Uncertainty but good returns

Having managed money during this period it is interesting to reflect on the impact of this event which is still being felt today even though we have seen a very strong recovery in risk assets. 

Whilst it would be unlikely that we witness a financial crisis of this magnitude again in the near future, it is important to recognise that economies move in cycles and  that downturns are a natural component of this cycle.

The greatest lesson that I can convey form my experience from the GFC for investors is to respect the principles of portfolio construction.

Understand that equities are the riskiest asset class and that returns from equities are best gained by holding a longer term view, and not reacting to market noise.

Always ensure that there is sufficient liquidity in your portfolio to cater to shorter term needs and allocate some of your portfolio to high quality defensive assets such as government bonds that allow some exposure to interest rate duration. 

On to more current matters.

Among our three key exposures to infrastructure type assets (toll roads and airports), I currently lean towards Transurban (TCL) , although I continue to hold Atlas Arteria (ALX) and Sydney Airport (SYD).

Over the last year, ALX has out-performed both TCL and SYD. ALX’s strong run (re-rate) has been on the back of catalysts such as re-financing of higher cost debt to lower interest rates, strong toll road performance from APRR (French asset) and internalisation of management. Comparatively, SYD and TCL have been largely trading within each other but both under-performing ALX over the last year.

I continue to like SYD but recognise that out of the three holdings, it has the most exposure to regulatory uncertainty with the Productivity Commission (PC) review outcome a key risk in our opinion. The PC’s final report is expected in June 2019.

This review is likely to shape the negotiation of the 2021 aeronautical access regime. The key points of contention are, the Airports want to retain the status quo while the Airlines (led by Airlines for Australia and New Zealand - Air NZ, Jetstar, Qantas, Rex, Tigerair and Virgin Australia) are pushing for easier access to arbitration. Airlines essentially want a stronger connection between payments and delivery of services. 

The key risk now, across all sectors, is that governments are willing to be more interventionist.

This could increase the regulatory risks for SYD going into 2019. In addition, there are also upcoming renegotiations for SYD in terms of T2 (terminal) with Virgin Airways (June 2019) and Jetstar (December 2019). There is also the International fee renegotiation for July 2020. 

This takes us back to TCL. Given the major hurdle of acquiring WestConnex is now complete, it is all about execution for TCL and its “really big” project.

Although cash flow will be weaker until WestConnex comes online (expected to be 2024 when WestConnex will be generating meaningful cashflow distributions) and a lower dividend growth profile, we believe at the current share price TCL represents the better risk/reward when compared to ALX and SYD.

In summary, in order of preference, Transurban (TCL) – execution risks on WestConnex, but with this acquisition (and equity raising) a lot of the uncertainty has abated, in our view offers the best risk/reward proposition; Atlas Arteria (ALX) – valuation risks – fairly valued; and Sydney Airport (SYD) – Good returns still, but regulatory uncertainties looming from the Productivity Commission outcomes.