Growth and urbanisation: A compelling investment opportunity
One birth every one minute, forty seconds. One person arriving in Australia to live every 56 seconds. These are powerful Australian Bureau of Statistics (ABS) figures, which highlight the remarkable growth taking place right here in Australia.
The ABS projects between 31 and 42 million people will call Australia home by 2056 – a significant increase on our current population of just over 25 million. This growth rate makes Australia one of the fastest growing ‘developed’ countries globally.
With population growth typically comes urbanisation. Despite our vast continent 90% of Australians live within 100km of the coast, with over two-thirds living in our capital cities.
For investors population growth and urbanisation is an enticing investment narrative. So how can we gain exposure?
Underpinning Australia’s growth
Two core elements which underpin any developed country’s growth are property and infrastructure.
For decades, Australian Real Estate Investment Trusts (A-REITs) have provided exposure to the property growth angle, delivering strong long-term returns. While we still believe high-quality A-REITs are sound investments they are not without risk and provide limited diversification.
The 10 largest A-REIT issuers currently account for 86% of the S&P/ASX300 AREIT Accumulation Index market capitalisation. Additionally, almost half of the underlying assets of A-REITs are now concentrated in retail real estate, a sector experiencing significant change due to the growth of e-commerce and changing consumer behaviour.
When it comes to infrastructure, Australian Listed Infrastructure (ALI) provides exposure to monopolistic assets critical to the growing population such as toll roads, airports, utilities and pipelines.
We view toll roads and airports as two sectors within ALI that are well positioned to benefit from ongoing population growth and urbanisation.
Pipelines and utilities are two other major sectors and have compelling investment prospects as well.
Infrastructure assets share some similar attributes to REITs, in that the primary source of earnings is derived from assets which generate sustainable, often long dated, inflation-protected cash flow. However, there are many traits relatively unique to listed infrastructure.
The most distinct is that many infrastructure investments provide exposure to monopoly-like assets. There are incredibly high barriers to entry for assets such as pipelines, toll roads and airports.
Due to their monopolistic status infrastructure assets are typically regulated which ensures stable returns, while performance is generally not dependent on the short-term condition of the economy – making infrastructure returns relatively defensive. In our opinion, these are highly desirable characteristics in any portfolio.
High-quality Australian Listed Infrastructure
One of the most well-known monopolistic-like ALI businesses is Transurban Group (ASX:TCL). TCL’s toll roads are critical infrastructure assets with high barriers to entry.
Over three quarters of TCL’s value comes from its Sydney and Melbourne road networks, with the remainder Brisbane, Washington DC and Montreal. Its Melbourne asset, CityLink, is a 22-kilometre road connecting the Monash, West Gate, and Tullamarine freeways. Cash flows from this asset (before any debt) have increased by over 9% per annum from 2014 to 2018. We only expect a slight deceleration the coming years.
CityLink is just one example of the lucrative business that is toll roads. TCL has many more. In Sydney, TCL’s toll road assets are immense, as you can see from the map below.
Consumers who value their time have few other options. Plus, as a shareholder one might feel (slightly) better paying the tolls!
Due to Transurban’s dominant Sydney toll road network, it has an intimate understanding of road traffic volumes. Importantly, the majority of Transurban’s tolls escalate at around ~4% per annum, this is above inflation and this real price growth is very attractive in the current low economic growth environment. Furthermore, population growth in both Sydney and Melbourne is expected to remain strong in the coming decades, which should provide further patronage for Transurban’s roads.
When considering the valuation of toll roads, investor should analyse three factors; concession length, traffic growth and toll price growth.
An ALI business which may be less high profile, but also has similarly powerful monopolistic traits, is APA group (ASX:APA).
APA has an around 60% market share of Australia’s gas transmission market, average contracts lengths are over 12 years with investment grade tenants. You can see on the image below just how vast APA’s pipeline network spans.
We believe other high-quality ALI stocks are companies such as; Sydney Airport (airports), Auckland International Airport (airports), Atlas Arteria (roads) and Ausnet Services and Spark Infrastructure (both energy transmission and distribution).
Airports exhibit high barriers to entry and in Australia and New Zealand there are limited effective substitutes for air travel. Road and train travel between major cities is less prevalent than in Europe for instance, underpinning airport passenger growth. Historically, air travel growth in Oceania has proved to be resilient to external shocks and growth has over the long-term exceeded GDP growth.
Sydney and Auckland Airports are both leveraged to population and wealth growth in Asia Pacific, because with increased wealth more air travel will follow.
Both airports generate around half of their revenue from their aeronautical businesses and these are subjected to regulatory oversight. The other half of their revenues is derived from non-aeronautical related activities, comprised of rent on highly productive retail shops in the terminals, including duty-free hotels, airline lounges, commercial office and logistics properties and car parking. Interestingly, Auckland Airport has immense land holdings which has enabled it to become one of the largest developers of industrial real estate in the country.
With respect to AusNet and Spark, as the owners of critical infrastructure assets including electricity distribution (poles and wires) and transmission networks (high voltage power lines) that effectively transport power from the generation sources to consumers and businesses, neither are susceptible to fluctuations in energy usage. Naturally, the forces of population growth and urbanisation create greater need for energy transport infrastructure.
A key positive theme for both AusNet and Spark is the decentralisation of electricity generation. This involves the retiring of coal-fired power plants replaced with new renewable power generation sources such as solar and wind farms. These renewables require energy transmission infrastructure to be built to integrate them into the electricity grid, providing a growth opportunity for both AusNet and Spark.
When analysing Australian infrastructure stocks over the long term, it’s clear they have outperformed A-REITs. The next chart illustrates this.
The primary reason for the outperformance is that A-REITs were ill-disciplined in the lead up to the Global Financial Crisis (GFC), resulting in the need to repair their balance sheets at a low point in the market.
Pleasingly, the sector seems to have learned from its mistakes, the balance sheets and strategies are currently in good shape.
Property and infrastructure a true measure of growth and urbanisation
We believe the best way for investors to gain exposure to Australia’s growth and urbanisation narrative is through a diverse portfolio of high-quality A-REITs and ALI.
By grouping together A-REITs and ALI we are presented with a $233 billion investment opportunity in ‘Real Assets’. We believe this is a case where concentration issues for both sectors are effectively addressed within a real assets framework.
This is an investment opportunity the Resolution Capital Real Assets Fund aims to exploit in order to generate annual total investor returns exceeding the S&P/ASX300 AREIT Accumulation Index, but with improved diversification.
We have been investing in A-REITs since 1995 and will continue our strong track record, but add ALI with its monopolistic characteristics, underpinning reliable earnings growth to achieve better investment outcomes for our clients.
Investing in the offices, roads, warehouses, airports, pipelines and shops, that underpin our nation is an opportunity we believe all Australians should have the opportunity to be part of.
To find out more about the Resolution Capital Real Assets Find, click here.
By Andrew Parsons, Resolution Capital Chief Investment Officer.
Interests in the Resolution Capital Real Assets Fund are issued by Pinnacle Fund Services Limited, ABN 29 082 494 362, AFSL 238371, as responsible entity of the Fund. Pinnacle Fund Services Limited is not licensed to provide financial product advice. You should consider the Product Disclosure Statement of the Fund in its entirety before making an investment decision. Resolution Capital Limited (‘Resolution Capital’) (ABN 50 108 584 167 AFSL 274491) is the investment manager of the Fund. Pinnacle Fund Services Limited and Resolution Capital believe the information contained in this communication is reliable, however its accuracy, reliability or completeness is not guaranteed. Any opinions or forecasts reflect the judgment and assumptions of Resolution Capital and its representatives on the basis of information at the date of publication and may later change without notice. The information in this communication is not intended as a securities recommendation or statement of opinion intended to influence a person or persons in making a decision in relation to investment. This communication is for general information only. It has been prepared without taking account of any person’s objectives, financial situation or needs. Any persons relying on this information should obtain professional advice before doing so. Past performance is not a reliable indicator of future performance.