Big pension funds are muscling out income investors

The proposed sale of ASX listed Spark Infrastructure is the latest in a line of utilities and infrastructure assets to be taken private, a trend that leaves fewer listed options for Australian investors seeking defensive income streams, say analysts.

On Monday the board of Spark Infrastructure (ASX: SKI) unanimously recommended shareholders accept a $10.1 billion offer from a consortium of private equity firm KKR and two Canadian pension funds.

Morningstar senior equity analyst Adrian Atkins thinks the deal is likely to go through given board approval. If it does, Spark will join a list of local utilities taken off the ASX, including last year’s sale of renewable energy generator Infigen to a Spanish suitor, narrowing listed options for income and defensive investors.

“There are so few infrastructure stocks left on the ASX. There have been quite a few takeovers over the last ten years and there are not many options remaining,” says Atkins.

“Those big sovereign wealth funds and pension funds are desperate for long life assets that are simple and provide good long-term returns.”

Sarah Shaw, chief investment officer at 4D Infrastructure, agrees saying a “queue of capital” is lined up because of the price disconnect between listed infrastructure assets and those in private hands.

“Sydney Airport, Spark and APA Group are on the table. Even Transurban is a target,” she says.

“This is a problem for people looking for access to the direct listed infrastructure market because we’re shrinking rapidly domestically.”

Atkins is circumspect about the $2.95 a share offer—the consortium’s third and a 30% premium on the pre-offer share price—which is a “modest” 13% premium to fair value. His full recommendation is on hold until further documents are released in the December quarter.

Spark owns 49% of the electricity distribution networks in Victoria and South Australia and 15% of the electricity transmission network TransGrid.

It is the latest target in a shopping spree by big pension and superannuation funds. Last week Sydney Airport knocked back a $17 billion bid from a consortium including several Australian superannuation funds.

These bids follow the sale of toll operator ConnectEast in 2011, power and gas pipeline operator DUET in 2017 and renewable energy generator Infigen last year.

The S&P/ASX 200 utilities index has five constituents.

Spark shareholders will meet at the end of 2021 to vote on the proposal. Board chair Doug McTaggart said in a press release Monday the deal is in shareholders’ best interests, pending the findings of an independent expert committee.

“The Board believes that the agreed Scheme value appropriately reflects the scarcity value of Spark Infrastructure’s Tier One assets and their reliable and inflation-linked operating cashflows,” he says.

Investors need to look further afield for defensive assets

Pension funds are hungry for assets like these and their regulated revenue streams for the same reason as many income investors: stable and long-life income streams to fund retirement liabilities.

Atkins says the hunger for these assets could work in shareholder favour if more bidders emerge. For now, he recommends shareholders sit tight and wait.

Other fairly valued utilities under Morningstar coverage include narrow moat APA Group (ASX: APA) and narrow moat Atlas Arteria (ASX: ALX).

Shaw says investors who want the yield and defensive characteristics of utility assets will increasingly need to look overseas, either through a listed infrastructure fund or buying directly on overseas exchanges.

Unrated 4D Global Infrastructure's 5-year total return of 8.92% trails the Morningstar Global Equity Infrastructure index by 1.96% and outperforms its fund category by 2.46%.

For Aaron Binsted, a portfolio manager at Lazard Asset Management, this wave of privatisations highlights the need for investors to take a dynamic view of defensive equities.

“You need a fundamental view of what constitutes a defensive equity, not a stagnant view.”

REITs, consumer staples such as supermarkets and certain high-quality miners are all options, he says.

Unrated Lazard Defensive Australian Equity's 5-year total return of 6.45% trails its index by 4.36%.

Spark earnings down but long-term outlook positive

The board’s endorsement of the deal came a day before Spark released half yearly results that saw earnings fall as expected.

Earnings before income tax depreciation and amortisation were down 7.1% to $402 million as regulators reduced the allowable return Spark can make.

Regulators determine the allowable return using a combination of prevailing interest rates, operating expenses and the value of their assets, says Atkins. Falling interest rates have seen allowable returns fall but Atkins thinks rates have probably bottomed and returns should lift.

The long-term outlook remains positive as Spark continues investing in its asset base, which grew 5% to $6.7 billion. The larger base should translate into higher earnings growth in the future.

The company paid an interim distribution of 6.25 cents per security with 1.5 cents of franking credits.