Full episode: Market Call for Monday, February 10, 2020
Varun Anand, portfolio manager at Starlight Capital
Focus: Infrastructure stocks
2020 has started off looking a lot like 2019. Macro factors dominate headlines, while stocks continue to march higher and hit records. In just one month, we've had two major events take place: the escalation of U.S.-Iran tensions and the coronavirus. In 2019, global and U.S. equities delivered returns in excess of 22 per cent, with the majority of returns coming from multiple expansion. This was driven by lower rates and stimulus, but it’s not sustainable given rates in many areas of the world are already negative, government balance sheets remain stretched and valuations are not cheap. As a result, we believe returns are going to primarily be driven by earnings growth and yield rather than multiple expansion in 2020, which makes stock selection more important than ever.
The infrastructure companies we invest in generally have revenue visibility for multiple years, combined with robust free cash flow generation which results in consistent dividend growth. We expect high single-digit earnings growth combined with mid-single digit yields, resulting in a 12 to 14 per cent total return in 2020 for the infrastructure equities we invest in, with none of the return coming from multiple expansion.
QTS REALTY TRUST (QTS NYSE)
QTS Realty is a carrier-neutral data centre operator providing solutions across a diverse footprint spanning more than 6 million square feet of owned mega-scale data centre space throughout North America, as well as two data centres in the Netherlands. The company stands to benefit from the strong growth in data consumption and cloud computing. Its revenue is split between hyper-scale and enterprise co-location, with the latter accounting for more than 65 per cent of the business. QTS's relatively small size (US$3.4 billion market capitalization) and lower percentage of hyper-scale business imply the company only needs one to three hyper-scale deals per year to maintain growth, which we view as achievable without eroding returns. We see further upside in the enterprise co-location business, where QTS's strategically located assets, combined with its cutting-edge service delivery platform, will result in strong demand from customers. In particular, QTS's Richmond facility is positioned very well to benefit from demand stemming from subsea cable development at Virginia Beach, as it owns the only data centre in the market where all networks can peer with each other with ample capacity available.
Ferrovial is a Spanish-based infrastructure conglomerate, operating globally in a number of sectors, including airports, toll roads, construction and municipal services. Ferrovial’s flagship asset is its 43 per cent stake in the 407, which is recognized as one of, if not the, best toll assets in the world. The company also has a 25 per cent stake in Heathrow airport, one of the largest airports globally. The company is in the process of selling several of its business units within the construction and services segment, which has been positively received by the market given the volatility in revenues and lower margins relative to Ferrovial’s concession assets. These asset sales will result in a simpler business mix for Ferrovial and turn investor focus to Ferrovial’s concession assets, which should re-rate higher once the asset sales are completed and the business is simplified. Ferrovial was also one of the first companies to pursue managed lanes in the United States, and we believe the market is not appropriately valuing the opportunity set in the U.S., particularly in Maryland.
TIDEWATER MIDSTREAM AND INFRASTRUCTURE (TWM TSX)
Tidewater Midstream and Infrastructure is a small-cap Western Canada midstream company, focused on natural gas processing, liquids upgrading, storage and transportation, and marketing. Tidewater is well positioned in some of the most active formations in North America, including the Montney and Duvernay. Since going public in 2015, Tidewater has completed a number of acquisitions while driving organic growth and optimizing operations at existing facilities. The shares are significantly undervalued, trading at less than 5 times 2020 EV/EBITDA, as the market overreacted to the downside after the Prince George Refinery acquisition was announced. We believe Tidewater's EBITDA guidance is conservative and the company will de-lever quicker than the market expects, resulting in a re-rating. We also anticipate several growth projects to be announced in 2021/2022 (Pipestone phase 2) within the existing footprint of the company, providing visibility on cash flow growth without the need for additional M&A.
NORTHLAND POWER (NPI TSX)
WASTE CONNECTIONS (WCN NYSE)
GIBSON ENERGY (GEI TSX)
Starlight Global Infrastructure Fund Series F
Performance as of Jan. 31, 2020:
- 1 month: 4.44% fund, 3.63% index
- 1 year: 23.33% fund, 19.46% index
- 3 years: N/A fund, 12% index
Index: S&P Global Infrastructure Total Return Index.