Overview
Magellan invests within a disciplined and tightly defined universe of listed infrastructure businesses. This infrastructure universe focuses on around 140 companies comprised of approximately 60% regulated utilities and 40% transport infrastructure, the latter being assets involved in moving people, data, and goods. These companies provide essential services and therefore experience reliable demand over the cycle.
Our current portfolio allocation is different from its universe, with an overweight in transport infrastructure at over 50% of the portfolio and an underweight in utilities at approximately 45% and a 3% cash holding.
Three major factors have influenced performance this year. First, the rise in real interest rates over the past couple of years has negatively impacted infrastructure performance, despite infrastructures resilience to inflation. Second, the increase in commodity and energy prices, particularly oil has benefited the benchmark, but not the portfolio, as we avoid oil-linked assets due to their volatility. Lastly, the return to normal commerce post-pandemic has positively impacted transport infrastructure, especially airports. Overall, while short-term factors have posed some challenges, our long-term strategy remains strong.
Airports
The COVID-19 recovery continues to be an important discussion, given its impact over the past few years. However, we’ve seen a strong rebound, especially in leisure, low-cost, and short-haul travel. This recovery has benefited our holdings in the portfolio such as Aena and Vinci. This is despite capacity not returning as quickly as anticipated due to issues with Boeing and Airbus.
Boeing has faced major production issues stemming from safety concerns. It was previously producing 52 Boeing 737 Max planes a month whereas it delivered only 19 Max planes last month, indicating a significant slowdown. Airbus has had issues with Pratt & Whitney engines, leading to many A320neos being taken out of service for maintenance, which has also impacted production.
Despite these challenges, companies like Aena in Spain have seen traffic increase by over ~11% compared to 2019 levels and ~8% versus last year. Spain in has not faced these delays as severely as other regions, highlighting its strength as a low-cost destination in Europe.
Looking ahead, we expect growth to moderate next year as the recovery from COVID-19 normalises. One aspect that investors might not fully appreciate is that companies like Aena have had their tariffs frozen since 2015. These freezes will end next year, allowing them to raise tariffs again from 2026, which will significantly increase their revenue.
In terms of geopolitical risks, while there are always concerns, some regions have benefited from the redistribution of capacity due to conflicts in the Middle East. If peace is achieved between Israel and Hamas, there might be some correction, but it wouldn’t be swift. Conversely, if there is a major conflict involving Israel and Hezbollah, it could draw more capacity out of those markets and push it back into southern Europe. However, these geopolitical factors are marginal compared to the overall positive outlook.
Toll Roads
We invest in companies like Vinci and Ferrovial and despite both being European, they have very different exposures. We favour these companies for their monopoly-like assets and high cash flow generation, and ability to pass through price increases.
Vinci, a French company, operates mature motorways in France with about a decade left on their concessions. These motorways generate significant free cash flow. However, recent political instability in France, including talks of nationalising motorways, has impacted Vinci’s share price. Despite these concerns, the strong contractual protections make nationalisation unlikely.
Ferrovial, though also based in Europe, primarily operates in North America. It has had a strong year, benefiting from selling its stake in London Heathrow Airport at an attractive price and strong performance from its U.S. roads. Its crown jewel asset, the 407 ETR motorway in Toronto, resumed toll increases, boosting investor confidence.
Transurban has also had a good year operationally, with traffic in line with expectations. Political risks, such as a toll review in New South Wales, seem minimal as contracts are respected. Additionally, projects like the M7 widening and potential developments in Queensland may add value not yet reflected in the share price. Despite some challenges, the underlying fundamentals for Transurban remain strong.
Utilities
The US utilities in our portfolio have consistently delivered strong operational results, aligning with typical guidance of 5-8% growth in earnings per share. This growth is supported by trends like the integration of renewable energy, upgrading aging infrastructure, and partial electrification of various sectors. Over the past year, we’ve also seen an increase in electric load growth, driven by the expansion of data centres, reindustrialisation efforts.
For example, Dominion has nearly doubled its load growth expectations for 2029, and Georgia Power revised its demand projections significantly upward. This load growth enhances the capital investment outlook and helps reduce customer costs by spreading infrastructure expenses over a larger demand base. Overall, these factors reinforce a positive long-term outlook for US utilities.
In the European market, we focus on two main areas: electric and gas utilities. Our electric investments are primarily in high-voltage transmission lines, driven by the EU’s ambitious climate goals and the rapid adoption of electric vehicles. For example, Terna, which operates Italy’s transmission grid, plans to invest €16.5 billion during 2024 to 2028 to enhance grid resilience and connect renewable energy sources, up significantly from its former plan.
In the gas sector, our holdings in Italgas and Snam, offer strong valuation opportunities with potential for secure growing dividend yields. Despite concerns about the future of gas, these companies are exploring ways to support decarbonisation, such as renewable natural gases and hydrogen. This dual focus on electric and gas sectors aligns with our strategy of investing in regulated monopoly companies with stable returns.
Over the past year, we’ve increased our holding in UK water utilities Severn Trent and United Utilities, taking advantage of stock price weaknesses driven by temporary factors. Concerns about the potential failure of Thames Water, an unlisted peer in the sector, and political uncertainties led to these stocks trading at Regulated Capital Value, which is rare and presented an opportunity.
Severn Trent and United Utilities are financially stable, unlike Thames Water, which is heavily geared and underperforming. Both companies have strong environmental credentials and have delivered solid returns, ~ 8% per annum in real terms, compared to Thames Water’s 1.9% per annum.
Looking ahead, we expect significant growth in the UK water industry. Severn Trent and United Utilities are proposing real growth in their regulatory capital value of ~5.5% to 6.5% per annum for the next regulatory period. We are confident the regulator will approve most of this investment due to legislative mandates.
Outlook
The companies we invest in have a history of strong operating and financial results, and their outlook is improving, even though they are trading at historically low prices. We believe interest rate conditions will normalise, as we are likely at the peak of the cycle. This normalisation should positively impact the valuation of these companies. We are optimistic about future returns, reflecting the strong earnings power of these companies in their investment performance.
