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Utility dividends fading into the rear-view mirror for income investors

Lewis Jackson  |  16 Feb 2022Text size  Decrease  Increase  |  
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Australian investors looking for defensive income have fewer options available as listed infrastructure and utility assets are taken private by yield hungry consortiums of private equity groups and pension funds.

The Morningstar Australia Utility index has shrunk to two companies, AGL Energy (ASX: AGL) and pipeline owner APA Group, following the December sale of Ausnet Services to a consortium of private investors. Ausnet owns gas and electricity infrastructure. Prior index constituents Duet Group, Infigen Energy and Spark Infrastructure were sold to private investors or foreign companies in 2017, 2020 and 2021, respectively.

Private groups want these assets for similar reasons to many defensive investors, consistent and predictable cash flows, often insulated by regulation, says Morningstar senior equity analyst Adrian Atkins.

“These assets are attractive because of the stability of the cash flows and dividends. High yield and stable. For retirees looking for income, they were a good option,” he says.

“The acquisitions massively reduce the options for investors that want to do it themselves and buy some stable income stocks.”

Dividends from essential utilities avoided major cuts during the pandemic. Spark Infrastructure paid 13.5 cents per stapled security in 2020, down 10% from the 15 cents paid in 2019. Dividends at APA Group (ASX: APA) and Ausnet (ASX: AST) rose during 2020 relative to pre-pandemic levels.

By comparison, Commonwealth Bank (ASX: CBA) and Westpac (ASX: WBC) slashed dividends by 42% and 82%, respectively in 2020 compared to a year before.

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Spark infrastructure, which owns electricity transmission assets in New South Wales and Victoria, was sold in December last year for $5.2 billion to a consortium of pension funds and private equity groups. Ausnet followed weeks later in a $18.2 billion deal led by Canada’s Brookfield Asset Management.

The hunt for assets

Spark and Ausnet were sold amid a record boom in Australian mergers and acquisitions. Once thought too big to swallow, pension funds and private asset managers took Sydney Airport private in a $23.6 billion deal. The stock left the ASX on 3 February.

Deals worth $308 billion were agreed across Australia in 2021 , compared to the 10-year average of $100 billion, according to data from Refinitiv.

Cashed up superannuation and pension funds are hunting for predictable cash flows to pay member claims , says Atkins. Shrinking yields from fixed interest is leading them to “bond-like” utility and infrastructure assets.

“They don’t want to buy something that’s difficult, volatile and hard to manage. They want to buy something even an idiot could run that generates stable earnings,” he says.

Local assets are attractive to deep-pocketed private investors given their high quality and Australia’s stable regulatory environment, says Sarah Shaw, chief investment officer at 4D Infrastructure, an asset manager specialising in global listed infrastructure. Takeover activity surged after the pandemic because private investors saw high-quality assets trading at discounts.

“The disconnect between listed and unlisted valuations was huge,” says Shaw.

“The unlisted investors were clearly valuing these assets better than the volatility of the equity market. So, we could see them use that opportunity to sweep up some quite undervalued assets. Sydney Airport is a good example of that.”

Where can investors go?

Narrowing options on the ASX leaves defensive investors with three choices, according to Atkins: add risk, look for close substitutes or go overseas.

Replacing utility dividends with high yielding cyclical stocks comes at the cost of adding volatility, he says. Returns at essential utilities are regulated and tend to be insulated from changes in demand. Falling iron ore prices or an economic downturn will cut into earnings and dividends for banks and miners.

Considering utility-like toll road operators such as Transurban or Atlas Arteria widens the options for investors, says Atkins. These “user pay” assets are more vulnerable to changes in demand than essential utilities such as APA Group. 

“There’s more demand risk. If demand on Spark and Ausnet power networks fall, the regulator will increase the tariff so that Spark and Ausnet continue to earn the same amount of profit. That’s the deal,” says Atkins.

“But if demand on the toll roads and office building falls because of covid… you’re not making anything. If the number of cars drops by 20%, your revenues drop by 20%.”

Atkins notes real estate investment trusts (REITS) are similarly vulnerable to demand changes.

Consumer defensive stocks, for example Coles (ASX: COL) or Woolworths (ASX: WOL), can also be appropriate for income investors looking for stability, he says. Woolworths has paid dividends around the 100 cents mark since 2018, dipping from 102 cents in 2019 to 94 in 2020.

Morningstar considers both stocks to be overvalued, and investors risk capital losses should prices fall to fair value.

Investors can also look overseas, where there are hundreds of listed infrastructure assets, says Shaw. The fund’s investable universe includes 300 listed stocks across developed and emerging markets after liquidity and market cap screens.

Those determined to stay local could see Australia’s few remaining infrastructure and utility assets move into private hands should valuation discounts emerge again, says Shaw.

“We still have a couple of very attractive assets. If you look at APA’s pipeline network or Transurban’s concessions framework. They’re fundamentally high-quality assets.”

“I know they’re a little bit bigger than some of the one’s we’ve seen taken out. But what we have seen is consortiums and conglomerates come together to take them private. Should we see a value disconnect, then I certainly wouldn’t rule out further activity.”

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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