Larry Antonatos, managing director and portfolio manager with the Public Securities Group at Brookfield Asset Management in Chicago, looks for both income and capital appreciation when he invests in infrastructure stocks.
To find names that offer strong total return, Antonatos and his firm, which manages the Renaissance Real Assets Private Pool, analyzes three things: the physical assets the company owns, the company itself, and the relationship between quality and the company’s valuation.
- The physical assets
Antonatos considers four factors when analyzing an infrastructure company’s physical assets:
- market position,
- regulatory or contract framework,
- growth prospects, and
- sovereign and political risk.
In terms of market position, Antonatos likes monopolies, “such as the only airport or water utility in town.” Opposite to that are assets in free markets, “such as cellphone towers, where revenues are derived from negotiated leases, a framework similar to real estate leases.”
But he also considers the second factor, the regulatory framework, because monopolies tend to be more heavily regulated. “In contrast,” he says, “competitive assets tend to be more lightly regulated, allowing market forces to provide quality and pricing discipline.”
Regulation can take the form of a concession agreement, which is a contract giving the company the right to operate a specific business within the government’s jurisdiction. Since these agreements determine revenues, Antonatos spends a lot of time analyzing them.
“Contract length is very important, as investors frequently return infrastructure assets to governments at the end of concession agreements,” he says. “So investors must earn both a return on capital and a return of capital over the term of the concession agreement.”
Once the length is understood, he can “model future cash flows in order to create the earnings estimates and discounted cash flow analysis we use in our security valuation work.”
The third factor he considers when analyzing physical assets is growth prospects. Looking long-term, “cash flow growth is driven by population growth and increasing wealth. And in the short run, volume-sensitive assets such as transportation assets may also be driven by GDP growth.”
Lastly, Antonatos will consider sovereign and political risk. “During difficult economic times, political pressure may be placed on regulators to favour the citizens who consume infrastructure services over the investors who own infrastructure assets.”
The government could limit price increases or force prices down, leading to lower revenues. “Regulators must balance short-term political needs with long-term infrastructure needs,” he says, because if they “fail to allow reasonable returns to investors or treat investors unfairly, [they] will find it very difficult to attract investor capital for future infrastructure projects.”
- The company
Antonatos analyzes company quality based on four aspects: “management strategic quality, management operational quality, corporate governance and capital structure.”
- Quality and valuation
“Once we have asset level and company level quality scores, our focus shifts to valuation and the relationship between quality and valuation.” Companies with higher quality deserve higher valuations, he says, and he’ll determine the relationship using three methods.
First, he performs a regression analysis “to identify companies that are attractively valued for their level of quality.” Then comes “a multi-year discounted cash flow analysis on each company to determine intrinsic value then compare the intrinsic value to stock price.”
Lastly, Antonatos will review the company in relation to the wider portfolio, since he wants to diversify “by geography, sector and other risk factors.”
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