Infrastructure - opportunities and threats from COVID-19

 

COVID-19 has challenged the assumption that infrastructure investment offers defensive revenue characteristics that tend to hold up during periods of economic stress.  

Investors need to appreciate that not all infrastructure assets are the same, and that each sub-sector will react differently to COVID-19.

Infrastructure can broadly be separated into at least 3 categories:

  1. Regulated assets, including electricity transmission lines, gas pipelines and water distribution systems.
  2. Transportation assets, including toll roads, tunnels, bridges, seaports and airports.
  3. Communication assets, including radio and television broadcast towers and wireless communication towers.

So far during the COVID-19 crisis, the revenues and share prices of regulated assets and communication assets have shown great resilience.  This makes sense as a business such as Spark Infrastructure, who provides the power line infrastructure to supply electricity to homes in South Australia and Victoria, will continue to be paid to transmit electricity with or without COVID-19.

The infrastructure sector that has seen the most disruption through the lockdown of populations has been the transport assets which includes toll roads and airports.  Transurban (tollroads) and Sydney Airport have seen share price falls of around 25 – 40% since the end of February 2020.  These assets would seem to provide investors with great opportunity for future profit, due to the high level of uncertainty that is currently reflected in their share price.

There has been much made of Sydney Airports debt, however if the airport closed tomorrow, it has enough funding to cover all expenses and refinancing requirements for at least a year.

Clearly passenger numbers at Sydney Airport will be down for some time, however analysts can arrive at a valuation materially higher than the current share price even allowing for some dramatic falls in passenger numbers.  A model we have read includes a 90% fall in international traffic for the next three months and then a 50% decline for the remainder of the year.  This scenario assumed for domestic passengers a 60% decline for three months and a 20% decline for the remainder of the year.  Short term earnings fall by around 40% under this scenario, but shareholders have over 80 years remaining of a 99 year lease over the Sydney Airport, which makes short term earnings movements less relevant.

What is more relevant is whether Sydney Airport is likely to breach any of its debt covenants, and whether it needs to raise capital by issuing new shares at discounted prices and diluting existing shareholders value in the process.

Sydney Airport’s debt covenants are not publicly available, but analysts are of the view that they are no more onerous than those originally set out in 2002.  Under the above modelling, Sydney Airport would be unlikely to breach its debt covenants.

Transurban, which is an owner of multiple toll road assets faces some risk of particular roads breaching debt covenants, but as a group Transurban looks to be well capitalised and not likely to need to raise capital on the basis that the lockdown period lasts for 3 – 6 months.

The key risk facing investors with respect to transport infrastructure assets revolves around knowing how long the population lockdown will last for.  The modelling outlined earlier shows that Sydney Airport would be unlikely to need to raise capital if the lockdown lasted for 3 months, but a lockdown of 6 months would intensify pressure on debt covenants and a capital raising.  The length of the lockdown in ‘unknowable’ at this stage but the message is clear, the longer the lockdown, the more damage is done to earnings and to valuations.  

Investors would be best served to think in terms of scenarios, rather than absolute points at this stage and remain flexible in their thinking to accommodate new information as it comes to hand.

Out the other side of COVID-19, as with past disruptions it is highly likely that airport traffic and toll road traffic recover to reach new highs. A case could also be made for greater motor vehicle transport as commuters could seek to avoid the health risks associated with public transport.  Lower bond rates could also provide a tailwind to infrastructure valuations.

While no-one knows how COVID-19 plays out yet, what we can say with certainty is that that toll road traffic should return faster than air travel passenger numbers.  This means that toll roads should offer less earnings risk than airports at the present time.  

  

This article was published in the Australian Financial Review during April 2020.