Investing In Real Assets: Infrastructure

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Includes: CCI, IGF, XYL
by: Vine Investor

Summary

The need for more Infrastructure investment affects both developed and developing countries.

Infrastructure investment offers uncorrelated returns and the private sector will be tapped more to fill the funding gap.

With returns higher than safe haven assets and inflation hedges, there are opportunities for long term income.

The asset classes we have addressed in the series thus far have seen an elevated degree of volatility, from oversupply, softening demand, or interest rate expectations. This is a good opportunity to get into these asset classes for the long term but the next asset class consists of slow and steady investments that may not have the same growth upside but provide better than average returns for uncorrelated risk, infrastructure investing.

Infrastructure investing is a relatively new asset class with availability to retail investors in the form of mutual funds and ETFs, such as the iShares Global Infrastructure ETF (NYSEARCA:IGF), that provide above average yields (2.80% SEC yields on the IGF) with an inflation hedge as well. How is this possible? It has to do with the structure of this investment type. Most infrastructure projects are massive in scope and cost, making a barrier to entry. As a result of these costs many of the services also have a captive customer base which has very little alternative to the use of these projects. Infrastructure is broken into two major types of investment, greenfield and brownfield. Green field investments are considered higher risk and return, because they are usually in the planning and building phase with a lot of initial upfront costs and no cash flows. Brownfield is the low risk/return option, an existing project where cash flows are determined and costs for repairs and replacement are relatively calculated out.

There is a growing need for infrastructure across the globe. In developing markets a growing middle class will demand better roads, bridges, and electric grids, developed markets will also have to address their failing roads and bridges not to mention upgrade the electric grids for increased usage of electric devices. With governments unwilling (or unable) to pay for the four trillion dollars that will need to be put into the global infrastructure by 2020 according to Bain & Company, the burden will come to the private sector, and the private sector will want a return.

One of the places that will see significant investing out of necessity as opposed to improving lifestyles is water infrastructure. Providing clean water to the places that need it is a growing problem globally but the problem (and the response) is no more severe than in China. The government has reported that over 60% of the countries groundwater is polluted which would require purification to be drinkable. But the big issue is that of water scarcity in China, with the south seeing heavy rainfall and the north being arid, causing the coal and agriculture sectors to be dangerously low on natural water sources. This is why since 2002 the government has been working on massive projects to bring the water from the south to the northern part of the country where it is needed.

source: BBC

A company with global reach and the ability to gain from the investments in China and around the world is Xylem Inc. (NYSE:XYL). While this company has a low dividend yield, it is well positioned for growth with a forward P/E of 17. In the last quarter the company has seen orders increase 7.5% with EPS and cash flows increase 50% in the same time frame. Improving metrics will give the company the ability to increase payouts in the future. The company will see an increase in projects over the developing world as countries have to address the resource intensiveness of manufacturing and addressing clean (and waste) water management in growing cities.

For a play on US infrastructure look towards the growing use of bandwidth. While many believe that the US market is saturated in terms of cell phone growth they need to look closer at the habits of cell phone users. The majority of cell phones in the US are still not classified as smartphones, add in other portable devices that now use wireless carrier services and you will see an increase in the amount of data moving across airwaves as opposed to broadband lines. This will require more towers and provide increased revenues to the companies that provide these services.

Crown Castle International Corp. (NYSE:CCI) is a company that can best capture this trend. Though the P/E for the trailing 12 months looks lofty the forward P/E is around 17, this makes the near doubling of the yield going forward look more likely to be sustained. Being registered as a REIT the company has to distribute 90% of its earnings to investors which could generate a good stream of income on a business that is only seeing growing. As far as the revenue stream for the companies, the majority of CCI's income is derived from AT&T (NYSE:T) (27%), Sprint (NYSE:S) (26%), T-Mobile (NASDAQ:TMUS) (21%), and Verizon (NYSE:VZ) (16%); all companies that are stable and looking to increase data usage as well. Another interesting thing to note about Crown Castle is that the costs of the company are relatively fixed, with management seeing costs increasing only at the rate of inflation, this leave opportunity for higher income generation and subsequent payouts.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.