Our Interview Series continues with Peter Meany, Head of Global Listed Infrastructure at First Sentier Investors (formerly Colonial First State Global Asset Management). Peter established the strategy in 2007.
GH: Infrastructure has many attractive features such as high barriers to entry, predictable cash flows and pricing power. What is the most powerful business attribute for your investing?
PM: They’re all important and they interrelate. High barriers to entry often bring predictable cash flows. If I had to pick one, it would be pricing power. An ability to charge prices at or above inflation separates the good companies from the great companies. Combined with an essential service, something that people need or want, the ability to price that is incredibly attractive.
If we are heading into lower growth in the long term because of demographics, or over the medium term because of economic conditions, that pricing power becomes even more valuable.
GH: Yes, I always think of Sydney’s Eastern Distributor opening with a toll of $3.50, and now it’s $7.76. And with automatic tolling and tags, drivers don’t even hand over the cash so they feel the cost less.
PM: It’s a classic example. The price started at a reasonable level but we’ve had increases over time at the higher of 4% or inflation. WestConnex will have the same pricing structure for 15 years so it’s a valuable franchise.
GH: What global trends are the most powerful for supporting infrastructure at the moment?
PM: There are a few. The longer-term structural drivers such as decarbonisation of the electricity grid are important. The world is moving more to renewables and less carbon intensity and the infrastructure needed is significant. On the one hand, it has negative implications for old fossil fuel power stations and the like but there's a whole new need for investment in wind farms, solar panels and increasingly, battery power storage. We’ll have new transmission lines, distribution networks, smart meters.
Elsewhere, the move towards electric vehicles means charging stations will need significant investments. A well-positioned utility company can more than offset the negatives.
GH: Will the market address these trends or should the government be doing more to encourage the changes, particularly in Australia?
PM: We need both. Governments can create certainty of policy and I think that's probably been lacking in Australia, such as what the country wants to achieve with a renewable energy target. Some incentives and penalties might help, then businesses can work with that if given enough time to adjust their capital expenditure and business models accordingly.
In the US, Federal politics has probably played less of a role. Their shift to renewable energy has been more due to state-based targets, such as in Florida, California and Texas.
But economics always beats politics. The reality is, with the investment that's taking place in renewables, we've moved a long way down the cost curve towards cheaper cost than fossil fuels.
GH: Which renewables are cheaper now and which have yet to catch fossil fuels?
PM: Onshore wind in the US is already there. Solar is probably a few years away, and it needs battery storage to extend the utilisation. Renewables are cost competitive with gas-fired power plants, and they've already surpassed coal and nuclear.
My favourite company example is NextEra, the world's largest renewable company and a big part of our portfolio. They've got some projects now where they combine wind and solar at the same facility with battery storage, and that increases the hours of the day that the facility is utilised.
GH: In Australia, most of our power still comes from coal, and yet we have an investor and public movement against coal. How do you see the timing of that transition, especially since your business is positioned as a responsible investor? Isn’t it a difficult call to decide we’re ready to move on from coal?
PM: Being a responsible investor also requires thinking about the sustainability of an energy market. While it would be good to go 100% renewable in a year, the practical reality is that we cannot achieve that, given the scale of the problem. It would help if we had some clear policies on when we want to achieve it.
The economics are moving so quickly that we will probably bring forward some of those longer-term decarbonisation dates. It’s a 10 to 15 year story rather than 25 to 30 years. I'm in the school that accepts for the next 10 or 15 years, a balanced generation mix make sense. We should be working with our companies to drive earlier changes and accept that gas will act as a transition fuel, while the future will be a lot more renewables.
GH: For the last 10 years or so, falling interest rates have provided a tailwind for your investments. While it doesn't look like rates will rise soon, at some point, we will have another cycle. What are the most resilient parts of an infrastructure portfolio against rate rises?
PM: Firstly, it depends how sharply rates rise, because businesses can adjust better to a gradual increase. If rates rise because of improvements in real economic growth, then there will be more traffic on roads and passengers through airports.
If rate rises are driven more by a pickup in inflation, most infrastructure companies that we invest in have the ability to pass on increases. It might not be as direct as a Transurban where it is quarterly, but it's at least annually in most parts of the world. So in the medium term, whether rates are going up or down, doesn't really concern me.
It's the short-term, sharp movements in rates of 100 or 150 points (1% to 1.5%) in a three or six month time frame that you see big sector rotations as people shift from defensives to growth sectors, and there's not a lot we can do in that short period of time.
GH: What types of infrastructure assets do you think will do best in the next five years?
PM: It depends somewhat on the economic and bond yield environment. If we're in a steady state, we prefer companies with good organic growth, prices linked to inflation and room for additional investment to expand a network. Toll roads are a good example. We also think mobile towers will continue to do well. There is massive demand for mobility of data, such as downloading Netflix on the phone and video games in high definition as we move from 4G to 5G. We are simply going to need more towers, more small cells and more infrastructure to support that demand.
GH: Is there a listed player in Australia in that space?
PM: Unfortunately not. Many of the towers here are owned by Telstra. The Vodafone Optus towers were sold by a US company, Crown Castle, to an unlisted Macquarie consortium.
This portfolio diversification is an advantage of being a global investor. While I love the thematic of mobile towers, I can’t play it on the ASX, while there are three big tower companies in the US that apply the theme exceptionally well (American Tower, Crown Castle and SBA). We also owned some European companies and just last year, the big Chinese telecom operators separated out their towers into one vehicle.
GH: Do you see any threats or worries to a particular sector, such as global epidemics for airports and ports?
PM: We saw September 11 and SARS affect airports, which was dramatic but in fact, short lived. Infrastructure is usually an essential service driven by long-term structural factors. We’ve seen earthquakes, terrorism, epidemics, bridges collapse. They make the news but in a diversified portfolio, they tend to come and go quickly.
Longer-term disruption events are more significant. Think about the potential impact of 3D printing on the world's chain of infrastructure. There’s the manufacturing of a $5 toy in a western province of China, and all the roads and ports on both sides of the world until it reaches New York. There's a massive amount of infrastructure moving low-value goods around the world. If 3D printing develops over the next 10 to 15 years, it might lead to more deglobalisation.
GH: Do you have a view on whether autonomous vehicles will be a plus or minus for a toll road business like Transurban?
PM: I’m definitely in the plus camp. Over the next 10 to 15 years, autonomous vehicles will create more trips. There might be less cars registered, but there will be more ride-sharing and third parties owning vehicles.
GH: They become more part of the ‘public transport’ system.
PM: Yes, and what about a future business model where the car manufacturers own the vehicles? You have a contract with say BMW, and a car that you select turns up at the door and takes you anywhere. Business models will evolve making it easy to do more trips. At the moment, people drive their car into work, pay a $4 toll and then $50 to park. Why pay for car parking when an autonomous vehicle could be sent back home? Or it could be used as an Uber during the day.
In the long term, when the whole fleet of vehicles is autonomous, perhaps the road network works more efficiently with less congestion.
GH: Your fund is up 13.5% per annum over seven years, and I’m sure you would bank that result again if you could. What is more realistic for the next five years?
PM: We've always said 8 to 10% total return through the cycle. The seven-year number is picking up from some low points and I would stick to 8 to 10% over the long term: say 3 to 4% yield, plus 5 to 6% growth. Over the next five years, perhaps we could see a 5% return if there’s a bit of mean reversion on growth and yield.
GH: Your fund is listed assets only. What do you see as the different opportunities between listed and unlisted?
PM: Both are buying the same underlying infrastructure assets generating the same cash flows. They're just held in different vehicles, which have pros and cons. Unlisted infrastructure has the advantage that revaluations are done infrequently, say every 6 to 12 months, which make them appear to be less volatile.
GH: And that has value from a reporting point of view.
PM: Yes. And there's an argument that a controlling investor has more influence over the investment. In the listed space, we offer liquidity and the ability to strategically and tactically reset our portfolio. When we see trends evolving, we can move in and out of sectors and countries and evolve the portfolio. We give investors instant diversification which would take a decade to build in a new fund in the unlisted market.
Talking my book, I believe listed infrastructure companies have become higher quality because they work to achieve a rerating as investors like us give them feedback. We might suggest that if they sell some non-core assets, or reduce their commodity exposure or economic risk through contracts, they can have a better, lower risk business. Then the market will reward them.
In the unlisted market, there is so much capital chasing so few assets, many infrastructure managers are broadening their definitions, from ‘core’ to ‘core-plus’, into areas such as car parking and merchant power generation, and shifts into less-developed countries which do not have strong political and legal systems. They are going up the risk curve.
GH: Do you have a favourite Australian and a favourite global stock at the moment?
PM: In Australia, I can't go past Transurban. It's the only Australian stock we own at the moment. The value of its networks is unique. Governments around the world need to think about congestion pricing in large cities, and Transurban owns and controls the network to do that.
Globally, we like NextEra, with half the business as a regulated utility in the high growth state of Florida, and the other half a renewable energy developer and owner. Over the next 10 to 15 years, it will be the scale operators that are best positioned, the ones that have moved further down the cost curve.
GH: Final question: has your business recognised a trend that the market is underappreciating?
PM: What we do well by being global is recognising trends that are happening in one part of the world, and seeing that as an opportunity in another part. Examples include in the satellite and mobile data space. Back in 2015, there was a clear trend in UK and Europe away from the set top box. It meant getting out of the satellite sector and moving the portfolio heavily into mobile towers.
But it’s also learning from mistakes. Germany 10 years ago moved into renewables early, and that had a significant negative impact on coal-fired generation in that country. Having made a mistake there, we moved our portfolio in the US away from utilities that had exposure to coal and more towards renewables.
Infrastructure seems like one sector but we think of it as many sectors, with specialisations within. Take mobile towers out of telecom, take airports and toll roads out of industrials, and then we see the interesting parts of each. Autonomy, 5G, 3D, globalisation, Brexit ... there are so many interesting things for an active manager.
Graham Hand is Managing Editor of Firstlinks. Peter Meany is Head of Listed Infrastructure at First Sentier Investors (Australia) Ltd, a sponsor of Firstlinks. This material contains general information only. It is not intended to provide you with financial product advice and does not take into account your objectives, financial situation or needs.
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