The Most Predictable Opportunity of a Lifetime

We won't beat around the bush, this is a simple suggestion to look at listed Infrastructure equities as a source of dividend yield, reliability and yes, even capital growth.

Author: Robert Swift

There are over 300 globally listed infrastructure companies and that list is likely to grow if we are correct about the anticipated increase in investment in the capital stock of major economies. 
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The current opportunity set is illustrated in the pie chart below.

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There are some characteristics of this stock universe that should appeal to investors who wish for capital preservation and yield. Something which used to be available from government bonds, but these are no longer a risk-free return but a return free risk. Over 1/3rd of the available government bond market now yields nothing or negative in nominal terms, let alone in real or inflation adjusted terms.

Listed Infrastructure equities offer:

• Yield and likely inflation protection
• Liquidity and accessibility to your money – unlike unlisted infrastructure
• Higher predictability of revenues, cashflow and dividends than other equities
• Lower Beta risk – we calculate about 0.8 for the universe
• Global diversification with diverse regions and sectors from which to choose

This increase would be a welcome return to investment levels required to maintain capital stock; and which used to be routine. It’s in the last 25 years or so in the West, that investment has failed to keep pace with urbanisation and population growth. It has been clearly flagged by policy makers that they would now like to play catch up.

In the Victorian and Edwardian eras, as much as 20% of the economy went on public works – bridges, railways, hospitals, schools, sewers, parks, and then roads. 
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Check out the below chart where it is clear that the West has fallen behind Asia.

​The paucity of investment has not surprisingly caused economic problems. The table below, compiled by the American Society of Civil Engineers, will tell you all you need to know about USA infrastructure. This report comes out every four years. We highly doubt the grades will be better next year.

Source: ASCE

Both Republicans and Democrats have committed to spend more on infrastructure, so this represents an investment with a good political hedge built in; unlike others such as healthcare stocks or even technology companies.

In terms of the increase in spending, it is huge. Almost $70 trillion is calculated as being needed in the next fifteen years to play catch up and to cope with increased populations and required connectivity. Some of this will come from the private sector and this is why the number of listed opportunities will increase. As active managers that is a good thing in that it provides opportunities for stock selection to work. For all investors it means they will have to consider how to get representation in this sector. 

It could be relatively soon that there are over 400 global listed infrastructure companies – there aren’t as many liquid listed companies on the Australian Stock Exchange.
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The chart below divides this anticipated investment into the major categories.

Source: Russell

​Additional attractions of investing in this area for some, will come in the form of cleaner types of infrastructure investment, and “renewable” as an investment theme. 

Quietly, the USA now produces more electricity from renewables than it does from coal. This is happening now under a Republican administration. Europe is likewise getting there. China’s solar installation is the highest in the World.

Source: US Energy Information Administration

We have adopted the (corny?) theme of 3R’s for the global infrastructure opportunity– 

Renovation of existing capital stock;

Reinvigoration of economies through productivity enhancing capital investment;
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Renewables – cleaner, sustainable, opportunities for innovation.

Our current infrastructure portfolio (available as a TAMIM Individually Managed Account) is invested in many sectors:-

​And many regions:-

A stock we would highlight is Kerry Logistics (636:HK).  We own this in the Asia Small Companies strategy and in the Global Infrastructure strategy. It’s been a good stock to own (its share price is up over 28% over the last 12 months); there is more to go for because the logistics’ supply chains are going to change as we see the continued switch from global sourcing to politically directed sourcing. Companies may have to sacrifice optimal sourcing where optimal means ‘just in time’ and to switch to optimal sourcing where ‘optimal means ‘robust’ and able to cope with politically motivated instructions from governments?

​It is still cheap:-

Source: Market Screener

It has a broad network and a diversified revenue base.

Source: Kerry Logistics company filings

​And it was carefully assessed by our team from a fundamental perspective. The Accounting Strategic and Governance lens we use for the analysis of all investee companies gave us no concerns.

Accounting, Strategy and Governance Comments

Accounting

1. 1. KLN is audited by PwC covering a network of operations in 53 countries, there are no qualifications to the accounts.
2. 2. Full compliance with accounting rules is maintained in each jurisdiction in which KLN operates.  The most recent interim results were compliant with Hong Kong Accounting Standard 34.
3. 3. In 2019 KLN changed accounting policy with respect to treatment of leases in compliance with HKFRS16, which applies a single discount rate to leases with similar characteristics.

Strategy

1. KLN has demonstrated a strong business model of developing their logistics coverage across Asia in order to benefit from the growth of intra-Asian trade. Intra-Asian trade recorded growth of 22% in the past year, a much faster rate than Asian trade with other continents. 
2. KLN has been successful in making strategic acquisitions in the region and utilizing joint ventures to enter new markets.  KLN’s expansion into Taiwan has been built around the acquisition of Science Park Logistics, which specializes in electronic components.
3. The Company looks to extract value for shareholders by selling assets when appropriate. Profits in the current year have been substantially boosted by the sale of warehouse assets in Hong Kong.  The company is also looking to list Kerry Express Thailand on the Bangkok exchange raising $300 million with that IPO.
4. KLN is a beneficiary of China’s Belt and Road Initiative, in particular road and rail assets across the interior of Asia into Europe is a strength for the Company, infrastructure in that region is receiving a significant boost from investment funded by China that will help drive higher volumes of freight.

Governance

1. Full governance with the Hong Kong governance codes.  KLN was a spin-off from Kerry Properties Limited (KWOK family) which remains a major shareholder with 42.12% of the outstanding shares.  The Company has declared continuing and ongoing connected transactions with the parent group in the appropriate manner.  We are satisfied that connected transactions are appropriately authorized, disclosed and take place on an arms-length basis.  
2. The Board of eight people comprises four executive and four non-executive directors of which three are defined as independent.  All directors have suitable qualifications and experience.  The company publishes an ESG report annually in compliance with Appendix 27 of the Main Board Listing Rules in Hong Kong.
3. The company has a 32% payout ratio in recent years and has paid special dividends following the sale of assets. 

Conclusion

The era of ever lower interest rates has produced little sustainable growth. Global economies need fiscal investment to correct this. If Covid-19 has a bright side, it is the excuse to unleash public fiscal spending. This is happening. The better led economies will spend on productivity enhancing projects including broad infrastructure enhancements, and thus be better prepared for the next version of the global economy. These economies will pull ahead and attract more people who wish to participate. Investors who catch this early will prosper too.