SINGAPORE (Feb 4): Nobody can build like I can build,” boasted Donald Trump when he was on the campaign trail in 2016. In addition to the oft-repeated promise of building a “big, beautiful wall” along the US southern border, to be paid for by Mexico, the other campaign promise made by Trump was a US$1 trillion infrastructure plan.

Although the House of Representatives is controlled by the Democratic Party, its leader and speaker of the House, -Nancy Pelosi, is known to be a pragmatist, focused on the well-being of the US. If she can strike a compromise over Trump’s border wall, Pelosi could negotiate an infrastructure bill that would have bipartisan support.

As late as February 2018, Trump proposed a scheme he claimed would boost the country’s infrastructure with US$1.5 trillion in spending over the next decade. Trump described this as “the biggest and boldest infrastructure investment in American history”.

Analysts from the Wharton School of the University of Pennsylvania — Trump’s alma mater — released a study on the plan. “The plan proposes to increase federal infrastructure investment by US$200 billion to provide incentives for a total new investment of US$1.5 trillion in infrastructure,” it explained. The study says the impact on GDP is likely to be limited. This is because the US$200 billion comprises grants and is likely to increase infrastructure spending by up to US$230 billion instead of the vaunted US$1.5 trillion figure.

“Based on previous experience, most of the grant programs contained in the infrastructure plan fail to provide strong incentives for states to invest additional money in public infrastructure. Indeed, an additional dollar of federal aid could lead state and local governments to increase infrastructure total spending by less than that dollar since state and local governments can often qualify for the new grant money within their existing infrastructure programs,” the Penn Wharton study says.

Benefits of infrastructure spending

Good infrastructure brings significant long-term benefits. If the US$1 trillion budget for infrastructure materialises, and if it is allocated across a decade, it would benefit service transportation, harbour maintenance and the US drinking and waste water sector.

A Congressional Research Service report entitled Economic Impact of Infrastructure Investment by Jeffrey M Stupak says: “Infrastructure is beneficial for both businesses and households and for the economy broadly. For businesses, infrastructure can help to lower fixed costs of production, especially transportation costs, which are often a central determinant of where businesses are located. Infrastructure benefits the economy overall, as it allows more goods and services to be produced with the same level of inputs, fostering long-term economic growth.”

Investments in core infrastructure such as roads, railways, airports and utilities are expected to produce larger gains in economic output than investments in some broader types of infrastructure, such as hospitals, schools and other public buildings, according to Stupak. “Deficit-neutral investments are less likely to affect employment, whereas deficit-financed investments are expected to reduce unemployment in the short term. During an economic expansion, with a relatively strong labour market, infrastructure investments are unlikely to have any sustained impact on the unemployment rate. However, during a recession, the same investment is likely to reduce the unemployment rate to some degree,” Stupak states in his paper.

State of US infrastructure

According to data from the Organisation for Economic Co-operation and Development, the US spends less on transportation infrastructure, such as roads, railways, inland waterways, maritime ports and airports, as a percentage of GDP than most OECD countries.

A study done by Deloitte reveals that 40% of US government infrastructure  projects are completed late, over the budget or of poor quality. Deloitte suggests an estimated US$2.1 trillion ($2.8 trillion) more from now until 2025 is required to close the infrastructure gap. Meanwhile, the American Society of Civil Engineers gave the US a D+ in its 2017 infrastructure report card, which is published every four years, further emphasising the urgent need for an infrastructure overhaul.

Public-private partnerships (PPPs) can help to fund infrastructure projects. In the US, the share of private investment in infrastructure had fallen to a decade-low in fiscal 2018, at 25% of total infrastructure spending. To stimulate PPPs, the Trump administration reduced repatriation tax on overseas profits, while allowing tax credit programmes of US$167 billion for private investments in the Tax Cuts and Jobs Act 2017. Part and parcel of the tax credit programmes is an 82% tax credit on equity financing of infrastructure investments.

The main purpose of the tax credit is to draw capital flow homebound, encourage PPPs and reduce dependency on government infrastructure spending.

Chart 1 shows several ways to stimulate infrastructure investments.

https://s3-ap-southeast-1.amazonaws.com/tesuploads/PC+Lee/867/ishares%20circle.png

Listed infrastructure plays

Although US stock markets fell in December 2018, US infrastructure stocks still enjoyed strong upward earnings revisions during the year and would be immediate beneficiaries of a US infrastructure bill.

For instance, iShares US Infrastructure ETF regained its December losses promptly. Its price has appreciated nearly 13% in the past four weeks. The ETF, one of the largest infrastructure-themed ETFs with a fund size of US$4.6 billion, tracks the NYSE FactSet US Infrastructure Index. This bellwether index tracks the performance of companies involved in the US infrastructure value chain, from asset owners and operators to their upstream enablers.

Key components of iShares US Infrastructure ETF

Railways form the transportation backbone of the US. Sea freight aside, railways transport almost all goods and raw materials, from commodities to construction materials that are too heavy to ship via planes and trucks. The railway sector is seen to be both a direct and indirect beneficiary of an infrastructure bill.

https://s3-ap-southeast-1.amazonaws.com/tesuploads/PC+Lee/867/ishares%20table%202.png

Kansas City Southern is the second-largest constituent by weight in the iShares US Infrastructure ETF. The railway company has a rail network connecting 6,700 miles of tracks from the US Midwest and the US southern states to Mexico, with almost equal revenue contribution from both the US and Mexico. The company has increased its dividend by 18% on average for the past five years. Although it yields only 2% in dividend income, KCS has the highest dividend payout ratio among the railway companies, at 41%. Most impressive is its 10-year consecutive growth in pre-tax income of 24% annually. The company is confident of maintaining this trend by implementing Precision Scheduled Railroading to improve the operating efficiency ratio, currently at 60%. Moreover, the company anticipates 3% to 4% in volume growth and 5% to 7% in revenue growth for 2019.

https://s3-ap-southeast-1.amazonaws.com/tesuploads/PC+Lee/867/ishares%20table%201.png

Another proxy for the US railway sector is Norfolk Southern. Its operating efficiency ratio is 65.4%, the highest among peers. Norfolk Southern has a highly diversified revenue, transporting cargo ranging from raw to finished goods and industrial products. In 4Q2018, its earnings per share increased 26% to US$1.64, owing to a 7% increase in revenue.

Similarly, CSX is also a leading railway transportation company, with diversified revenue from each sector at no more than 20% of revenue concentration. Like KCS, CSX has been able to increase dividends for 13 consecutive years. The noteworthy aspect of CSX is its high net income conversion to free cash flow, of up to 98% of net income. This enables the company to carry out share buybacks while increasing its dividend every year.

In the water sector, America’s Water Infrastructure Act 2018 authorises the spending of US$6 billion over 10 years on water and wastewater infrastructure. The bill, passed in October before the Democratic Party took over the House of Representatives, received bipartisan support. It represented bipartisan concerns over growing water challenges. The Act authorises funds to be allocated to create access to drinking water, and to upgrade ageing dams and irrigation systems.

https://s3-ap-southeast-1.amazonaws.com/tesuploads/PC+Lee/867/ishares%20chart.png

Within iShares Infrastructure ETF, the biggest water company by weightage is Cadiz. California produces US$47 billion of GDP a year in agriculture, but suffers from drought periodically. Cadiz seeks to extract 50,000 acre-feet of water from an underground basin in the Mojave Desert each year and pump it to urban users near the coast. The Cadiz Water Project was initiated a decade ago. It operates on privately owned agricultural land in San Bernardino County and claims to offer a new water supply for up to 400,000 people a year by reducing a recurrent loss of 10 billion gallons of water per year to evaporation.

Amid strong discontent from desert and wildlife preservation groups, this project, which was blocked by the Obama administration, is now making progress under Trump. Cadiz as a company remains loss-making. Despite the uncertainties inherent in the project, selected investors are still keen to invest in it.

Another water stock with better financials is California Water Services Work. It is the third-largest water utilities services company by revenue in the US, servicing two million people across 100 communities. The San Jose-based company achieved a record profit of US$67 million in FY2018 and has experienced consecutive earnings growth over the last 10 years.

American Water Works Co is the most geographically diverse publicly traded US water and wastewater utility company and the largest by revenue. It serves up to 15 million people across the US and Canada. The company turned profitable in 2010, reporting US$450 million in profit before tax. Its share price has risen 4.5% since the beginning of the year.

Summit Materials is one of the fastest-growing construction materials suppliers, producing aggregates, cement and ready-mix concrete in the US and -Canada. Summit Materials turned profitable only in 2015. For the nine months to September 2018, the company reported US$54 million in net income.

Aggregates, together with asphalt concrete and cement, are a core material for road pavement. In Summit Materials’ 3QFY2018 earnings announcement, aggregates recorded 21% in sales growth, followed by ready-mix concrete and asphalt (12.6% growth). However, cement sales declined, owing to a reduction in average selling price. There is an urgent need for road improvement across the US, as seven out of 100 miles of roadway in the US are in poor condition, with 9% of bridges requiring repairs.

H&E Equipment is another proxy for US infrastructure. The company leads the market in the construction equipment rental space, where it is the largest distributor of crane equipment. Its competitive advantage lies in its young fleet of versatile, non-specialised crane and an extensive distribution network. Its fleet of cranes is 34 months old compared with the industry average of 44 months. In its 3QFY2018 results, revenue rose 24% q-o-q, underpinned by strong demand from the non-residential construction market and an uptick in equipment rental rate.

As at Jan 25, H&E Equipment was up 42% from its low of US$18.40 on Dec 11. A US infrastructure bill with bipartisan support could boost infrastructure stocks such as H&E Equipment further. Whether such a bill materialises remains to be seen.

US needs infrastructure upgrade, and iShares Infrastructure ETF provides exposure

Related News

Highlights

'Transition credits' could sweeten deal for early retirement of coal-fired power plants: MAS, McKinsey paper

Related News

Hong Kong investor and EPF pare stake in Interra Resources, Riverstone respectively

DBS and Sea: Two ends of a barbell?

SGX sticks to multi-asset push as MSCI ditches Singapore to cast its lot with Hong Kong