Stranded assets?

We previously wrote in our September 2020 newsletter about the differences in interest rate sensitivity between perpetuities and annuities. An interesting follow on is whether Australia’s listed infrastructure assets exhibit valuations that reflects the expected useful lives of their underlying assets.

The following is the trailing twelve-month enterprise value to EBITDA ratios over the last 10 years for three of Australia’s listed infrastructure companies – Transurban, Sydney Airport, and APA. At the end of 2009, Sydney Airport (then called Macquarie Airports) divested its stakes in Copenhagen and Brussels airport and became the 100% owner of Sydney Airport. From this point onwards these three assets are a pureplay on quality domestic infrastructure and traded between 10-15x EV/EBITDA ­a bargain compared to today! Since then, each of the three assets have taken a different path with respect to their valuation.

Transurban has been a market darling for some time now. Its trailing valuation has steadily risen during the period to sit at 35x EV/EBITDA today. This is due to a combination of factors ranging from attractive toll road concession terms which provide virtually locked in above inflation growth, smart toll road acquisitions (including acquisitions out of receivership), and a pipeline of augmentation projects, as well as greenfield projects (eg. Westconnex). Today they are the dominant Australian toll road operator and are a formidable party to bid against in any greenfield road project. Such is the extent of their dominance, it is now difficult for Governments to entice bids from alternative consortiums! The majority of concessions end between 2050 to 2060. This is 30-40 years of cashflows with both growing volumes and higher than inflation toll escalation. The higher valuation multiple is probably justified given the potential to extend this 30-40 years even further through augmentation and greenfield projects. Put it another way, in 2019, Transurban negotiated an extension of tolls on Citylink from 2035 to 2045 as part of funding for the West Gate Tunnel project – who wants to bet me a bottle of wine that Transurban doesn’t hand Citylink back to the State for $1 in 2045?

Sydney Airport is another quality infrastructure asset that grew to around 22-23x EBITDA before the pandemic hit. Obviously, Covid has been catastrophic to current passenger numbers. Sydney Airport has a similar growth profile to Transurban, however, there are some limitations to passenger growth due to regulations that limit the number of aircraft movements to 80 per hour and only between 6am to 11pm. Under the dual till approach landing charges are lightly regulated and all other revenues such as carparking and retail are largely unregulated. Unlike Transurban, there are no brownfield or greenfield acquisitions. The concession with Government ends in 2097 which means this is effectively a perpetual type of investment and indeed is priced as such with a low 20s EBITDA multiple valuation.

APA Group is the third listed core infrastructure asset listed on the ASX. Over time the valuation of APA has stayed the same with a mid-teens EBITDA multiple valuation. Considering the fall in base rates over the last 10 years, the valuation has gone backwards today relative to 2010 when adjusted for base rates. APA has acquired a few assets over the years and even diversified into renewable energy with various solar and wind farms in the portfolio (albeit they are immaterial in terms of the value of the total business). The market however has looked less favourably on APA compared to Transurban and Sydney Airport.

Gas usage is declining in Australia and across the world. Many new homes today are being built without a gas connection (including those of Infradebt employees). Heat pumps are four times more efficient than instantaneous gas for both domestic water use and for hydronic heating. Likewise, induction cooktops deliver over 90% of electrical energy as instant heat where a gas cooktops only convert 40% energy to heat and it also takes time to heat up. For the household, it is a no brainer to switch to an all-electric house even when putting aside the environmental benefits and the ability to couple with rooftop solar. In industrial applications, heat pump technology is getting closer to reducing the need for gas for heating in applications that involve relatively low levels of heating (eg pasteurisation processes or drying of product).

In the electricity grid, renewables are displacing base load gas plants and eventually batteries will replace peaking plant. We are less confident there will be a role for gas outside industrial applications. It could be possible that gas pipelines are used to transport gas blended with hydrogen. But this is dependent on hydrogen becoming much cheaper over time, and of course adopted for various application (eg heavy vehicle transport or aviation etc)

While there has been talk of repurposing natural gas infrastructure for the transportation of hydrogen this appears to be hot air (sorry, couldn’t help myself). The reality is that pressurised hydrogen in steel pipelines causes ‘embrittlement’ (ie pipeline degradation) at anything other than very low percentages (eg over 10% hydrogen). No doubt there are solutions to this problem, but they are not costless.

At a 13x EBITDA multiple (and base rates near zero) the market is implying that the gas assets of APA are not perpetual in nature. The market is probably pricing in around a 20 year remaining operating life. Our view is that the market is probably correct even when ignoring the value of carbon reduction.

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