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Roads to riches

High returns keep shareholders happy.

April 4, 2007

Beth Quinlivan, The Sydney Morning Herald

The debate about whether listed infrastructure stocks were set up mainly to generate fees for investment bankers or to secure defensive long-term investments suitable for anyone looking for a reasonable yield is as strong as ever.

It's more than a decade since the first of the infrastructure groups was launched on the Australian investment scene and, excluding the public utility groups, infrastructure funds listed on the stock exchange are valued at close to $35 billion.

The biggest - and oldest - is Macquarie Infrastructure Group, worth $10 billion with toll roads in Australia, Europe and North America.

The smallest - and newest - is RiverCity, which floated last year. It is building a north-south bypass in Brisbane due to open in 2010, but the price has dropped 20 per cent since listing, to $252 million.

In the middle are Transurban (toll roads mainly in Melbourne and Sydney), Macquarie Airports (interests in six airports around the world including a major stake in Sydney Airport), Macquarie Communications (television and radio transmission infrastructure), Babcock & Brown Infrastructure (ports, power transmission, wind generation), ConnectEast (building Melbourne's newest toll road) and Australian Infrastructure Fund (interests in nine airports, three seaports, light rail and one toll road).

At face value - looking at the quality of assets and the returns generated to date - there is plenty to like about infrastructure investments. They generate reliable and inflation-indexed cash flows that are valuable for a broad spectrum of investors, from institutions to retirees running their own super funds.

As far as returns, most have been pretty impressive. Anyone who put money into Macquarie Airports has enjoyed an average total return over the past three years of 40 per cent a year. The share price of Transurban has been flat recently but it has returned 26 per cent on average for the past three years. According to Aspect Huntly, Macquarie Infrastructure has the lowest average total three-year return - hardly disastrous at 19 per cent a year for a mature company.

Ask the sceptics about infrastructure, though, and they run through a series of negatives. At the top of the list are the complicated structures favoured by most infrastructure groups which makes it difficult for even professional analysts to understand the cash flows and accounts.

Other negatives include the hefty fees that are paid by the funds to managers and promoters and high levels of gearing which make them susceptible to interest rate rises.

And although the underlying businesses tend to generate reliable cash flows, stock prices are volatile.

The larger funds trade as triple-stapled securities. Investors buy shares or units in three separate corporate entities which trade as a single unit. For Macquarie Airports, the traded security consists of units in two trusts (which hold the assets) and equity in a Bermuda-based company.

With Macquarie Communications, securities are made up of equity in both a local and an international company (Bermuda) and units in a trust. Transurban and others follow roughly the same arrangement.

The funds say they use these structures because they are financially efficient but it really means investors end up having to take it on faith that the managers know what they are doing. The chances of ordinary shareholders making sense of the information provided - enough to pick up warning signs or follow important developments - is pretty slim.

Common practices, such as treating asset revaluations as revenue, also sit uneasily with some more conservative investors.

With Macquarie Infrastructure, for example, the $1443 million reported net profit for the July-December half-year was heavily dependent on asset revaluations. The group reported revenue from its toll roads of $121.5 million for the six months, but further revenue of $1160 million was booked after asset revaluations.

"The assets are unilaterally good - if you look across the funds, it is hard to find duds," says Clinton Wood, analyst with Deutsche Bank. "Investors are getting decent yields, infrastructure looks reasonable value among the defensives."

But he notes not everyone is entirely comfortable with the sector. "Some of the institutions still won't touch infrastructure because of the structures and fees. Prices also tend to whip around on sentiment.

"But the market is maturing. If you compare infrastructure to property, infrastructure is still smaller and impacted by quirky accounting. The big difference is that with property you're getting 5 per cent yield. With some of the key infrastructure names, you're getting 7 to 8 per cent yield. In my mind, the risk reward is still in favour of infrastructure."

Prices across the sector dipped in the middle of last year although most picked up again by the end of the year - in some cases up 30 per cent of the mid-year lows. In more recent months, the three Macquarie funds have outperformed the other infrastructure stocks, with not much excitement anywhere else.

Wood says last year's falls followed a combination of investors cashing out of defensive investments to allow them to buy resources stocks and negative sentiment following interest rate rises and high oil prices, especially the impact on toll road and airport traffic.

So with the outlook for interest rates uncertain, investors should ask is it a good time to buy infrastructure?

"They are defensive stocks and that has been one of the recent attractions, but when interest rates go up, the stocks are sold down," says Luke McNab, an analyst from broking firm ABN Amro.

As for recommendations, McNab believes the pick of the sector is Macquarie Airports and has a price target on the stock of $4.50 (trading about $4).

"[Macquarie Airports] reported a solid result in 2006 but the real story is what is happening in 2007. We expect strong earnings growth from core assets, the sale of Birmingham airport, the refinancing of Brussels airport to fund a special distribution, buyback or acquisitions," he says.

Wood takes a different view. After its recent price rises, he believes Macquarie Airports is fully valued. He thinks there is better value in Transurban and Australian Infrastructure.

"Australian Infrastructure has a very good portfolio but gets overlooked because it is small. But its airport interests are in some of the fastest growing population areas, especially Perth and the Gold Coast."

He says the upcoming sale of the 15 per cent stake in Perth Airport owned by British group BAA (following BAA's takeover by Spanish infrastructure group Ferrovial) will update the real value of the asset. Given the demand for quality assets, he believes bidding for the facility will be strong. He says potential US acquisitions will underpin price rises for Transurban over the next year.