Infrastructure is in the news, with the Commonwealth Government deciding to dust off the plans for a second airport for Sydney, at Badgerys Creek, 56 kilometres west from the central business district, to lessen what is seen as the pressure on Sydney’s Kingsford Smith Airport at Mascot.
The news took 4.4% off the share price of Sydney Airport (SYD), the owner and operator of Kingsford Smith Airport, under lease until 2097. But while a second Sydney airport would theoretically compete with Kingsford Smith, the reality is that major international carriers would still want to fly into Kingsford Smith, which has scale and quick links to the central business district; and SYD has first right of refusal over the second airport.
That means that (a) any second airport would mainly accommodate surplus demand that Sydney Airport was unable to meet, and (b) SYD would be the most likely entity to develop and own a second airport.
The discussion has brought investor attention back to the infrastructure stocks, a sector of the Australian Securities Exchange (ASX) that has – like the real estate investment trusts (REITs) – cleaned up its act. Just as the REITs got the financial engineering bug pre-GFC, ramping up their gearing, expanding overseas and developing non-rental sources of income, many of the infrastructure stocks geared-up well beyond what their cash flows could support.
But post GFC, the sector has largely settled down into what infrastructure should represent to an investor: a defensive asset class, offering the potential for stable, inflation linked income, portfolio diversification and capital growth.
In particular, the “regulated” infrastructure stocks, such as electricity distributor Spark Infrastructure (SKI), electricity and gas transmission and distribution group SP AusNet (SPN), gas pipeline operators APA Group (APA) and Envestra (ENV), and diversified energy infrastructure investor DUET Group (DUE), have become favourites of conservative, yield-conscious investors, who want access to the relatively predictable cash flows from strong ownership positions in essential-service infrastructure.
Come fly with me
Sydney Airport does not qualify as a regulated infrastructure stock: its performance is economically cyclical, and depends on passenger numbers through the airport. It has developed highly lucrative cash flows in the form of retail operations (22% of revenue), car parking (12% of revenue) and property/car rental (17% of revenue): all up, these sources just shade aeronautical services (49% of revenue) as the dominant contributor to revenue.
SYD has been a strong performer, with a 12-month total return (dividends plus capital growth) of 31.8%, and 33.4% a year over the last five years, but as is common with performance of that kind, the stock appears fully valued. The analysts’ consensus target price (collated by FN Arena) has it trading, at $4.11, just three cents short of target. On yield grounds, investors are still expected to pick up 5.8% in FY14 and 6.3% in FY15, which does not look enough to make up for minimal capital growth likelihood.
Sydney Airport is not the only airport stock listed on the ASX: Auckland International Airport (AIA), its counterpart in New Zealand’s largest city, also has a dual listing in Australia. AIA has also been a very good performer for Australian investors: a total return of 53.5% in the last 12 months, up 35.3% a year over the last three years and up 26.7% a year over the last five years, but on yield grounds, AIA does not stack up: having not paid an interim dividend this year – because of a one-for-ten share cancellation and a payment of NZ$3.43 for each share cancelled – its yield is expected to fall to 1.7% this year and 3.6% in FY15.
Also a problem for Australian investors is that the imputation credits from fully franked New Zealand dividends are not available to Australian residents: the New Zealand government refunds the imputation amount to foreigners, minus 15% withholding tax. This refund is paid as a supplementary dividend, increasing total dividends received by foreigners by about 18%. This makes New Zealand dividends not as tax-effective for Australian investors as local stocks paying fully franked dividends: this is a very important consideration for SMSFs.
The better options
On the regulated infrastructure front, Australian investors have a small but high-quality population of stocks to choose from, comprising:
- Regulated utility SP AusNet (SPN), which operates Victoria’s primary electricity transmission network, an electricity distribution network in eastern Victoria and a gas distribution network in western Victoria.
- Spark Infrastructure (SKI), which owns 49% stakes in three electricity distribution networks: CitiPower and Powercor in Victoria; and SA Power Networks in South Australia.
- Gas pipeline operator Envestra (ENV), which delivers natural gas to more than one million Australians in South Australia, Victoria, Queensland, NSW and the Northern Territory.
- APA Group (APA), which operates gas pipelines and storage facilities across Australia. (APA owns 33% of Envestra, and manages and operates its gas distribution networks and pipelines under a long-term agreement, and is trying to buy the rest in a $2.1 billion deal.)
- Diversified energy infrastructure investor DUET Group (DUE), which owns majority stakes in three Australian assets: the Dampier-to-Bunbury Pipeline (DBP), United Energy, and Multinet Gas, which distributes electricity and gas to eastern Melbourne and the Mornington Peninsula. Multinet and United Energy are regulated utilities, while the DBP operates under contracts: it will come under regulation in 2016.
- Transurban Group (TCL), a toll-road owner and operator with interests in Australia and the United States. It wholly owns the CityLink tollway in Melbourne and the Hills M2 and the Lane Cove Tunnel in Sydney, and owns majority or half stakes in six other roads, three in Sydney, one in Melbourne and three in Virginia in the US).
What you should be looking for in an infrastructure stock is a strong yield, from a payout that is well funded from earnings. Mature infrastructure companies are able to pay out more than 100% of profit because their predictable earnings and strong free cash flows cover it – but payout ratios of 200% plus are grounds for concern. Only Transurban and SP AusNet offer any franking.
Most stocks appear fully valued, with only Spark Infrastructure offering any meaningful upside to target price. The three stocks projected to pay nominal yields of 6% plus in FY15 – DUET Group, Spark Infrastructure and SP AusNet – look the best current value at present, given reasonably favourable outcomes from their next rounds of regulatory review. And that is the major caveat when it comes to regulated infrastructure plays.
Tale of the tape
Source: FN Arena, company dataImportant: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report:
- Peter Switzer: Why I think this bull market has legs [1]
- Paul Rickard: Product road test – a UBS dividend ETF [2]
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say [3]
- Gary Stone: The little Aussie performer [4]
- Penny Pryor: Shortlisted – Dick Smith, Telstra [5]