Infrastructure stocks can pay solid dividends, but the returns from infrastructure funds are mixed. Here’s what you need to know about investing in the sector.
Investment-wise, infrastructure includes purchasing individual stocks in a utilities company or going with an infrastructure fund that buys into a suite of stocks in the sector. Infrastructure projects generally have a single purpose, such as building a hospital, railway station or road.
The costs for developing a piece of infrastructure are generally too high for other companies to enter the market and become a competitor, and oftentimes it doesn’t make sense for several businesses to produce duplicate facilities for the community; so the infrastructure sector is what economists call a ‘natural monopoly’. Hence, the few companies involved in developing infrastructure or utilities are in an advantageous position. For the dividend investor, yields are generous.
Tim Wong, Senior Research Analyst at Morningstar says the risk within the infrastructure sector varies, depending on the type of utility.
Companies with regulated prices or revenue have predictable streams of cash flow, because such prices incorporate potential changes in inflation and interest rates. As a result, regulated infrastructure brings reliable returns even during an economic downturn.
Infrastructure companies involved in projects based on a ‘user-pays’ system, are influenced by wider economic activity and can be a little riskier.
“The cash flow of a seaport, which depends on the level of demand – like the number of ships coming in – may be less stable than the earnings of a regulated energy provider”, Wong says.
Although utilities were once developed by the public sector, the government has increasingly delegated the task to the private sector, sometimes with conditions attached.
“There is a regulatory risk as many utilities’ returns are set by a government agency which is tasked with setting a fair return for investors while protecting households from high energy prices”, says Adrian Atkins, Morningstar’s Senior Equities Analyst.
Another risk includes the potential worsening of debt markets. Atkins says that because infrastructure projects require plenty of capital, the sector is highly dependent on accessing debt markets. “If debt markets freeze again, some companies may be unable to refinance maturing debt, though most have lower gearing than in the GFC which makes it easier”, says Atkins.
1. APA Group (APA)
APA Group owns a gas transmission network across Australia. The growth in gas as an environmentally-friendly alternative to coal will give the company opportunities to expand its projects.
APA Group faces fairly limited regulation, which enables it to generate relatively better returns than some of its competitors.
“We currently have a ‘hold’ recommendation on them, but we recommend buying them when the price dips”, says Atkins.
• Current price: $4.76
• Target price: $5.30 (Deutsche)
• Dividend yield: 7.21%
2. SP Ausnet (SPN)
SP Ausnet is involved in diversified energy infrastructure. Operating in Victoria, it runs electricity transmission and distribution networks, in addition to a gas distribution network.
The company has a strong balance sheet, regulated cash flows and has had a steady history in its dividend payments. “SPN is an attractive yield play in the utilities sector”, says Michael Wu, Equities Analyst at Morningstar.
• Current price: $0.97
• Target price: $0.97 (InvestSmart)
• Dividend yield: 8.27%
3. Transurban Group (TCL)
Transurban develops and manages toll roads in Australia and North America. In the latter half of 2011, the company recorded a 27% jump in net profits which was welcomed by the market.
Sada notes that Transurban benefits from the stability of regulated revenue, as the toll price rises according to inflation and traffic volumes. The company’s cash flow has been stable and is likely to boost on the back of its latest project.
“The M2 in Sydney is being widened and now that TCL has won a deal from the NSW government to expand the M5 motorway, there’s potential for further toll revenue growth in coming years”, says Benny Sada, Senior Equity Analyst at Australian Stock Report.
• Current price: $5.68
• Target price: $6 (Bloomberg)
• Dividend yield: 4.77%
1. Vanguard Global Infrastructure
Vanguard invests in the more defensive stocks selected from the UBS Global Infrastructure and Utilities Index. These companies selected have few competitors, regulated revenue, is not heavily influenced by global share markets and come with little risk in terms of the companies’ balance sheets.
Wong says this fund has fared better than others during economic downturns. For the hedged fund, the 1-year and 3-year trailing returns were 2.62% and 7.72% respectively.
However, the returns are very disappointing for the unhedged fund: the 1-year return was -7.62% and the 3-year return was -10.32%. Morningstar labels the unhedged fund’s risk as ‘above average’.
2. RARE Global Infrastructure
RARE looks for under-valued listed infrastructure that is regulated or based on a user-pays system, such as toll roads, gas pipelines and electricity distributors.
Wong says the fund comes with some risk, as one-quarters of the fund’s assets are based in emerging markets; and excessive gearing has been an issue for the fund before.
The fund’s returns suffered in 2008, however still outperformed the S&P Global Infrastructure Index at the time. In the year to June 2011, defensive areas including water and gas fared well although railways and toll roads struggled due to tougher economic conditions.
The hedged fund’s 5-year return was 3.75%, while the 3-year and 1-year returns were 13.97% and 5.13% respectively. Returns figures for the unhedged version of RARE are currently unavailable.
-- By Stephanie Hanna