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Is it time to buy monopolies?

In the good old days, infrastructure and utility stocks and their bonds were considered very conservative and safe investments with high, reliable yields. For this reason, they were often described as candidates for a “widow’s portfolio”.

One of the earliest industries for utility investment was railway companies. Back in the day railway companies owned the tracks and were effectively mini-monopolies providing very steady earnings. However, all this changed when the motor car was invented! This was perhaps the first major sign that infrastructure and utilities, as an asset class, don’t always provide safety to investors.

In more recent times, businesses such as toll roads, gas pipelines and airports have again had their relative safety brought into question. This time, not from being structurally displaced by modern technology but rather by eager private equity players and investment bankers who took a liking to their steady earning streams, pounced on them, levered them up with unimaginable amounts of debt and then flogged them back to the public.

Danger signs

Danger 1: Too much debt. Given the defensive, reliable earnings of monopoly-type assets, these businesses can handle significant levels of debt on the balance sheet, nevertheless this does increase the riskiness of the investment and needs to be scrutinised by investors.

Danger 2: Underinvestment in maintenance. Utility and infrastructure assets need maintenance. While there are some assets that require low levels of maintenance expenditure, more often than not the assets require an enormous amount of money to maintain their safety and quality. Investors need to check that a business is not underspending on maintenance, as eventually this will catch up with the company and could cause major issues.

With those alerts in mind, some “monopolies” whose balance sheet debts are probably sustainable, have highly regarded management and may warrant further consideration include:

AGL Energy (ASX: AGK) is one of Australia’s oldest companies. In recent years it has increased its position in wind and hydro-electric generation. AGL manages a diversified portfolio of gas exploration, electricity generation and processing assets as well as being a major retailer. This diversity does blur the line on it strictly being classified as a utility.

Spark Infrastructure (ASX: SKI) owns a half-share in major electricity distribution networks throughout South Australia and Victoria.

Sydney Airport  (ASX: SYD) as you might guess is the owner and manager of Sydney Airport. The business has been simplified and management internalised in recent years.

Transurban (ASX: TCL) is a well-established toll road operator that owns toll roads in Australia and the USA, including Melbourne’s CityLink.

Foolish takeaway

Utility and infrastructure stocks are usually considered low growth stocks that pay high dividends. Current yields in the sector are nothing to get excited about and suggest valuations are stretched. While debt levels may be maintainable, they are above my Foolish comfort level.

One utility stock that has a sound balance sheet and decent yield is Telstra. With its legendary, fully franked 28 cent dividend, Telstra is the darling of Aussie investors. But with its share price skyrocketing over the past year, is Telstra past its prime? Click here for our brand-new report: “Is It Time to Sell Telstra?”

More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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