Listed infrastructure stocks are all the rage at the moment as record low interest rates fuel demand for highly regulated, defensive businesses which are unaffected by the broader economy. The predictable cash flows from infrastructure assets like electricity transmission lines, ports, toll roads and airports means stocks like AusNet Services (ASX: AST), Qube Holdings Ltd (ASX: QUB), Transurban Group (ASX: TCL) and Sydney Airport Holdings Ltd (ASX: SYD) all command high price-earnings multiples as they provide investors with the closest alternative to bond-like yields.
With earnings season well and truly behind us, investors now have the luxury of picking the infrastructure stock with the best outlook for earnings growth.
My pick of the bunch is Sydney Airport. Here’s why.
Sydney Airport results
Sydney Airport released results for its half-year ended 30 June 2016 in August, with management revealing strong revenue growth across all businesses.
Headline revenue grew 11.3%, led higher by a solid 6.7% increase to total passenger movements in the first half of 2016. Impressively, operating margins were unchanged at 81%, despite an increase to service standards, auguring well for overall profitability.
Sydney Airport’s structure (as a stapled security) means net profit after tax is not a meaningful metric, given tax distortions between accounting and cash profit occur. Accordingly, investors in Sydney Airport (and almost any other infrastructure stock for that matter) are most concerned with distribution growth, as that generally drives share price movement.
Sydney Airport delivered on this front, upgrading its full-year distribution guidance to 31 cents per stapled security, up 21.6% from prior year. Pleasingly, Sydney Airport has done this more than once, indicating management often under promises and over delivers.
If this growth rate in distributions is maintained, I would expect Sydney Airport’s share price to soar higher from current prices.
What sets Sydney Airport apart from other infrastructure stocks is its ability to naturally grow earnings in the near future.
With the exception of Transurban which has the luxury of easily building (or buying) more toll roads, most infrastructure companies are captive to regulated pricing and limited in their ability to expand based on competition or foreign investment review board (FIRB) concerns.
Sydney Airport, on the other hand, has a clear opportunity ahead of it; to develop the Western Sydney Airport in Badgery’s Creek. Whilst I am cognisant that a second Sydney airport could cannibalise traffic numbers to Sydney’s main airport – Kingsford Smith – the opportunity to build and operate a second key infrastructure asset would bode well for earnings.
Whilst it would mean shareholders take on additional investment risk, the monopoly environment and operational synergies should outweigh these concerns in the long run.
At Thursday’s close of $7.28, Sydney Airport’s forecast full-year distribution of 31 cents per security places it on current yield of 4.3% (unfranked). Whilst this distribution yield is likely to grow if traffic growth continues at current rates, I believe the current price of Sydney Airport is too expensive for an entry point.
Instead, investors should monitor for developments concerning the Western Sydney airport and look for a pull-back in price before gaining exposure to this infrastructure star.