Global infrastructure poised to shine on growth, inflation and value

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Andrew Maple-Brown, co-founder and portfolio manager, Maple-Brown Abbott, Global-listed Infrastructure 

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We’re constructive on the outlook for listed infrastructure, really, for three key reasons. Firstly, we see the macro conditions as being supportive. Infrastructure assets — and especially when using a tight definition of infrastructure, as we do — are typically best economically sensitive than the broader market and often have natural inflation linkages.  

For these reasons the market conditions, which favour infrastructure assets when compared to global equities, are when economic growth is weakening or when inflation is strong. So, we believe the current market conditions are supportive for the sector. 

Secondly, we’re excited by the earnings growth in the sector, which is being driven by massive investment needs. The capital investment opportunity within the sector continues to grow, and is particularly being driven by the mega themes of decarbonization and digitalization. 

To put the size of that opportunity into context, our opportunity set that we look at is slightly over 100 companies, and we forecast that this year, those companies will be investing approximately US$375 billion in just organic capital expenditures. This is money spent on upgrading or extending their existing networks, investing in the electric networks, replacing water pipes, upgrading airports, or widening toll roads. All work that is captive to just that company, so in our experience, provides the lowest risk accretion for this investment. 

And finally, we believe that valuations are reasonable. Listed infrastructure looks fair when we compare it to where it has traded on a historical basis. But we believe that it looks cheap when compared to broader equities, and very cheap relative to where comparable assets have been trading in the private market. 

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We believe that the energy transition and digitalization are providing excellent opportunities for the infrastructure sector. The electric utilities in particular are benefiting from these mega themes, and this sector makes up more than 35% of our portfolio. 

These companies are seeing strong capital expenditure driven by the energy transition, which is causing large investment, not only in the renewables, but also in the transmission network that is so important to support the renewables, and from growing electricity demand, which is notably coming from data centres. 

As a result, the earnings growth has been accelerating. For example, U.S.-regulated utilities have historically seen earnings per share growth of around 4% to 6% per annum. But currently we expect the average such utility is having more like a 6% to 8% growth over the next five years. 

I think it’s important to note that not all electric utilities have the same exposure to these themes. For example, the impact of data centres is much greater for utilities that are in U.S. states, where the regulated utilities own the electric generation, and not just the distribution and transmission, as the majority of the needed investment for data centres has been on the generation side. 

Over the last couple of years, our holding in U.S.-regulated utilities have been focused on those fully integrated utilities, and in states which have been encouraging data centre developments. Although more recently, we’ve also been finding that the utilities that are less exposed to data centres have become somewhat unloved. So I’ve seen some good opportunities there as well. 

The other sector in our portfolio that benefits from the ongoing digitalization are telecommunication towers, which are about 15% of our portfolio. We see these as being critical, long-dated assets for modern communications. Data consumption continues growing rapidly, and we like the assets for their high barriers to entry. These are large, physical assets that are difficult to get approval to build, because, frankly, no one wants more of them in one’s community unless they are absolutely necessary. 

And finally, we view the valuations of these assets as being at historically cheap levels, with our focus on European and U.S. to our portfolios. 

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We see infrastructure assets as being well placed in the event of a higher inflation environment. 

Stepping back briefly to our strategy, we focus on investing in the infrastructure assets that have the strongest combinations of low cash-flow volatility, and natural inflation linkage. Not all infrastructure assets have strong inflation protection, but many do, and we particularly focus on those areas. 

For example, regulated assets in areas like the United Kingdom earn a real rate of return. And so each year, the value of their assets is escalated by the regulator, by the actual inflation rate in that country. Similarly, most toll roads have tolls that escalate based on the actual inflation levels. And contracted assets, like European telecommunication towers, have inflation escalators in their tolls with the telco companies. 

Certainly, relative to the broader market, we’d expect that our portfolio should have considerable more protection from inflationary pressures. To provide as an example, back in 2022, it was a very tough year for equity markets, due primarily to a large increase in inflation expectations. In U.S. dollar terms, global equities were down nearly 20% in that year. That’s still not a good year for listed infrastructure in absolute terms, but we believe that the inflation linkage characteristics of the portfolio did well protect it during that rising inflation period, with our portfolio down only very small single digits in that year. 

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We think that regulatory risk is probably the biggest bottom-up risk when investing in infrastructure assets. And so we spend a lot of time analyzing regulators to evaluate whether they are both predictable and fair. 

We do also see significant differences in regulators across different regions. For example, in the U.S., most regulation is done at the state level, whilst in the U.K., the regulators are national based. 

Similarly, how the commissioners are appointed is important. In some U.S. states, they are elected, whilst in others they are appointed. We’re generally cautious in relation to elected commissioners. A regulator’s job is meant to be to balance the interests of the customer and the utility. And in the case of elected commissioners, they are normally more focused on pleasing the customers, for that is who will be responsible for electing them again in the future. 

In order to consider regulatory risk, we study the behaviour of the commissions over extended periods, so to determine their level of constructiveness to the utilities. [In] many cases, commissioners are willing to meet with investors, either in group settings or individually, and we certainly look to do this. In other cases, we need to rely on what they say and the decisions that they hand down. We’re also very mindful of when commissioners are set to retire, and so how that may change the future makeup of the commission. 

In relation to political risk, this is also important for infrastructure assets, and in our experience have been particularly important when things go wrong for infrastructure assets, such as in relation to major events like hurricanes or wildfires. It’s at these times that having strong political relationships is so critical for the owners of infrastructure assets. And the quality of infrastructure assets in response and recovery from these events is key to maintaining that support. 

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To start with what is the opportunity set for the listed infrastructure sector, about half of what we look at are regulated assets, so regulated water, gas and electric utilities. 

About a quarter of what we invest in are transportation concessions. So we invest in toll roads, in airports, in railway track, where the majority of the value is in the monopoly track asset.  

And then the final quarter of what we invest in are assets subject to long-term contracts. So these can include renewable assets, pipeline assets and telecommunication towers. 

From a regional perspective, most of the assets, not surprisingly, are North America, with the U.S. comprising about 40% of the opportunity set, and Canada contributing to that. But there’s also significant assets across western Europe, and to a lesser extent, through Asia and emerging markets. 

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From a region perspective, we’re overweight the U.K. and western Europe, as we like the regulation in the United Kingdom, including the inflation protection that it provides, as we discussed. And we see strong transport and telecommunication assets in Europe at what we view as attractive prices. 

We’re underweight the U.S., mainly because we don’t view the U.S. railroads as having the low cash-flow volatility and natural inflation linkage that we seek, and so we exclude those companies from our definition of infrastructure. 

From a sector perspective, we’re currently overweight water utilities. We view these assets as having high investment needs that will deliver a strong growth rate that is very long dated. We also like the water sector, as we see it as having very low stranded-asset risk. But there could well be new technologies in, say, the electric sector. But I feel pretty confident that in 100 years, the water utilities will continue to supply fresh water and remove sewage from our houses, especially in urban areas. We view the capital programs of water utilities as being low risk, as they involve a large number of very small value projects, as opposed to large projects that are more susceptible to cost and time overruns. 

And finally — and something that is pretty topical for utilities generally at the moment — we see there being less affordability risk for water utilities than, say, electrical gas utilities, as bills are typically a smaller share of the customer wallet. 

Separately, and as already mentioned, we also very much like telecommunication towers, which we see as being very high-quality infrastructure assets at currently depressed valuations.

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