Infrastructure is no longer a dull source of revenue

Investors in infrastructure perceive a significant need for funding, which is causing faster growth than the markets anticipate

When is it going to occur?

It was unlikely ten years ago that infrastructure could be an exciting, growth-oriented investment. The industry was viewed as a reliable source of income that would, ideally, keep up with inflation but most likely not provide much more. When you speak with an infrastructure expert today, you can see how much has changed over the past few years, particularly in the areas of power and energy.

I have had conversations with Daniel Chu of ClearBridge Global Infrastructure Income Fund and Jean-Hugues de Lamaze of Ecofin Global Utilities and Infrastructure (LSE: EGL) over the last two weeks. Both contend that although the industry's fundamentals have changed, markets continue to underestimate the amount of capital needed and the implications for investors.

In a nutshell, the bull case starts with the necessity of updating and replacing outdated infrastructure, a large portion of which was constructed more than 50 years ago. This holds true for numerous subsectors of infrastructure. The second is the electrification of the economy brought about by the energy transition, which necessitates investments in batteries, grids, and new generation to enable greater use of renewable energy sources in the generation mix. AI and data centers are two examples of new, power-hungry users that are contributing to this trend (see chart). Lastly, strengthening supply security and resilience against climate change and geopolitical threats is becoming increasingly important.

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Discounted assessments of infrastructure.

The required investments will be substantial. De Lamaze cites Germany's infrastructure plans as an example, which may need more than 700 billion between 2026 and 2035. Given the state of public finances, governments won't want to pay for all of that. This will open up enormous opportunities for private investment, frequently in collaboration with the government.

He adds that many utilities' business models have improved, particularly in the power sector, which is another benefit for investors. Longer-term contracts account for a larger portion of revenue than short-term sales. This increases earnings certainty, which is comforting if a large portion of the industry plans to invest in capacity expansion in the coming years.

According to both managers, listed infrastructure fund valuations are still significantly lower than the value of comparable assets in private transactions, despite these favorable conditions. Even before allowing for a structural shift in growth rates, listed stocks appear appealing by historical standards, but we shouldn't wager on this gap being closed. According to Chu, investors are looking for more evidence of profitable growth and successful execution. That might occur by 2028, bringing with it a rerating of some kind for the industry.

Next week, you can listen to my conversation with Jean-Hugues de Lamaze on the BFIA Talks podcast.