Earnings down as private money circles infrastructure: Reporting season roundup

<p><strong>Lewis Jackson</strong>: August was an exciting month for the utility space with most of the major names reporting and the Board of Spark Infrastructure, recommending that shareholders accept an offer from pension funds, and private equity groups. I'm joined today by Morningstar's, Adrian Atkins to discuss how the sector went this reporting season.</p> <p>Adrian, thanks for being here.</p> <p><strong>Adrian Atkins</strong>: Hi, Lewis.</p> <p><strong>Jackson</strong>: Let's start at the sector level. What were some of the themes you noticed coming out from the names that you cover?</p> <p><strong>Atkins</strong>: Well, overall, it was a pretty weak reporting season. Most of the stocks that I cover reported earnings down a bit on the prior year. We're still seeing some impacts from the Coronavirus. So particularly toll roads, they continue to report soft traffic volumes and earnings. Logistics companies were also hit by the pandemic earlier on, but they are doing much better now. We've got container volumes recovering, bulk export volumes, like resources in agricultural products, they've been pretty strong. And we've also seen logistics companies increasing prices for customers. So that's helped their profits.</p> <p>In terms of the utilities, what we've seen is AGL and Origin, they weren't impacted really by the virus, but they've got other issues to deal with including high fuel costs and lower wholesale electricity prices. So their profits were down. The regulated utilities the more kind of infrastructure utilities, bit like Spark Infrastructure and AusNet Services, their earnings are also under pressure at the moment from falling tariffs due to the regulatory process. Meanwhile, over in New Zealand, conditions are a bit better. Utilities over there had a relatively flat year overall, as strong wholesale electricity prices offset headwinds from lower hydroelectric generation and higher fuel costs.</p> <p><strong>Jackson</strong>: So there's quite a varied landscape there. When you look across it, were there any standout performances, anything unexpected that investor should keep an eye on.</p> <p><strong>Atkins</strong>: The logistics companies all did well and better than I was expecting. I was expecting them to grow earnings and they did a bit better. Things like Qube, the New Zealand based Port of Tauranga and Aurizon Holdings. They were able to grow their earnings despite headwinds to international trade. As I mentioned before, it was because of things like growth in resources exports and agricultural products and also the ability to push up customer tariffs. The other one that surprised, well didn&rsquo;t surprise any upside but did very well compared to peers at least was Contact Energy. So that's one of the New Zealand utilities. Contact has a very flexible generation fleet. So it was able to increase its output amidst high electricity prices and thus boosted profits.</p> <p><strong>Jackson</strong>: So uncertainty around the Delta variant sort of maintains, you talked about how certain names in the transport and logistics sector have been struggling because of that, was there any guidance from these companies on what they expect over the next six months as the virus progresses?</p> <p><strong>Atkins</strong>: They've all provided, well, most of them provide earnings guidance looking ahead. In terms of the Delta variant I guess once again, it's just going to be the toll roads who are going to be impacted. Other businesses seem to be coping fairly well with the Coronavirus and the lockdowns.</p> <p><strong>Jackson</strong>: And turning to AGL, one of the names under coverage a best idea for several months, it's been struggling recently, what were some of the highlights from its report?</p> <p><strong>Atkins</strong>: Well, profits are down so there's not that many highlights. But we were expecting this, and in fact, profits are going to fall again next year. But we do still expect a turnaround over the medium term. Because we're seeing higher and more volatile electricity prices. And if that kind of upward trend continues, then AGL's earnings should also trend higher. But it will take a little while to flow through just because of multi-year sales contracts and hedging. And our thesis, in large part is just based on the fact that coal and gas prices have increased, and we think at least gas prices will remain well supported. And that just pushes up the cost of running power stations. And that's a plus for AGL because AGLs got a lot of cheap coal supply contracts for the long term. So it's going to continue producing electricity cheaply while most of its competitors face rising costs.</p> <p><strong>Jackson</strong>: And turning back to the sector more broadly, there's been lots of interest from pension funds and private equity groups for utility and infrastructure assets over the last several months. What's your reaction to that? And what do you think the outlook is? Are there any listed names that could be targets next, you think?</p> <p><strong>Atkins</strong>: Yeah, I think it all stems from the fact that bond yields are so low, you know, with record monetary policy, stimulus from all the global central banks, we've got low bond yields. In inflation adjusted terms, they're probably negative for a lot of debt. So big investors, like pension funds are having to look for alternatives. And a good alternative for them, long term cash flows is infrastructure stocks. So we've seen a couple of takeover offers in the infrastructure space in recent months, including for Spark Infrastructure, which you mentioned, and I cover. So it's got a takeover offer from some Canadian pension funds. And Spark's directors have accepted it, subject to independent expert report, and no higher bid. So for us, though, we're not 100% convinced that the offer is good enough, it's only a 13% discount to our underlying fair value estimate, which isn't a huge premium, considering how few infrastructure stocks are left. So we'll have to consider all that information as it comes out, and we'll make a recommendation on that later in the year.</p> <p>As for what could be next as a takeover target, there's not&mdash;I don't think there's that many, you know, because companies like Transurban, I think that's just too big. AusNet Services is already 51% owned by a Singaporean and a Chinese state-owned entity. Something like Aurizon would probably be unappealing to a lot of investors because of its coal exposure. So I think maybe Atlas Arteria or maybe APA Group, but on the other hand, APA Group had a takeover offer knocked back by the government on security grounds, so that's a bit unclear as well.</p>