12 minute read
Christopher Voyce | Executive Director, Co-Head Infrastructure, Utilities Renewables, ANZ, Macquarie Capital
Christopher Voyce
• Australia’s urban infrastructure will need to grow because of population growth. • Recurrent service costs will be forced to change because the public sector will need operating efficiencies to fund capital investment needs. • The need for competition and innovation in service value will see major changes to the role of government in service sectors.
Macquarie is extremely optimistic about infrastructure. Today, I am going to cover three topics: the global economy, financial markets and recent infrastructure themes.
In the global economy, we’re seeing weakness in emerging economies being offset by slightly moderate recoveries in advanced economies. There are various economies in different states of transition, making it very difficult to forecast economic performance even on a short-term basis. Forecasts are reflecting that we are seeing a tail off in the United States, a tail off in Europe and also stronger growth coming through in Australia. That backdrop of uncertainty is against a very strong growth of profile across the world, where we’ve seen average growth in gross domestic product (GDP) per capita across the world of about 3.5 per cent per annum.
That gives us great confidence as we look to the future, and we’re actually seeing it come through now, with global indicators showing very positive signs. For the first time in quite a while, both the manufacturing sector and the services sector in all the major economies are in expansionary territory. That gives us some indication that the world is becoming a better place, and we’re likely to see more growth in future.
Turning now to the regions, and the big issue in Europe is Brexit. The impact of Brexit can be observed via Macquarie’s Composite Volatility Index – a measure of volatility across financial markets, whether it’s stocks, bonds, currencies or commodities – shows the performance through the global financial crisis, the United States losing its AAA rating, and a small dip for Brexit in the context of Europe.
It’s very important in the context of Britain, but in the context of the global economy, Brexit really hasn’t had much of an impact; it has been relatively contained. In the markets around Brexit, there was a very significant impact on the value of the pound, but that seems to have absorbed most of the damage from the fallout from Brexit, with the domestic sectors having rebounded strongly since the initial fall and global indices doing the same. In the longer term, the International Monetary Fund (IMF) is saying that the spillover to the rest of Europe will be limited.
Given the United Kingdom’s limited contribution to global growth over the last 20 or 30 years, it’s unlikely to be a big drag on global growth into the future. Similarly, as the United Kingdom’s share of Australian exports has fallen over time, and as economies like China and the United States have
continued to grow, Brexit’s impact on Australia will be very limited, as well.
Looking at the United States, the key point is that there’s been a strong and sustained growth in US jobs. More people are now willing to change jobs in search of more opportunities, and the number of layoffs is reducing, so we’re seeing a lot of confidence in the labour market as more jobs are being put into the economy. That’s against the backdrop of limited inflationary pressures, so over time there’s been deferral and reductions in the forecasts of when and by how much the US Federal Bank raised interest rates, as we’ve seen a lack of inflationary pressures in the United States. But that confidence in the labour markets is not necessarily coming through into the US markets. There has been low US confidence, and we are not sure whether the recent drop-off is all about the US election cycle, as there were similar dips in 2008 and 2012. But that confidence in the labour market is not coming through necessarily into US stock markets.
China’s concerns remain, but recommitted to growth, albeit at lower levels. We’re likely to see increasing levels of leverage and potentially a lack of structural reform in that economy. China’s transition is well underway. The economy is diversifying strongly away from the manufacturing sector. The property market continues to recover in the tier-one and tier-two cities, and the Chinese economy is benefiting from the diversification away from a reliance on state-owned enterprises. So, in general, we’re relatively confident about where China is heading in the longer term.
Australia is also transitioning, and this is relatively well known. Mining investment continues to decline, but the mining production boom is really just starting, and you can see that the Australian economy continues to grow strongly, boosted by the reductions in the exchange rate over the last couple of years. We’re seeing that spending is continuing to grow strongly, despite low income growth, and that’s really coming as a result of a reduction in the national savings rate. People are continuing to spend but are reducing their savings, and they’re prepared to reduce their savings as a result of the rising property prices and the wealth effect that they’re feeling from their property prices continually going up.
Stepping back now from the economies and just thinking about macro-economic policy, obviously since the global economic crisis we’ve seen an unprecedented monetary easing. We have seen more than 666 rate cuts around the world by central banks since Lehman Brothers went bankrupt, and it shows no sign of letting up. We’ve seen all of those interest rates cut, and it leaves less room for further cuts to give a boost to the economy.
There’s a very significant number of government bonds with negative yields: it’s approaching $12 trillion. If governments and central banks are going to keep economies growing given the weak recent performance, we believe that fiscal stimulus is really going to be where it’s coming from. The IMF agrees, and has even said for about a year now that we should be using debt with low interest rates to invest in productivity, generating infrastructure in our economies. You’ve got moderate growth prospects, very low interest rates and a large reliance on fiscal stimulus, with infrastructure being seen by most as the key area where governments can do more.
Moving now to the financial markets, and after a shaky start to 2016, we’ve seen equity markets rally quite strongly since January. Global commodities are also up, well into the double digits, with gold, crude oil, iron ore and coal also increasing strongly. Australian equities are trading above their longterm price earnings ratio. Different to the period in the past where they may have been driven by
Christopher Voyce
Christopher Voyce
growth prospects, they’re currently being driven by extremely low discount rates. There’s quite a degree of dispersion between the sectors and how they’re affected, with utilities and health care trading well above the average price-to-earnings multiples.
The other thing to note about the financial markets is that the investors are holding record levels of cash. One of the things driving the listed markets is that there’s a real bifurcation of the market. There are certainly companies that offer a combination of earnings, and sustainable dividends in a transparent growth profile are very attractive to investors. But those stocks are being pushed up to levels where most investors would consider them to be fully valued. There are also other investment opportunities – they’re seeing a risk of negative earning shocks, so rather than invest in the market, a number of those investors are staying on the sidelines.
People are interested in stocks represented by industries, such as real assets, real estate, transport and utilities. On equity capital markets, the difference between the price earnings multiples at the top quartile stocks and the price earnings multiples at the bottom quartile stocks is at its widest point since around about 2000, which was the first internet boom, when earnings really went out the window. A dispersion between the most favoured stocks and the least favoured stocks is the broadest it’s ever been. That means that stocks like infrastructure are very well favoured by investors, and you’re seeing great demand for infrastructure projects and infrastructure investments.
As we turn now to infrastructure, there are three key themes I want to touch on that we’re seeing in our discussions with governments and our clients.
The first is city building, which remains a nearterm priority, and there are a number of projects that are underway. The second is that in the medium term, we’re starting to see a focus on recurrent expenditure, and also changes to the clarification of the Renewable Energy Target (RET), which is driving renewable energy into the mainstream.
Everybody knows about city building and the response that governments are putting into investment in the cities to absorb population growth over time.
The amount of money that’s projected to be invested in infrastructure by governments and others over the next four years is around $100 billion. If you look at recurrent expenditure over the same period, it’s around $2.5 trillion. Recurrent expenditure represents an opportunity set somewhere north of 25 times the opportunity of the capital investment. Given the long-term pressures across all of the areas of expenditure, governments and future governments will have to seek to do more with less money. We also note that health care is expected to double over the next 20 or 30 years.
How we see that manifesting is that our government clients are really looking at how they can provide better service outcomes at lower costs for the people that they serve. They’re not as focused as they have been in the past, or potentially in the nearterm future, on just asset creation; they’re focused on how they can improve those services and how they can improve the lives of people so that they don’t demand the same degree of services into the future. A significant element of opportunity coming up in the near future is around government outsourcing, and around providing services in response to that trend.
Some of the projects that have been undertaken recently are incorporating elements of the improved service outcome. Sydney Metro Northwest, and the Sydney CBD and South East light rail’s performance and payment regimes reward service, reliability and frequency, particularly during peak periods, linking up returns to performance. The Northern Beaches Hospital, which was closed a couple of years ago, has created efficiencies by colocating the public and private hospital, and it has driven incentives for continued efficiency for the operator by linking the price that they get paid for the services they provide in the public hospital as a discount to the state price.
In the corrections sector, in both New Zealand and Australia, we’re seeing the inclusion of custodial services that allow more efficiencies to be brought in through the provision of additional services provided by the private sector, and the payment regimes are beginning to reward high-quality operators undertaking programmes that reduce reoffending rates, and that will hopefully reduce the cost of the corrections system as a whole over the longer term.
The last kind of trend that we’re seeing is the confirmation of the Renewable Energy Target last year, which has really changed the playing field for renewables. That’s sending a very clear pricing signal to the market that new projects are required. In the renewables sector, we’re seeing frenzies of new project development. There was the ARENA announcement of the solar programme, with 10 new projects receiving grants from ARENA. We’re
Christopher Voyce
seeing dozens and dozens of renewables projects working through the approvals process. It’s an interesting time, because first-generation renewables projects were financed on the back of long-term volume purchasing agreements for the full life of the project over the bulk of the output from these projects. Retailers are stepping back into the market and providing power purchase agreements, as are governments, but only until around 2030, when the current scheme of large-scale generation certificates expires, leaving quite a significant tail of merchant risk within those investments. That means that those renewables projects will be funded in a much more equity-heavy manner moving forward.
In the past, renewables investment may have been around 20 per cent equity, 80 per cent debt, while the ratios for projects that have been financed under this new scheme will be closer to 40/60. Out of the $15 billion that’s required to just meet the target at 2020, roughly half of it will need to come from equity. That’s the bottom of equity; it hasn’t necessarily been invested in the renewables sector to date, so there are great opportunities in the renewables sector.
Longer term, if current policies are extended beyond 2020 to 2035, there will need to be a very significant change in the mix of energy, with renewables potentially representing up to 50 per cent of the capacity, generating capacity within the national electricity market. This brings with it a whole load of very interesting issues around net metering behind the meter generation, peak saving and system reliability, and all of those issues will need to be dealt with by regulators in the industry over the next 10 or 15 years in order to make that a reality.
With low interest rates and a fair degree of reform going on in energy and government service markets, there’s never been a more exciting time to be an infrastructure professional in Australia.
Mr Voyce is the Co-Head Infrastructure, Utilities & Renewables, ANZ, for Macquarie Capital, and was previously a Senior Managing Director in the New York infrastructure team, heading the Transport and Public Private Partnerships (PPPs) practice for North America. Mr Voyce has more than 18 years of experience in infrastructure and PPPs. He has closed more than $50 billion in infrastructure financings, fundraisings and acquisitions for a range of clients in the utilities, airports, and road and rail transportation sectors in Australia, Asia, Europe and North America.
Mr Voyce has developed strong relationships with many prominent strategic and financial investors, contractors, engineering and legal firms, some of which are evidenced in the transaction experience.
