Australian Equities – The case for investing in infrastructure
12 February 2025
Our expert partner, Northcape Capital, shares their insights into the Australian infrastructure sector and why their Australian Equities portfolio is overweight to the sector. The team explores the valuation potential, reinvestment opportunities and critical drivers for the portfolio’s key infrastructure holdings. It concludes that the portfolio’s infrastructure exposure is underpinned by attractive valuations, resilience across the business cycle and promising improvements in key performance drivers.
This information has been prepared by Northcape Capital, the underlying investment manager for the Warakirri Concentrated Australian Equities Fund and Warakirri Ethical Australian Equities Fund.
Why is the infrastructure sector important within an Australian Equities portfolio?
Northcape maintains a significant allocation to the Australian infrastructure sector, circa 10% on average at the time of writing, within their Australian equities portfolios. The Warakirri Concentrated and Ethical Australian Equities Funds both have holdings in Transurban (ASX: TCL) and Auckland International Airport (ASX: AIA).
Transurban has been a cornerstone investment for many years, while Auckland International Airport is a more recent addition. We capitalised on a large capital raising and a sell-down by a major shareholder to establish a substantial position in recent months.
We believe this infrastructure exposure provides a compelling combination of attractive upside potential over the next few years and downside protection in the event of a market correction.
Below, we outline the unique features of these stocks that justify their inclusion in the portfolio.
Transurban – Business Model
Transurban operates dominant toll road networks across Sydney, Melbourne, and Brisbane, along with two key toll roads in Virginia, USA. The portfolio boasts concession lengths exceeding 30 years, providing long-term stability. Demand for these assets is highly price inelastic, with annual toll price increases tied to CPI or, in some cases, a fixed rate that exceeds CPI. This structure ensures predictable revenue streams and offers valuable optionality to invest in brownfield projects, delivering attractive risk-adjusted returns.
Transurban Express Lanes in Virginia, USA
Source: Northcape Capital
Auckland International Airport – Business Model
Auckland International Airport, New Zealand’s largest airport, has embarked on a significant NZ$7 billion capital expenditure program. This includes the construction of a new domestic terminal, a transport hub, and the expansion of the international terminal. The airport will generate a regulated return on its aero capital expenditure, with additional benefits expected for its non-aero operations, including retail, parking, and industrial developments.
We anticipate double-digit medium-term revenue growth, driven by a recovery in passenger numbers, which remain below pre-COVID levels but are steadily improving.
Valuation Upside Opportunities
Both Transurban and Auckland International Airport have underperformed in recent years, driven by different factors.
For Transurban, dividend growth has been constrained due to the WestConnex acquisition and several large capital projects aimed at expanding existing toll roads. Additionally, construction activity has temporarily restricted traffic, but this will normalise over time. Proposed toll road reforms in NSW have also weighed on the stock, but progress toward resolution suggests minimal impact on the value of existing concessions.
For Auckland International Airport, its share price has remained stagnant over the past four years, largely due to a slower-than-expected recovery in passenger numbers following COVID-19. Airline capacity constraints, particularly at Air New Zealand, have been a key factor, but these are expected to ease in 2025. Previous uncertainty around funding for the NZ$7 billion capital program has been addressed with a recent NZ$1.4 billion equity raising, and the completion of a significant sell-down by a major shareholder has removed an overhang on the stock.
Auckland Airport, New Zealand
Source: Auckland Airport
The underperformance of both stocks has seen a gap develop between their share prices and fundamental value. This gap presents an opportunity, particularly as their operating environments improve.
For Transurban, greater clarity on NSW toll reform could alleviate investor concerns and see an improvement in sentiment.
Re-investment Options
Both Transurban and Auckland International Airport have significant re-investment options which should yield a good economic return.
Transurban can use existing concession rights to propose network enhancements to government, which only it can offer. This creates a higher degree of franchise duration than currently implied by its concession agreements and a solid incremental return.
Auckland International Airport earns a regulated rate of return on the aero capital expenditure, but this allows it to earn much higher returns from its investment in other areas such as duty-free retailing and car parking. Agreement has already been reached with the regulator on the magnitude of capital spend, but the allowed return is still subject to final negotiation (Auckland International Airport is seeking an 8.7% return).
West Gate Tunnel construction, Melbourne
Source: Northcape Capital
Key Drivers – Below Mid Cycle
At Northcape we discount long-term cash flows back to the present to allow us to value infrastructure stocks. This requires an analysis of key drivers such as traffic (passenger cars/ commercial vehicles) for Transurban and international / domestic passenger numbers for Auckland International Airport (AIA). In both cases we conclude the key drivers are below long-term trend levels and we may see accelerated growth over the next 3-4 years as traffic and passenger growth normalises post COVID.
Passenger numbers at Auckland International Airport grew 17% last year to 18.5m but are still 12% below the pre pandemic number of 21m in 2019. We would expect accelerated growth over the next 3-4 years as passenger numbers return to long term trend, although airline capacity could be a headwind.
Aircraft availability has been affected by problems at Boeing as well as engine issues, which has been a major constraint on Air New Zealand. Total passenger growth of 5% pa+ is forecast over the next 8 years.
The key value driver for AIA is international passenger growth and this is forecast to grow even faster at 6% pa which underpins a strong earnings growth profile for the company over the next decade.
For Transurban, traffic growth on existing toll roads in recent times has been a bit anemic, partly reflecting disruption from construction work. Much of this work will be completed in 2025 (Melbourne – West Gate Tunnel) and 2026 (Sydney – M7-M12 Interchange; M7 widening). Transurban should benefit from traffic returning to normal as well as a revenue contribution following completion of these projects.
Transurban will also gain in 2028 from completion of the Western Harbour Tunnel project (Government owned) which will feed traffic onto West Connex.
Infrastructure v REIT’s
In simple terms investors selecting an income stock will likely prefer those providing a solid running yield (supported by free cashflow) and potential for this income stream to grow at an above average rate. At current pricing we believe this strongly favours infrastructure stocks over real estate investment trust’s (REIT’s).
For example, Transurban has a dividend yield close to 5% which we forecast can grow at 6% pa over the long term (2% pa volume growth +3% toll increase +1% from toll road expansions) to give a total return of about 11% pa. Consensus expectations for distribution growth by Auckland Airport is about 12% out until the end of the decade.
Both these growth rates are stronger than that of the REIT sector, which is expected to grow by around 3% over the same period.
Listed v Unlisted Infrastructure
Infrastructure investments appeal to long term investors such as industry funds who value inflation protection, GDP+ volume growth and stable cashflows. We have seen airports acquired at multiples above those typically paid by the listed market. Some regional airports in Australia are currently in a sale process and it will be interesting to watch the multiples paid and compare these to valuations on the listed market. Our investment thesis is not predicated on these businesses becoming takeover targets, but as we have seen with Sydney Airport, a potential bid is an upside scenario we don’t have to pay for at current prices.
Conclusion
Currently, our infrastructure exposure accounts for nearly 10% of the portfolio. We believe this allocation is well-supported by attractive valuations, resilience across typical business cycles, and the potential for medium-term improvements in key performance drivers for these two companies.
For more information, please contact us on 1300 927 254 or visit Our Funds.
The information in this document is published by Warakirri Asset Management Limited ABN 33 057 529 370 (Warakirri) AFSL 246782 and issued by Northcape Capital ABN 53 106 390 247 AFSL 281767 (Northcape) representing the Northcape’s view on a number of economic and market topics as at the date of this report. Any economic and market forecasts presented herein is for informational purposes as at the date of this report. There can be no assurance the forecast can be achieved. Furthermore, the information in this publication should only be used as general information and should not be taken as personal financial, economic, legal, accounting, or tax advice or recommendation as it does not take into account an individual’s objectives, personal financial situation or needs. You should form your own opinion on the information, and whether the information is suitable for your (or your clients) individual needs and aims as an investor. While the information in this publication has been prepared with all reasonable care, Warakirri and Northcape do not accept any responsibility or liability for any errors, omissions or misstatements however caused.
