Some years ago, the importance of infrastructure hit us in the pocket.
We were driving from the Peak District in Derbyshire to Heathrow Airport in London. That’s about a three-and-a-half-hour drive on the M1. We had factored this in, leaving in the morning since we had a rental car to return by 3pm that afternoon.
It was a weekday, and the traffic was heavy. Not unusual for England.
Then a truck overturned somewhere midway. And heavy traffic turned to chaos. The motorway blocked up completely, and the connecting roads became gridlocked.
Now, as an Aucklander, I’m used to jam-ups on the motorway.
But this was no city traffic jam. This was a national traffic jam, affecting half of the M1.
Trapped for hours, we had to pay for another day of car rental and nearly missed our international flight.
Now, there are two certainties in the countries which I invest: the population is growing and infrastructure investment is important. We need more airport terminals, motorways, data centres, and public transport services.
A preferred model we see is a partnership between public and private investment.
That private investment part allows investors like you and I to own some of the most secure and strategic assets in the nation.
The investment case for infrastructure
- Capital preservation
When you buy a software company, the main asset you own is IP (intellectual property). If the software becomes obsolete, your asset could disappear into the ether.
With an infrastructure business, you own tangible assets like airport terminals, car parks, and power stations. Sometimes the government or local council owns a significant part of those assets alongside you.
My point is those assets and your capital aren’t going anywhere.
The challenge with investing in infrastructure is that you don’t pay too much for the assets. Infrastructure investments are sought after by sovereign wealth funds (for example, the New Zealand Super Fund). They are also complex investments.
- Capital growth
A good infrastructure operator should be able to grow the value of their business in a situation of increasing demand. For example, an airport with growing passenger numbers earns more from landing fees, car parks, and retail concessions.
As income increases, the business value increases. Meanwhile, associated services like logistics and hotels want to be close to the growing airport. Land around the airport increases in value, as does the land holdings of the airport itself.
This is one reason why we’ve seen the Auckland International Airport [NZX:AIA] share price grow from $1.53 in 2009 to around $9.50 in 2019.
Capital growth can be strong in infrastructure.
This is because many infrastructure businesses have a ‘wide moat’. In a city the size of Auckland, there’s only one major international airport. Only one bus company can be contracted to serve the bus network. And only one major motorway tunnel can connect the northern part of the country smoothly and quickly.
- Capital yield
The best income is passive. You earn it while you’re at the beach or cooking dinner.
Infrastructure assets can be profitable, particularly when the bulk of initial capital investment has been paid for. Auckland Airport’s 2019 interim report shows revenue of $370.6m, up 11.5% from last year. Also, the company has a policy of paying 100% of NPAT (net profit after tax) as dividends to shareholders.
At the current share price, the dividend yield offers about 3.2% per annum.
At the time of writing, this is a similar yield to a six-month term deposit. But, for taking some market risk, you receive the potential upside of more growth in the share price. Of course, the share price could also fall, so you need to consider the long-term growth outlook for this airport.
One infrastructure business offering a higher dividend yield is Infratil Limited [NZX:IFT].
At time of writing, the dividend yield is 4.38%.
In 2017 and 2018, it was above 5% and has been as high is 10% in the past.
In recent years, Infratil has taken on more risk through more speculative infrastructure projects. Still, these businesses look to be solid, offering a mix of growth and yield.
Recent investments in renewables-energy provider Longroad and data-centre owner Canberra Data Centres offer good growth prospects. Both investments have been made alongside the New Zealand Super Fund and the Commonwealth Super Corporation (a super fund for Australian government employees).
Infratil is also in the airport business, owning 66% of Wellington Airport (alongside Wellington City Council’s 34%). It also owns energy, retirement, and student accommodation properties.
The company provides good exposure to a range of infrastructure assets in energy, transport, data infrastructure, and social infrastructure. It targets a consistent return of 20% per annum.
I’m sceptical of targets.
Yet, after tax returns, Infratil has managed a compound of 16.6% per annum since its NZX listing 24 years ago. Given the 20% target was likely before tax, this company has provided a very good risk-to-return result for investors over a long period of time.
Recently the company has acquired a ‘jewel in the crown’ in the form of a $3.4 billion acquisition of Vodafone New Zealand, shared with global-infrastructure investment partner Brookfield Asset Manager.
While the acquisition is not cheap at a suggested multiple of around 7x EBITDA, there is upside. Infratil company Trustpower plans to supply wireless broadband and mobile services to customers. The overlaps create investment synergies.
Ordinarily, I would think Infratil paid too much for Vodafone. This is not like the deal they obtained on Z Energy some years back, where they virtually tripled their money.
Yet, given the proven skill of Infratil’s investment management team and the potential synergies between Vodafone and Trustpower — I was confident enough to take up the share options when they came through.
Tomorrow, most crucially — we will look at when to buy infrastructure shares like Infratil or Auckland Airport.
Regards,
Simon Angelo
Editor, Money Morning New Zealand
Important disclosures
Simon Angelo owns shares in Auckland International Airport Limited [NZX:AIA] and Infratil Limited [NZX:IFT] via portfolio manager Vistafolio.