Infrastructure shares to sell
Rising interest rates are an extra threat to overpriced road and airport stocks
When we visited the infrastructure sector back in 2016, we declared many of the stocks to be overpriced. They later declined by between 10% and almost 20% before recovering to be virtually unchanged. So what has changed?
It remains the case that sitting down at a dinner party and stating you own a toll road like Sydney’s M2 will get jaws dropping and tongues wagging. There is no question that owning a piece of essential infrastructure will elicit all the responses experienced by monopolists. In the absence of regulation or taxation by federal, state or local governments, infrastructure owners can charge what they like thanks to the often inelastic demand for its use. And when legislation at the time of the sale of the infrastructure, or before permits are granted for its construction, is inadequate, owners are subject to a barrage of inquiry and investigation.
Nevertheless, the benefits of ownership of the hard assets on the balance sheets of Sydney Airport, Auckland Airport, Transurban and utility companies like Origin Energy, DUET Group and AGL Energy are the inflation-protected revenues, as well as some immunity from economic fluctuations and the business cycle.
But what has materially changed since we last wrote about this sector in 2016 is that expectations of inflation have emerged globally and Donald Trump has accelerated that sentiment. Long bond interest rates are now rising. Evidence of this is best illustrated in the US 10-year Treasury rate, which in July last year was just 1.36% – the lowest since before 1773. Today that bond rate is 2.40%. The impact of this shift in rates and inflationary expectations won’t be felt in the very near term. Indeed, initially the market will see higher rates as a sign of economic recovery and growth, which are generally positive influences on the profits of companies. But if rates keep rising the negative impact on the present values of future cash flows will overwhelm the benefit of growth and press asset prices lower – much as gravity brings us all back to earth.