In Brief: Infrastructure, Non-Banks, Mining Services & Affluent Aussies

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Weekly Broker Wrap: A&NZ Infrastructure returns booming; commercial real estate exposures of NBFI's; Macquarie on mining services & half of Australians own most of the wealth.

-Superior returns for A&NZ Infrastructure, outlook positive 
-Exposure of NBFI’s to commercial real estate 
-Macquarie’s outlook for mining services companies 
-Half the Australian population owns 95.4% of the wealth 

By Mark Woodruff 

Superior returns for A&NZ Infrastructure, outlook positive 

Total shareholder returns from the Australian and New Zealand Infrastructure sector have placed both short-and long-term performance by the ASX200 firmly in the shade, and UBS suggests the environment for such assets should remain favourable for the rest of this year.

The broker divides the A&NZ listed infrastructure landscape into 23 stocks representing $90bn worth of “Pure Players” and “Infra-Industrials” valued at $150bn.

The three largest Pure players are Transurban Group ((TCL)), Auckland International Airport ((AIA)) and APA Group ((APA)), while Telstra ((TLS)), Origin Energy ((ORG)) and the NZ-listed Meridian Energy (MEL.NZ) are the largest Infra-Industrials.

Infra-Industrials are defined as having some infrastructure assets but also have meaningful exposure to riskier, industrial operations, as is the case for Telstra and AGL Energy ((AGL)). In some cases, UBS suggests these riskier businesses could be the reason defensive infrastructure assets are kept within the corporate portfolio.

On a five year timeframe, A&NZ Infrastructure has delivered a 54% total return (9% per annum) compared to the 16% total return from the ASX200 which translates to 3.1% per year. 

Pure-players and Infra-industrials delivered 8.7% and 9.1% per annum, respectively, over the five years.

The performance over the last six months is no less impressive, with A&NZ Infrastructure delivering a 9% return compared to the 2% gain by the ASX200.

Infra-Industrials have returned 11% in this period, driven by the outperformance of NextDC ((NXT)) and AGL Energy which have gained 40% and 34%, respectively, while Spark New Zealand ((SPK)) has been the weakest link with a -3% loss.

Pure-players returned 6% due to strength for Dalrymple Bay Infrastructure ((DBI)), Transurban Group and Auckland International Airport, with returns of 13%, 12% and 9%, respectively, dampened by losses for APA Group and Atlas Arteria ((ALX)) of -7 and -3%.

UBS lists attractive attributes of infrastructure assets including stable and inelastic customer demand. This can be due to provision of essential services and high barriers to entry which may arise from unique assets, high invested capital in physical assets, long-term contracts, or regulation. 

Moreover, infrastructure assets largely offer economic hedging such as CPI linkage or have counter-cyclical earnings drivers, explain the analysts.

The broker’s positive outlook for the rest of 2023 for the infrastructure space is based on investors' defensive equity positioning arising from perceived risks around a domestic economic recession, while lingering inflation should lead to outperformance by stocks whose pricing are linked to the CPI.

Additionally, the analysts point out the conclusion of central bank hiking cycles historically results in a fall in long-end bond yields, which supports the valuations of stocks with long-dated earnings streams.

As UBS forecasts sideways movements in equity markets for the remainder of 2023, investors are also expected to favour dividend-paying equities.

The broker has Buy ratings on 37% of its recommendations for A&NZ Infrastructure including: Transurban, Spark New Zealand, NextDC, AGL Energy and New Zealand-based Infratil ((IFT)), Mercury NZ ((MCY)) and Contact Energy ((CEN)).

UBS also has 12% of its recommendations set at Sell incorporating Auckland International Airport, Chorus ((CNU)) and Meridian Energy.

Exposure of NBFI’s to commercial real estate 

The history of commercial real estate shows those arriving last are ‘left to carry the can’ on property development risks and asset quality.

With this potential outcome in mind, Citi undertakes a review of the growing rise of non-bank financial institutions (NBFIs) as a backstop for the commercial property sector, with implications for private credit investors such as Qualitas ((QAL)).

The broker points out the highest impairments for commercial real estate in the global financial crisis (between mid-2007 and early 2009) were incurred by the last entrants, which were largely foreign banks and subsidiaries.

This experience for domestic banks reinforced a key lesson from the early 1990’s recession regarding having too much direct balance sheet exposure to the sector.

Typically, new entrants are attracted by the ability to deploy a large amount of capital via relatively few transactions, and they generally have a greater risk tolerance than the existing major/domestic banks, explain the analysts.

As in all cycles, highlights Citi, losses from Australian banks’ non-housing books are of a much larger significance.

The broker notes these banks are currently retreating from lending for commercial real estate, particularly for residential development and problem areas like office. Banks have been calling in loans where borrowers are succumbing to impacts from higher interest rates, yet NBFIs often fund the gap.

Happily for the majors, the NBFIs are effectively creating a new ‘first line of defence’ by refinancing their lending, and in so doing are helping pave the road for a softer landing in asset quality, explains Citi.

The rise of private credit lenders has emanated directly from the likes of family offices and via managers such as ASX-listed Qualitas (not covered by Citi).

Recent announcements by Qualitas suggest to the broker investor demand for private commercial real estate credit is showing no signs of abating. 

As a major private credit investor, the company achieved 91% of its FY22 capital deployment in the first half of FY23, which is considered notable given FY22 deployment was 57% higher than FY21.

In the FNArana database both Macquarie and Morgans have Buy (or equivalent) ratings for Qualitas. 

Around a month ago, Morgans suggested the company was nicely positioned to grow its market share in the debt funding of more affordable multi-unit metro developments. The retreat of the big four banks from this type of commercial real estate lending was also noted.

Macquarie’s outlook for mining services companies 

Buoyant commodity prices and a positive equity market outlook for miners and explorers have contributed to rising mineral exploration and capital expenditure, resulting in a bright outlook for the Mining Services sector on the ASX.

Macquarie notes first half FY23 results for companies, along with management outlook statements and targets, highlight an ongoing recovery for margins. In addition, the opening FY24 expectation for capital expenditure is higher than than at the corresponding for the FY23 estimate.

While labour availability and a potential recession may present hurdles, Macquarie maintains Outperform ratings for Macmahon Holdings ((MAH)) and Perenti ((PRN)), with a leaning towards the latter on increasing margins and opportunities for both organic and inorganic growth. 

Perenti has upgraded guidance four times over FY23 and recently announced the proposed acquisition of DDH1 ((DDH)), which would result in the ASX's largest diversified contract mining services company. 

Moelis recently noted the deal would result in accretive outcomes for all shareholders amid enhanced scale and a global service offering.

The proforma group would have a FY23 result of around $3.45bn in revenue and an earnings margin of 10%, according to Macquarie. It’s noted management had a 10% margin target for FY25 prior to the DDH1 approach.

Industry margins are recovering from a tough FY21/22 when impacts were felt from a tight labour market, inflationary pressure and covid impacts, explains the broker.

The analyst expects margins for Neutral-rated NRW Holdings ((NWH)) and Macmahon will remain above 6% in FY23, with management at Macmahon targeting growth to 8% over the medium term.

Over the last six months, the broker highlights NRW has had a plethora of contract wins including with Fortescue Metals ((FMG)) for a $30m contract at Iron Bridge and a $34m contract at Christmas Creek.

In addition, the company won a $54m contract with Rio Tinto ((RIO)) at its Western Range Mine, and most recently an $332m mining services contract at for 36 months at the Mt Cattlin project for Allkem ((AKE)).

Half the Australian population owns 95.4% of the wealth 

Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery, according to Dickens’ Mr Micawber character in David Copperfield, who often ran foul of his creditors and landed in debtor’s prison.

No such problems for Australians over the period March 2020 to March 2023.

While the value of debt in this period increased more quickly than the value of assets, Roy Morgan notes this was not enough to stop growth in overall wealth, with the value of assets now six times higher than the value of debt.

Aussies are wealthier than before covid, though from an equity standpoint, unfortunately half the population is sitting on 95.4% of the wealth, according to the sixth edition of the 2023 Roy Morgan Wealth Report, which incorporates a study of consumer financial behaviour.

After allowing for inflation, the country’s wealth increased by 7% in the 36-month period to March this year, driven largely by the soaring value of owner-occupied homes, which increased by 43.2% to $5.95trn from $4.16trn.

The poorest half of the population, dominated by renters, saw their share of wealth increase, though only to 4.6% from 3.6%.

The lowest 10% of the population has had the toughest period during the pandemic, with the average amount of net wealth in negative territory and going backwards (down by over -400% from March 2020), an outcome Roy Morgan CEO Michele Levine finds extremely worrying.

The lowest 10% of the population was the only decile (each of ten equal groups) to lose wealth over the last three years, notes Roy Morgan.

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