Infrastructure predicted to boom in years ahead

Mar 26 2008 by Andrew Miller, The Journal

SOMETIMES it pays to ignore short-term volatility and focus on the long term. When markets seem to be sound-tracked by The Flight of the Bumblebee, it is worth taking a step back, setting aside sub-prime, credit crunches and structured investment vehicles – and considering how the major challenges facing us will translate into deeper, more profound investment trends.

One long-term trend that we have covered before is the rise in food prices and commodity costs. Another, and our theme for this week, is infrastructure. Over the coming years, we see increasing business for the companies who make and maintain the energy, water, and transport air networks that support the global economy.

Firstly, global demand for energy is set to increase over the next decades, as the Chinese and Indian economies boom, and that will mean more spending on infrastructure. The International Energy Agency forecasts that US$20 trillion will be spent on energy infrastructure between 2005 and 2030.

Infrastructure companies’ business will also be supported by the need to replace ageing equipment, not just for commercial reasons, but also to meet political demands, like measures to prevent climate change and ensure energy security. The UK Government’s White Paper on Energy last year said that substantial new investment will be needed in infrastructure in the UK.

Changing demographics and investment trends are also supporting demand for infrastructure companies. These businesses by their nature tend to have long-lasting, reliable returns. That makes them very attractive to investors like pension funds, who need a guaranteed, long-term stream of cash.

The most accessible way for UK investors to profit from the infrastructure theme is via the national utility companies. Electricity and gas network manager National Grid remains our preferred UK utility, and we think it is the best-placed candidate in this country to benefit from our broader global infrastructure theme.

National Grid is attractively valued, and offers a compelling long-term growth opportunity from the hefty investment programme it expects to undertake in the UK and US – the group plans to invest an additional £12bn gross in its networks by 2012. (To put this in context, its current market capitalisation is roughly £17.9bn.)

Unlike most other UK utilities, National Grid’s valuation has not been artificially boosted by M&A speculation. The group is simply too large for most potential suitors to stomach. In addition, the complications of obtaining regulatory approval for any deal from both the UK and US federal and state regulators is likely to put off bidders.

On pure fundamental grounds, National Grid looks the most attractively valued of its peers. Its stable cash flows provide an excellent basis for the group to reward shareholders with an attractive and fast-growing dividend. Our fair value estimate for National Grid is 844p per share, more than 15% above the current level.

Our satellite holding is electricity generation group International Power, which has slightly under-performed the UK electricity sub-sector so far in 2008, largely due to concerns that the credit crunch would increase the expense of its project financing. However, recent results showed that this is not currently a problem. Its impressive project pipeline should go some way to assuage nervous investors, and other attractions are relative international diversity and strong free cash flow generation.

Andrew Miller is regional head of Barclays Wealth.