Solid returns tipped for infrastructure stock

A key point of debate for investors regarding the sector is the risk of rising government bond rates. Rising bond rates are generally viewed as a headwind for the sector as it is considered to have bond-like features due to the stability of cashflows. We think interest rate rises affect the valuation of all asset classes, and interest costs for infrastructure stocks are likely to continue to fall as debt is refinanced at lower rates. Instead, the short-term underperformance of the sector in a rising rate environment is due to the lower sensitivity of infrastructure earnings to an economic uptick that normally accompanies interest rate rises than is seen with cyclical stocks. Even in a rising rate environment we expect infrastructure stocks to generate solid returns over the medium-long term. 

We don’t believe there needs to be a mad rush to exit infrastructure stocks. In fact we are interested in infrastructure investments which have a high probability of increasing their distributions paid to shareholders.   

We believe one of these investments is  Macquarie Atlas Roads (MQA). MQA invests in toll roads, with its largest exposures being in France and the United States.  MQA has a market cap of $2.8 billion and ranks in Australia’s top 100 companies by market cap.

Recently, MQA acquired the remaining 50pc of the Dulles Greenway in Virginia (USA) that it did not already own for US$445m by exercising its pre-emptive rights. The price paid was broadly in-line with our existing equity valuation of the asset.   

The bulk of MQA’s valuation is sourced from its stake in the APRR, which is the second largest motorway in France. Toll revenue growth slowed from 5pc down to 2.1pc for the March quarter 2017.  The slowing in revenue growth was due to effectively flat traffic growth as a result of cycling a strong March quarter 2016 (including Easter falling in March last year).  Factoring in the quarterly data has seen our 2017 traffic growth forecast decline  from 2.8% to 1.0%. We’ve left our long-term traffic growth assumption of 1.3% pa unchanged.   

APRR is benefitting from a rapid reduction in debt service resulting from the ultra-low interest rates currently available in Europe. We expect material reduction in debt service to occur in 2017 with maturity of expensive CNA debt, and in mid-2018 when the Eiffarie interest rate swaps expire (a key contributor to financial year 2019 forecast step-up in distributions per share). The legislated cut in the French corporate tax rate from 33% to 28% applicable 2020 should benefit distributions from 2021. 

Revenue growth of 7.1pc on the March quarter 2016 was driven by 4.1pc growth in traffic and an increase in tolls from March 2017. On the face of it, this looked a solid result. However, the quarter had a number of positive impacts (Spring Break in April, fewer weekends than the previous corresponding period, minimal weather impact). Adjusting for these, we understand the underlying traffic growth was close to flat.  This can partly be explained by the negative impact of the widening of the Gloucester Parkway (completed August 2016) which benefits competing routes in the corridor. Adjustments to our revenue forecasts are minor. The economic development in the road’s catchment area should drive growth over the medium-long germ. 

MQA offers good valuation support with strong potential distribution growth into 2019.  We forecast that the dividend yield will grow from 4pc to 8pc in 2019. This dividend increase is driven by growing toll revenues, cost containment, potential for substantial decrease in debt service, and initial distributions from the Dulles Greenway in 2019 as lender distribution criteria are met for the first time.