- Infrastructure is crucial to the evolution of our modern world.
- American Tower, Union Pacific, and DTE Energy are some of the most important companies for the future.
- I hope to provide a unique engineer's perspective on the critical need for these corporations.
Based on my contributor name and previous articles, it is likely no surprise that I am a strong believer in the importance and strength of engineering and infrastructure companies. As an engineer myself, I will discuss several important companies that operate in this space and provide my perspective. In order to dive into greater detail, I will limit my discussion to three stocks in particular in which I have strong convictions.
American Tower Corporation
First is American Tower Corp. (AMT), a company that I have previously analyzed but would like to reiterate. AMT is one of the largest global players in physical communications assets, most notably in macro cell towers and now data centers. Both of these assets are absolutely crucial to how our modern world operates and this necessity is only growing.
The critical necessity for AMT's assets will be at the heart of what is being dubbed as "Industrial Revolution 4.0" which is being discussed in regards to 5G and the Internet of Things, IoT. For those who do not fully understand the concept of IoT, I will attempt to quickly summarize. IoT is the connection of nearly all devices to one another via virtual networks and cloud technology, allowing the communication of data and information between essentially all internet connected devices. While at first this may seem somewhat concerning or unnecessary to integrate our lives even further into a digital world, the end goals of IoT are to actually improve our physical world. With improved communication in manufacturing equipment, better informed vehicles operating on the road, and more closely monitored energy distribution networks we open the door to some truly magnificent improvements to modern society.
With the implementation of 5G and IoT we have the capability to significantly reduce traffic accidents, drastically improve manufacturing operations for greater flexibility in meeting global demands, and greatly improve our efficient use of resources with improved distribution networks of energy sources.
Union Pacific Corporation
A staple of the American economy, essentially since its inception, is the railroad industry. For most people railroads probably aren't even thought about as a major piece of modern infrastructure. However, railroads remain as important as ever and the assets and services they are able to provide are essentially impossible to replicate. The transportation of a large percentage of resources and goods is only possible due to the capabilities of rail companies, ranging from timber, coal, and agriculture all the way to finished vehicles. Union Pacific Corp. (UNP) operates as one of the largest railroads in North America and is heavily tied to the success of the American economy.
Train operations have greatly improved in recent years through a revolutionary change in the approach to rail operations known as precision scheduled railroading, PSR. While there is viable criticism of this new operating model, the benefits of PSR are significant to rail operations. At a high level, PSR changed the focus of traditional rail operations from full train operations to individual train car operations. Traditionally, goods were not transported by railroads until the full train was completed with all of the various goods in different cars were present and ready for delivery. The issue with this system is that a delay in coal mining for example and the subsequent loading of a train car would cause a delay for the rest of the full train that is carrying other types of goods for multiple varying customers. By placing a focus on transporting ready train cars as soon as possible and attaching to the next available train, noticeable improvements are made to delivery times and efficiency of company resources. In a recent government report it is evidenced that PSR has led to a drastic decrease in operating ratios (operating expenses as a proportion of revenues) from 2011-2021 as nearly all Class I railroads implemented PSR. The decrease from 73% to 62% operating ratios led to a whopping 58% increase in operating profits across Class I's from $18 billion to $28 billion. Profits aren't the only benefit, railroads also witnessed a significant improvement in fuel usage with decreased fuel consumption per ton of goods transported. Canadian National Railway (CNI) has a fairly transparent report in its investor fact book that can be found here. I am using the CNI example due to their earlier implementation of PSR and greater visibility of its effects versus UNP.
Lastly, Union Pacific will be a central key to a developing macroeconomic change that appears to be taking place. If the U.S. does in fact decide to reduce its dependence on foreign goods, the domestication of energy needs and manufacturing will put UNP directly in the crossroads of making that possible.
For the third and final infrastructure stock I am looking at a utility company, DTE Energy (DTE). The main reason for including this company among the most important is due to the increasing electrification of our world. After spinning off the midstream business in the past few years, DTE is now a pure-play utility for electric and natural gas services. The vast majority of DTE's revenues are derived from its 2.2 million electric customer connections, the undisputed leader in the state of Michigan.
This is significant for several reasons, chiefly being the fact that demand for electricity is accelerating to support the implementation of IoT, dependence on devices, and the EV revolution in automotive. The automotive component is the one most important to DTE and puts the company in a position of extreme responsibility. By responsibility I mean that it will play a major role in the adoption of EVs due to its position directly at the heart of a major global automotive hub. Detroit automakers own roughly 10-15% of global market share for vehicle sales and closer to 40% of the United States market share. If DTE is successfully able to expand and sufficiently meet the energy demands of the EV ramp-up in Detroit it will be pivotal in proving the viability of EV adoption not just in the United States but for the rest of the world as well.
Valuations and Performance
Of course wonderful companies are great but if they are not at a fair or wonderful price then it makes for a tough investment case. To evaluate each company I will look at popular metrics such as P/E, P/AFFO, current dividend yields, and growth rates. Due to the fundamental operational differences between standard C corps and REITs, I will separate AMT's comparisons from DTE and UNP.
Let's look at AMT's valuation first.
|5-yr Average||Current||Upside/Downside to 5-yr. Avg.|
|Dividend Yield||1.97%||3.05%||54.80% Upside|
|EBITDA Growth||10.46%||9.06%||13.40% Downside|
As we can see, AMT is actually sitting at a great valuation versus its historical levels. However, we see that there has been a slowdown in EBITDA growth that may persist in the coming years with inflationary pressures so I will use that to discount the potential upside. Based purely on P/AFFO upside at a 13.4% discount to the 24.06 past average (P/AFFO target reversion now 20.84), there is a 3.7% potential upside. For dividend yield, a 13.4% discount to the 1.97% average leaves us with a target reversion yield of 2.24%. From the current 3.05% yield we project a 36.2% potential upside based on dividend yield theory. Averaging between the two, I arrive at a roughly 20% potential price upside from current levels for AMT. Collecting the ~3% yield along the way gives me a total potential return target of 23% in the next 12 months.
Now let's look at DTE and UNP.
|DTE||5-yr Average||Current||Upside/Downside to 5-yr. Avg.|
|Dividend Yield||3.19%||3.39%||6.27% Upside|
|EBITDA Growth||7.42%||8.61%||16.04% Upside|
First thing to note is that DTE appears to be picking up its growth rates which I believe is in agreement with its new business model. This would warrant a higher P/E reversion target versus the current 5-yr. average as it is growing faster than it did in the past, the new P/E reversion target will now be 19.00 x 1.1604 = 22.05. From 18.06, this represents a 22.08% upside with regards to P/E valuation. Inversely, the higher growth rate and higher price will decrease the dividend yield average reversion target from 3.19% to 2.75%. From 3.39%, this represents a potential 23.27% upside based on dividend yield theory. Averaging between the two valuation method, I am calculating a 22.68% upside from current prices of DTE plus the 3.39% dividend yield gathered to a potential 26.07% total return in the next 12 months.
|UNP||5-yr Average||Current||Upside/Downside to 5-yr. Avg.|
|Dividend Yield||2.04%||2.66%||30.39% Upside|
|EBITDA Growth||2.86%||2.77%||Negligible Difference|
For simplification I will regard the EBITDA growth rates as a non-impact on the reversion targets. Using the two different valuation method upsides in the table, I come out to an averaged 29.52% upside plus the 2.66% dividend to equal a potential 32.18% total return in the next 12 months.
Takeaways and Risks
Infrastructure companies are typically regarded as boring investments but I hope some new perspectives were realized during this article. Without a doubt, these companies will be critical to the evolution of the modern world and macroeconomic landscape and I believe their potential for outsized total returns is much greater in the future than it has been in the past.
Because I am a more conservative investor, I will look to target total returns of just 50% of the potential returns discussed in the previous section. Even with this large safety factor that would equal an average of 13.54% 12-month total returns for an investment spread equally across all 3 companies.
Of course there are risks associated with these investments. For AMT there is continuous talk of satellite technology making macro towers obsolete, however that is fundamentally not the case for implementation in the near future. Macro towers will actually be central to the operations of low-earth orbiting satellites as a distribution node, evidenced by partnership agreements reached between American Tower and satellite operators. The major risk, and one that has been quite public, for railroads operating on PSR is increased risk of crashes and derailments. This is mainly due to the reduction in inspection time allotted for rail cars and equipment, but I believe that this concern is now being addressed appropriately and that rail operators will find a solution. Lastly, risks to DTE include competition and the ever-increasing severe weather events that we are witnessing across the globe. Downtimes and repairs for electric infrastructure are both costly and lengthy. A comforting fact for this concern is that energy storage systems are being deployed at an accelerated rate that can provide energy instantly to blackout areas and help supplement periods of increased demands.
While each of these companies may not provide home run returns witnessed by tech in the past several decades, I'd be surprised if they do not provide solid, healthy returns and stability to a portfolio. If these corporations and their peers suffer substantial losses or fail in the near future, we most likely will have bigger concerns as a society than the performance of these stocks.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMT, UNP either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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