The infrastructure industry was recently thrust firmly into the spotlight by a combination of events. These included in the UK the award of contracts to build the first phase of the controversial second high speed railway project between London and Birmingham.
Struggling infrastructure construction company and support services supplier Carillion featured as one of the three companies appointed by the UK government, despite its recent well documented problems.
It will work with the UK's Kier Group and France's Eiffage Genie Civil in the CEK joint venture.
Supporting 16,000 jobs
The expected total value of the contracts including both Stage 1 and Stage 2 (the full construction phase) is currently estimated to be worth £6.6 billion, said transport secretary Chris Grayling in the official announcement.
Stage 2 will commence in 2019. Along with Stage 1, it is expected to support 16,000 jobs across the country. The stages are expected to generate 7,000 contract opportunities. Of these, around 60% are expected to go to small or mid-sized companies.
Keith Cochrane, interim chief executive officer at Carillion, said: “We expect the UK Government's objective of generating economic growth through investing in infrastructure to continue creating opportunities for us to grow our business in these core markets."
Moody's 2017 outlook
In its 2017 construction global outlook paper, debt rating agency Moody's Investors Service writes of healthy prospects for infrastructure construction. It points to increasing traffic volumes, especially in emerging economies.
The trend towards urbanisation should lead to expansion of roads and railways, it says. Electricity Transmission and Distribution (T&D) networks should see modest growth in developed countries to improve security of supply.
In emerging countries, it expects high and growing demand from new projects. Government budget constraints, however, may limit infrastructure spending. Low prices for power, oil, gas and coal will continue to weigh on capital expenditure.
This will affect conventional power generation, upstream facilities for oil and gas, as well as mining. Renewable energies, especially wind, will continue to benefit from strong political support and efficiency improvements.
Moody's notes that affordability is the main constraint on the sector.
Trump and infrastructure construction
Phil Seefried, co-founder and chief executive officer of Headwaters MB, and Mark Wilson, a UK-based partner at specialist corporate finance firm Catalyst Corporate Finance, issued a comprehensive note on the topic late in June.
Their observations include the suggestion that infrastructure will be among the key industries to watch as the political landscape in the USA begins to settle down into the reality of the Trump administration.
They see opportunities for US and UK businesses and investors. These will arise as president Trump begins to fulfil election campaign pledges that he will deliver major programmes of public works.
Sectors in favour include infrastructure industry
Investors remain convinced that the US president’s administration will create exciting new opportunities. Infrastructure, where the president has promised huge programmes of public works, is a key focus.
Catalyst's Wilson said: “Looking beyond the headlines, the stable economic backdrop continues to excite investors in the US, while US investors have the strength and confidence to pursue international opportunities.
“For UK businesses, opportunities in sectors such as infrastructure and natural resources look especially enticing in a Trump context, but there will be possibilities throughout the marketplace; UK businesses can also expect to continue to be targets for US investors.”
UK can teach global infrastructure industry a few lessons
A study released recently by Dr George Inderst, an independent adviser to pension funds, institutional investors, and international organisations also considers the infrastructure construction industry and what lessons the UK experience have for other countries.
In a nutshell, he notes, the UK has for some time been living on the combination of an ageing infrastructure, weak spending by the state (and taxpayers) and strong private sector involvement in infrastructure finance.
The country’s creaking infrastructure needs more investment when public budgets are already stretched. The question is, he suggests, whether private capital will be as easily available in future as in the past, especially from trusting institutional and foreign investors.
Major UK positives
- Financial centre with high private sector capacity and international expertise
- Long experience with PPPs, especially in social infrastructure with availability payments; PPPs in particular require time and a high degree of trust to succeed
- Proven regulatory system for utilities, telecoms, and other infrastructure sectors
- Strong private sector involvement in infrastructure, both via privatisations and PPPs (public private partnerships)
- Open borders for overseas infrastructure developers, operators and investors
- Highly developed capital markets, with a strong and diverse investor base
- Solid institutional and legal environment, clear property rights
- Importance of a stable political system and macro economy
What affects the sector’s share prices?
The strength of demand for infrastructure construction services. The availability of sufficient funds to pay for those services. The quality of management in the deployment of cash and other resources to meet contractual requirements and make a profit.
The contractor’s development of revenues. A company with shrinking revenues will typically show increasing contingent liabilities to revenues, until existing projects are completed and related guarantees expire. An increase in the contractor’s order backlog is a positive.
Tradition, perspective and habit. George Inderst notes that most domestic UK institutional investors have traditionally been keen investors in listed utility stocks and bonds. They have been relatively late in seeking investment opportunities in the unlisted market sector.
What can make one company buck the trend?
Recovery potential. An undervalued current share price. A good spread of sources of profitable business. Exposure to the railway sector where the UK government is pledged to spend more than £100bn in rail projects across the country, dominating the transport pipeline, as Liberum puts it.
Affordable Housing and regional building are working well for Kier, the broker Liberum says. It also sees Morgan Sindall as a beneficiary of a commitment to the housing sector. Costain has strong positions in the key regulated markets, most notably highways and rail.
Liberum identifies Babcock as the key beneficiary of the Hinkley nuclear power plant project. It singles out Balfours as likely to secure the greatest overall revenue from HS2. Most UK contractors and consultants should benefit from Heathrow's third runway project.
What can make a company’s share price fall?
Carillion presents a text book example of how what can go wrong will go wrong. The company generates around 70% of its revenues from support services, estimates Liberum. But as HS2 shows it remains involved in infrastructure construction.
The company lost most of its value in two days of trading this month. A succession of botched projects forced it to take £845m of provisions against a market value around £830m. The level of debt and possible pension problems also quickly became issues of concern.
Rank bad management was the root cause, it would seem. Yet still it wins contracts.
What should I look out for in company accounts?
Pension obligations: does the company have a pension deficit? If so how is it tackling that deficit? Can it close the deficit? Are the plans realistic? Is it an infrastructure construction company or a pension fund with an infrastructure construction business attached?
Sales and the direction of sales. Costs and the direction of costs. New business being acquired: is it keeping pace with business completed? How strained is the balance sheet?
What else is there to watch out for?
Is the company overindebted? Is management remuneration controversial or a non-issue? How aligned are the interests of the management with the separate interests of shareholders, staff and other interested parties?