High-Grading Amid Market Swings

Infrastructure update

High-Grading Amid Market Swings

Thematics that we favor going forward over the medium to longer term include renewables, sustainably driven utilities and tower companies with very strong underlying businesses.


Markets rallied on technical and fundamental drivers

There are a couple of reasons the markets have rallied, technical and fundamental. From a technical perspective, there has been a lot of pension fund rebalancing. With equities underperforming bonds, pension funds have found it necessary to come in and rebalance their equity exposure. In addition, hedge funds closed a lot of shorts, which created somewhat of a squeeze. Lastly, retail investors’ selling started to slow.

From a fundamental perspective, the moves last week involved both fiscal and monetary stimulus, which in the U.S. measures almost 10 percent of GDP (Gross Domestic Product), a $2 trillion action by the U.S. government. The Group of 20 is talking about injecting over $5 trillion. Monetary policy continued to be easy with both the European Central Bank and the US Federal Reserve indicating they'll effectively do whatever it takes to provide liquidity to the market.

Hard to call

In our view, with over 700,000 detected cases, almost 30,000 deaths and most major economies in lockdown, it is hard to say the markets are at a bottom. As countries struggle to contain the virus, until we get hope of a vaccine or some type of moderation of its growth, there is too much uncertainty to call a bottom -- even with the huge amount of stimulus put in place over the last month. I would say, though, in that type of environment, essential service utilities tend to see very minimal relative impact due to their strong and dependable cash flows.

Impact on sectors

Ultimately, if one assumes the virus is transitory rather than structural, there'll be minimal value destruction over the cycle. Comments coing out of the U.S. and European utilities is that they would expect minimal short-term impact to earnings. The numbers we've calculated internally show probably only a 2 to 7 percent impact on EPS (Earnings Per Share) total in the short term -- even though longer term it's transitory and there's very little value destruction. Infrastructure assets that leverage to GDP and pipelines may have exposure to counter-party risk. This is a much longer grind with the recovery of airport traffic and the recovery of road traffic when business as usual comes back. In addition, from an oil price and a pipeline perspective, it's understanding the counter-party risk that a lot of pipelines are exposed to.

Impact on earnings and investment action

Some of the utility companies have come to market and tried to quantify the impacts of Covid-19 on their business (low to mid-single digit impacts on Earnings Per Share), yet the share prices of some of these names were down close to 20 percent. We think it has been overdone and that's just really been a function of short term need for capital, nothing to do with the underlying assets themselves. In terms of investment actions, we've been high-grading our holdings, taking the opportunity to increase exposure to beaten-up high-quality utilities globally.

Thematics that we think are favourable going forward over the medium to longer term include renewables, sustainably driven utility businesses, as well as tower companies which have very strong underlying businesses. We continue to engage in liquidity work and looking at balance sheets, we continue to assess the strength of dividends, the coverage, the growth of dividends and our companies' ability to pay those underlying dividends to investors.

Keeping an eye out for a comeback

There are several things we are watching. Firstly, how quickly impacted countries will come back to work and then how sustainable coming back to work is, whether it's affected by further lockdowns, really the true impact to employment and economic growth and how long that kind of bottom part of the U-shaped recovery lasts for that's key, especially for investing in infrastructure stocks. At how governments and central banks continue to respond to this crisis, whether there is some political noise, especially in places like the U.S., as we approach a U.S. election. And whether there is any structural change in consumer behaviour. Certainly, if you look at airports, there is risk around businesses seeing their staff travelling again. Obviously risk around whether the virus will impede that travel. And so, whether that means more business is done virtually rather than face to face.


Definitions:

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The European Central Bank (ECB) is the central bank for the European Union (EU).

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Earnings per share (EPS) is the portion of a company's profit allocated to each outstanding share of common stock. An index EPS is an aggregation of the EPS of its component companies.

COVID-19 is the World Health Organization's official designation of the current coronavirus disease.

A central bank is a national bank that provides financial and banking services for its country's government and commercial banking system, as well as implementing the government's monetary policy and issuing currency.

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