In an uncertain world, 'boring' can be beautiful.

In this article, which was published on Trustnet, Tim Humphreys, Co-Manager of Marlborough Global Essential Infrastructure, highlights three infrastructure companies that provide strong in-built inflation protection.

Infrastructure companies are often regarded as ‘boring’ by investors, and that is perhaps no bad thing. After all, we want the companies we depend on for essentials such as water and energy to be predictable and reliable, with stable dividends underpinned by strong long-term cashflows.

However, with the UK inflation rate at more than 10% in November, there is another characteristic of many infrastructure companies that makes them anything but dull for investors – strong embedded inflation protection.

Around the world, governments and regulators recognise that companies operating the essential infrastructure we rely on for the basic functioning of society must be able to provide a sensible return for their investors, and one that is protected against inflation.

We hold UK water company Severn Trent, which serves more than 4.5m households and businesses in the Midlands. Ofwat controls the revenues the company can earn and the regulator must ensure returns for investors are sufficient to attract capital for further spending on the network.

Helping protect investors from the ravages of inflation is an important element in this calculation. So, the value of Severn Trent’s ‘asset base’ – including pipes, treatment works and reservoirs – is increased each year in line with inflation. This enables the company to pass on the effects of inflation in the tariffs charged to customers.

Severn Trent has a very positive relationship with Ofwat. The regulator sets performance targets, known as Outcome Delivery Incentives, and when these are successfully achieved revenues can be increased to cover the cost. In the last financial year, Severn Trent earned a reward of nearly £80m for hitting 88% of its targets.  

Severn Trent has first-class management and a strong track record of investing in its infrastructure assets. We believe this is a quality company with excellent long-term prospects.

We also hold Australian company Transurban, which is one of the world’s largest toll road operators. It operates 14 Australian toll roads, which generated AU$ 2.4bn (approximately £1.3 billion) in revenues last year. Close to 70% of these revenues are increased each year in line with inflation, with almost all of the remainder increased by a fixed 4.25% annually. These annual increases, which are enshrined in government contracts, can provide a powerful compounding effect over time.

Transurban’s dominant position in the Australian toll road market also creates a very positive network effect, which means the company is highly effective in integrating new toll roads into its system. The company’s status as an established operator, with a proven track record, also helps when it is bidding for new operating contracts.

Macroeconomic trends will, Transurban believes, continue to drive increasing use of its toll roads. Australia’s population is projected to grow by 20% over the next two decades and the country’s central bank is predicting GDP will continue to increase next year and the year after, albeit it at a relatively modest 1.5% per annum.

We value the inflation protection in Transurban’s contracts, the company’s dominant market position in Australia and the fact that it is expanding into North America. We believe this is a business robustly positioned for future growth.

US utilities company Xcel Energy is another holding. It supplies electricity and gas to millions of homes and businesses in eight western and mid-western states.

Over 80% of Xcel’s infrastructure assets benefit from forward-looking calculations that mean US regulators allow the company to increase charges in anticipation of inflation in the year ahead – rather than waiting until it has happened. In addition, more than two-thirds of its assets are covered by multi-year rate plans, giving much greater visibility around revenues and avoiding the need to negotiate with regulators every 12 months.

Xcel also manages costs very efficiently, which puts it in a strong position to mitigate the impacts of inflation. In addition, the company will benefit from tax credits introduced in the US government’s Inflation Reduction Act, which will help with affordability for customers and support Xcel’s returns on equity.

The company has a track record of successfully negotiating with regulators and we believe Xcel is strongly positioned to continue to deliver attractive returns in real terms as it navigates this period of higher inflation and rising interest rates.

Inflation protection is not the only attraction of infrastructure companies like Severn Trent, Transurban and Xcel Energy. These are robust businesses, with dependable cashflows and strong long-term growth prospects. Recent research by Bank of America showed that, in aggregate, utility companies listed on the S&P 500 have achieved an annualised return of 11% a year since 1980, which is exactly the same as the tech-heavy NASDAQ. The difference is the utility businesses have delivered these strong returns with a far smoother ride – and that is one of the key benefits of investing in essential infrastructure companies. In an uncertain world, ‘boring’ can be beautiful.

Tim Humphreys 05/12/22

Risk Warnings
Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds. Our funds invest for the long-term and may not be appropriate for investors who plan to take money out within five years. The fund will be exposed to stock markets and market conditions can change rapidly. Prices can move irrationally and be affected unpredictably by diverse factors, including political and economic events. The Fund invests mainly in the global infrastructure sector therefore investments will be vulnerable to sentiment in that sector. The Fund may therefore be more volatile than more diversified funds. The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of your investment. In certain market conditions some assets may be less predictable than usual. This may make it harder to sell at a desired price and/or in a timely manner. In extreme market conditions redemptions In the underlying funds or the Fund itself may be deferred or suspended.

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