the provision of water, electricity and gas.

These types of assets are often less influenced by economic factors than many other businesses. In addition, infrastructure assets often enjoy the protection of monopolies, or operate in markets with high barriers to entry, meaning they lack the competitive pressures some other companies face.

2) Defensive characteristics

According to Keegan, infrastructure generally, and unlisted infrastructure particularly, can play an important role for long-term investors due to the stability it can provide within a diversified investment portfolio and the visibility of the income streams it generates.

"In a low-interest-rate environment, where the outlook for total return appears compressed, asset classes that exhibit defensive characteristics with an attractive and stable income profile are obvious candidates for a long-term investment strategy," he says.

3) Ongoing need for more and updated infrastructure

Infrastructure is an investment thematic that will continue to play out because the need for infrastructure is a never-ending cycle. Growing populations need to be supported by additional infrastructure while ageing infrastructure needs to be periodically upgraded or replaced.

Investment in infrastructure helps stimulate sustainable, long-term economic growth, which then creates a further need for infrastructure.

Ultimately, infrastructure promotes higher living standards as it fosters economic growth and creates jobs. A McKinsey report estimates that US$57 trillion of global investment in infrastructure will be required by 2030. 

Aussie infrastructure stocks

While an infrastructure fund may be an easier way to access international and/or unlisted infrastructure assets, there are also several infrastructure-related stocks listed on the ASX.

Spark Infrastructure (ASX: SKI) owns 49 per cent of three major Australian regulated electricity distribution networks, and 15 per cent of a major electricity transmission network.

"We like its secure earnings, material unregulated operations, and internal management," says Morningstar senior equity analyst Adrian Atkins.

While he notes Morningstar holds a few concerns about the company, including its acquisition strategy and relatively high financial leverage, he views its distributions as sustainable.

Toll roads are another popular infrastructure asset, with an operator in this space, Transurban (ASX: TCL), among the most highly capitalised Australian-listed companies. It holds concessions to operate 14 Australian and two US motorways.

These concessions grant the right to operate the roads and collect tolls for predetermined amounts of time. In Australia, they are key parts of the motorway networks in Sydney, Melbourne and Brisbane.

"The roads benefit from strong competitive advantages, and the assets generate attractive returns on initial investment, warranting a wide economic moat rating," says Adam Fleck, Morningstar's regional director of research, equity analysis.

Sydney Airport (ASX: SYD) is also a moat-rated company, which Fleck describes as "an irreplaceable monopoly asset and a key piece of Australia's transport infrastructure".

He believes the airport benefits from "limited long-distance transport alternatives; close proximity to the central business district, with good road and rail access; a network effect from its status as a transport hub hosting international, domestic, and regional flights; and efficiencies generated from the large scale of operations".

"A benign regulatory environment is unlikely to change in the medium term, and thus we expect returns to exceed the airport's cost of capital," he says.

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Glenn Freeman is Morningstar's senior editor.

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