Keynote address | John Pickhaver, Macquarie Capital, Australia and New Zealand

Keynote address John Pickhaver, Macquarie Capital, Australia and New Zealand Economic outlook and the opportunities for Infrastructure

Key points:

• Despite the impact of the pandemic on global economies, the recovery is already underway. • Stretched government balance sheets have provided an opportunity for record levels of unallocated private capital to support the economic recovery from COVID-19. • Investment activity will be driven by the digital transformation of infrastructure assets, corporate and government efforts to decarbonise and a focus on sovereign resilience.

I would like to take you on a journey through what the data is telling us about our economy and its recovery from the pandemic. Firstly, we will take a global perspective then deep dive into the Australian market and finally we will look at the opportunities that will drive investment activity in the infrastructure sector.

From a global standpoint, in terms of real gross domestic product (GDP) there was a sharp drop-off courtesy of COVID-19 in 2020 before a recovery during 2021. Compared to the preCOVID trend, there has been a very sharp recovery (Figure 1), in fact, it is the strongest in history – much stronger than the recovery from the global financial crisis (GFC).

Looking forward, our forecasts show very strong GDP growth before returning to more normalised levels as we travel

forward through to the first half of next year. We are observing some of the leading indicators of economic growth, including the global Purchasing Managers’ Index (PMI) having had a big spike in 2021 which is now starting to tail off. The PMI is a leading forward indicator that is showing us that growth is slowing and returning to normal levels.

The biggest risk to our recovery remains COVID-19. Thankfully, the vaccine program has exceeded expectations in terms of both the development of vaccines, and then the rollout of doses particularly in Australia. The vaccine rollout is a massive logistical challenge that is unfolding across the world. Interestingly, it’s happening unevenly both by country and by income distribution. One of the key risks to the global economy recovering to normal levels is the uneven distribution of vaccines.

Pleasingly, as vaccines roll out, it seems that they are working well. We can see that the rate of fatalities and hospitalisations has significantly reduced during the Delta wave, compared to the big wave last year. In the middle of last year in the United Kingdom, the seven-day average of COVID-19 cases, and the number of fatalities and hospitalisations, followed very similar trends. What we’re seeing now, through August and September in the United Kingdom is that while there is a surge in cases, the hospitalisation and fatality rate remains quite low, indicating that the vaccines are doing their job.

Turning to the major economies around the world – the United States recovery is well advanced. Business investment is strong despite a surge of Delta cases. Another leading indicator of the recovery of economic activity in the United States is the shipments of capital goods, which began to rise coming into 2021 and is up again in this quarter.

US real GDP did tail off in the last quarter of 2020, but there has been a significantly faster recovery from the initial shock than what was observed in the GFC. In our forecast, we predict US real GDP to return to the pre-COVID trend in 12 quarters, or three years, after the initial impact of COVID.

Turning to Europe, there was a bigger initial impact on the economy in terms of a reduction in GDP, followed by a sharp recovery before a bit of a hiccup a couple of months ago, which is now beginning to trend up again. As everyone will recall, it took Europe longer to recover from the GFC than other economies – in particular Australia and the United Kingdom.

Figure 1

Figure 2

One interesting thing we’re seeing in Europe is that the rates of vaccination in many of the European countries have gained pace, are well-advanced and have overtaken the United States. Whilst the United States was out of the blocks early its vaccination uptake is now tailing off at the low to mid-50 per cent vaccination rate. This is a risk factor as we look at those economies going forward, particularly the United States.

Turning to China – a major trading partner of ours and a big influence on our economy. China had a recent Delta outbreak in July and August, resulting in a big drop in the Purchasing Managers’ Index as Chinese authorities restricted economic activity. Consequently, government responses to increases in case numbers remain a threat to Chinese growth and, by extension, Australian exports.

Lastly, looking at Australia, we had a lower level of COVID-19 impact in the Australian economy in the first wave last year, and we saw a classic V-shaped recovery. Employment dropped off, as did GDP, but it recovered very quickly to pre-pandemic trends; however, we are seeing that recovery significantly impacted in the current Delta wave.

In terms of unemployment, Australia has performed relatively well with a 4.5 per cent unemployment rate announced for the month of August; however, in our view, the low rate is masking the realities underlying our economy as the participation rate is down quite significantly. The actual number of jobs in the economy and the actual number of hours worked in those jobs is significantly reduced. So, whilst the headline figure for unemployment is positive, the other measures of actual productivity and wageearning capacity in our economy are quite low.

We’re expecting GDP to fall heavily in the third quarter as a result of the current lockdowns, but we expect it to rebound in the fourth quarter upon reopening. Last year, when lockdowns and restrictions were eased, we saw that our economy bounced back quite quickly, and we expect that to happen again, hopefully in a more sustainable way.

We’re optimistic here, in terms of the efficacy of the vaccine, that we will have a successful program similar to that in the Northern Hemisphere, with governments discussing 70 and 80 per cent as targets, similar to the UK experience. If we are at that level of vaccination and we open the economy, even if case numbers rise on the back of that, the fatality and the hospitalisation rates should remain low as we have witnessed in the United Kingdom, Canada and the current wave in New South Wales. We are positive and optimistic that those vaccine targets should allow economies to reopen. Of course, that vaccine target rate is the topic of our daily and hourly news coming through our feeds. New South Wales should hit their targets first, with Victoria and other states not too far behind. We can already see that the vaccine is working in terms of lower levels of fatalities and hospitalisation rates in Australia.

Figure 3

When we do recover, what do we expect to drive our economy? Where should we see growth returning? Traditionally, we’ve talked about population growth as a big driver for infrastructure investment and Australia’s high level of population growth relative to the averages provided by the Organisation for Economic Co-operation and Development (OECD). Australia typically runs well above the OECD average, in the range of 1.5–2 per cent. Recently, population growth has fallen off a cliff with Australia’s borders being shut. We’ve had our natural population growth, but no immigration supercharging total population growth, which traditionally underpins the economic and social infrastructure requirements of our cities.

Our expectation is that that population growth will return. We think it will bounce back as the natural drivers of population growth, the demand for labour, skilled migration and education as an export return – not immediately, but overtime. As a result, we expect population growth will return and continue to be a driver of economic activity and therefore infrastructure demand. We’re starting to see governments look to step up their investment in infrastructure. Across the states and the Commonwealth, there is a large step up in the aggregate numbers and forecast budgets for investment in infrastructure, with a significant amount of it directed toward rail.

What are the implications of that higher spend? Looking at government balance sheets, we are observing the combination of infrastructure and other spending to support economic growth. The stimulus that governments injected into the economy over the past 18 months, such as JobKeeper in Australia, has resulted in record levels of government debt globally.

In terms of government debt, historically, significant world events, such as World War I and World War II, have caused big increases in government debt. Post the GFC, however, government debt increased significantly and never really came down. The ‘Great Lockdown’, as we’ve called the pandemic, has seen government debt step up again (Figure 2). In particular, debt in emerging markets has increased meaning that government balance sheets across the board will be stretched. Governments have borrowed a lot already and are continuing to do so, which will impact their capacity to spend. Interestingly, it’s not actually costing governments all that much to service that debt at present. With historically low interest rates, the cost of the interest expense is actually quite low, and so the danger is that governments get used to low-interest bills, alongside higher levels of debt.

All of that sounds a little bit negative, which is not normally my style. So, I’d like to step back out of the daily noise of COVID-19 and have a look at longer-term trend lines. We’ve gone all the way, back to 1871 (Figure 3) to look at US economic growth in terms of real GDP. Over the long term, it’s observable that the world will continue to grow and bounce back to its long-

Figure 4

term trend of growth. We also expect that to happen coming out of COVID-19. While in some short-term periods you can see pockets of poor growth, when you step back and think about it over the very long term, we’re optimistic that things will recover.

We’re seeing a lot of positive opportunities within that recovery. One of those is that with government balance sheets stretched, the requirement for private capital and the opportunity for private investment in our sector is substantial. There is capacity and an appetite to invest in the private capital sphere. We can see in three categories (Figure 4) – private equity, real estate and infrastructure funds – that have large amounts of unallocated capital that has been raised, and is ready to be deployed and invested, but has yet to be spent. We’re now starting to see a lot of that capacity beginning to be deployed.

The mergers and acquisitions (M&A) market has seen a record level of activity across the infrastructure sector this year. Some examples include the Future Fund, Commonwealth Superannuation Corporation and Sunsuper acquiring 49 per cent of the Telstra Towers (Amplitel Towers) business for almost $3 billion. We’ve also seen the IFM-led Sydney Aviation Alliance consortium, comprising IFM, Global Infrastructure Partners, QSuper and AustralianSuper, propose an acquisition of Sydney Airport for $32 billion (including debt). Finally, we’ve seen Aware Super and Macquarie Infrastructure acquire Vocus at an enterprise value of $4.6 billion.

Recently, we finished the 2021 Australian Securities Exchange (ASX) reporting season, and there’s a great degree of positive sentiment in the listed market. The ASX is continuing to trade at all-time highs with a lot of capital available and positive sentiment from investors. In the Australian market, we’re observing the price response of a lot of companies negatively impacted by COVID – travel, hospitality, leisure and so forth – has been much, much better in terms of a share price uplift, or lack of fall, after announcing downgrades to their forecast earnings. This is an indication that investors understand the challenges. They’re saying, ‘I’ve got it, you’ve had a tough time through this period, but we’re very optimistic in supporting you in the recovery, and we see that recovery coming.’ On the flip side, the stocks that have been beneficiaries of COVID-19 – online retail, for example – have actually had a less positive share price response post reporting their results.

Another marker of optimism in our listed market is when you look across companies that have started to be beneficiaries of the recovery; they’ve started increasing distributions again. The audience will remember that as we initially came through COVID-19, a lot of companies weren’t able to provide dividend or distribution guidance, or even forecast earnings guidance for the years ahead. Companies are starting to be able to do that again, or at least provide a framework for how they’re thinking about their business in the years ahead. Dividends have increased: 49 per cent of companies who reported this year increased their dividend. About 15 per cent still have no dividend coming through, and about 10 per cent reduced their dividend.

Moving on from of reporting season and into AGM season, some of the other key takeaways we’re seeing with investors looking through the COVID-19 cycle and remaining quite optimistic is a strong M&A market. In fact, this year to September there’s been more M&A announced in the Australian market than we’ve seen on record, and we’re only three-quarters of the way through the year. We expect by year end to be north of $350 billion of announced M&A in the Australian market, which will be the highest year on record. There’s been about $240 billion announced to the end of September, similar to the calendar year just before the GFC and the current high marker.

As we head towards AGM season, historically the focus of investors has been governance and remuneration, whereas the focus of investors this year has significantly heightened on

environment, social and governance (ESG) factors. Many of our listed company boards are spending a lot of time with investors on their ESG measures, and, interestingly, lots of investors are wanting a trading update as part of their AGMs, which isn’t the traditional place to provide that.

So what does all of this mean for investment activity in infrastructure, where are we seeing opportunities?

There are three main areas we’re seeing opportunities. Firstly, digitalisation: the digital transformation of our infrastructure assets, and our existing and historical infrastructure assets, and making use of digital technology to improve their maintenance and performance. This is in addition to new digital infrastructure: the infrastructure that supports the new areas of the economy. The energy transition is the second area, specifically decarbonisation – not just renewable generation, which obviously is a component of the requirements to decarbonise, but decarbonisation more broadly. Finally, a new theme that we’ve been talking about is resilience, particularly in the areas of health, in national manufacturing, in cybersecurity and in defence. That’s an area where we’re currently seeing a lot of opportunity to support future requirements in those sectors.

Turning to the first of those, it is very clear that the world is digitising. The number of internet users was 3.9 billion in 2018, which is expected to increase to 5.9 billion by 2022. Of course, with that increased use and demand for digital and data services, there are supporting infrastructure requirements in terms of poles and wires, data cables, data storage, submarine cables, and fibre optics, that are really stepping up. The required funding gap, specifically in digital infrastructure, is nearly $700 billion as we move towards 2030.

The second theme is decarbonisation. In the context of this year’s COP26 Conference, there is a lot of opportunity to think about the pathways to decarbonisation to support our efforts in addressing climate change across Australia and globally. We know the global greenhouse gas emissions present in the global economy, and if we continue with our current trajectories and policies, the International Energy Agency is showing a 2.7- to 3.1-degree increase in temperature worldwide, which is well above where we want to be at 1.5 degrees. Getting to these lower trajectories requires a lot of capital to be spent, presenting an infrastructure and an energy investment opportunity. The gap of required funding will be up to US$5 trillion each year by the time we get to 2030, and not all of that is on the energy sector. There are associated costs for general infrastructure across the industrial sector, production, buildings and transport.

Within Australia, corporates are taking advantage of the opportunity to decarbonise. On the ASX, 54 of the ASX 100 companies have set net zero targets in 2021. The challenge then becomes how do those companies achieve those targets, and what are the actions that they might be taking? Carbon offsetting is one pathway, but more fundamentally there needs to be the sponsoring of projects, the purchasing of energy through power purchase agreements from renewable generators, the transformation of industrial processes and construction processes, the source and the components of our materials in the infrastructure sector, and supporting the research and development of green, cleaner inputs into our processes. There is a lot of opportunity in that space from both an industrial and an infrastructure point of view across the Australian economy.

Turning to our last area of investment opportunity within infrastructure, resilience. On the health side, we’re familiar with the efforts to increase the number of ICU beds and available hospital beds in response to the current crisis. In Australia, we currently have 3.8 hospital beds per thousand people, which is below the OECD average of just over 4.5 hospital beds per thousand people, and so there continues to be a need for investment in our health infrastructure. While we’re going to be living with COVID-19 for the foreseeable future, having the sustainable health infrastructure to deal with that remains a critical opportunity.

In terms of housing, the waitlist for social housing has increased significantly, with a 50 per cent increase between 2017 and 2020. Looking at forecast population growth and the stock of housing, there is a real mismatch there in terms of the social housing stock needed to support the level of population growth. On average in Australia, around three to four per cent of our total housing stock is social housing, whereas the OECD average is seven per cent, so here in Australia we have a lot of work to do to catch up. We have also seen a revolution in online education. The demand for different ways of delivering education has grown significantly in our regional areas, where we’ve seen significant growth in regional school enrolments, however regional school infrastructure hasn’t kept pace with those enrolments.

In conclusion, what we’re seeing for our economy is a very positive and optimistic path forward, despite the challenges of COVID-19 and the challenging circumstances that we’ve faced within the last two years.

John Pickhaver – Co-head of Macquarie Capital, Australia and New Zealand

John Pickhaver is the Co-head of Macquarie Capital for Australia and New Zealand. Pickhaver has 19 years of experience in the finance and infrastructure sectors, both as a civil engineer and in infrastructure finance. While at Macquarie, Pickhaver has advised on corporate and project financings, mergers and acquisitions, and arranging debt and equity for a variety of transactions. Pickhaver has also provided strategic financial advice to corporates in relation to capital structure reviews, and to governments in relation to projects, assets and financing. Previously, Pickhaver worked for a number of years as a civil engineer in Australia on infrastructure projects, before completing his Doctorate at Oxford University in civil engineering, and subsequently his Master of Applied Finance.

RBC Capital Markets’ strong foundations in infrastructure advice

Top-rated RBC Capital Markets draws on Australian expertise and global resources.

Antony Steinberg, Head of Power, Utilities and Infrastructure at RBC Capital Markets (RBC) in Australia, cannot recall a busier time for the local infrastructure sector.

‘I am not sure we have ever seen this level of deal flow,’ says Steinberg, a Managing Director at RBC. ‘The second half of 2021 will be even busier given the infrastructure and renewables deals currently underway in the market, including toll roads, regulated utilities, ports and towers.’

Steinberg expects the elevated deal flow to continue. ‘In a low-rate environment, pension funds are focused on deploying capital into infrastructure with high EBITDA margins and defensive low-risk stable cash flows, evidenced by the recent Sydney Airport bid and the WestConnex transaction. Also, the energy transition from fossil fuel assets to renewables – a focus for RBC globally – will continue to create deals.’

Steinberg joined RBC in 2019, attracted to the strength of its global infrastructure franchise and the opportunity to refocus and expand the local team. ‘Globally, RBC focuses on sectors where it can differentiate itself. Infrastructure perfectly fits that criteria and, as a result, is a primary focus.’

RBC’s power, utilities and infrastructure team in Australia has over 20 Sydney-based specialists. They work closely with their global colleagues who this year have completed deals for a number of Australian asset managers, including advising on the sale of the Elizabeth River Crossings toll road and the acquisition of Enwave Energy’s Canadian district energy business.

RBC advised New Energy Solar on the sale of its Australian solar farms to the Thailand-based Banpu Public Company, sourcing potential buyers globally through RBC’s international networks.

RBC’s ability to form multifaceted teams is an asset, says Steinberg. ‘On buy-side infrastructure mergers and acquisitions (M&A), we can bring in both M&A and infrastructuredebt advisory teams that work closely together.

‘Being part of a full-service global investment bank with access to RBC’s balance sheet and global capital markets capability is helpful when advising clients.’

High performance

RBC’s infrastructure work has had strong industry recognition. RBC is a top-ranked global financial adviser for infrastructure by deal value.

RBC has advised on over $30 billion of successful privatisation bids. Steinberg, who led the sellside financial advisory team for the 2018 $9.3-billion, 51 per cent sale of WestConnex, has just advised the New South Wales Government on the $11.1 billion sale of its 49 per cent retained stake in WestConnex.

RBC is also a leading debt adviser, and major underwriter and lender in Australia, having structured and arranged over $35 billion of debt finance over the past three years for its infrastructure clients.

Philip McLaughlin, a Managing Director at RBC and Head of Capital Structuring Advisory in Australia, says,

Antony Steinberg Philip McLaughlin

‘We’ve been able to help infrastructure clients raise debt to fund M&A, and then help them refinance debt across bank and capital markets, including raising debt with sustainability-linked terms. We work closely with clients across the infrastructure sector to help them optimise shareholder value through the creation of capital structures that are sustainable in the long term.’

Royal Bank of Canada is one of the world’s largest banks,1 with $1.6 trillion in assets and A2 and A credit ratings from Moody’s, and Standard & Poor’s.2 RBC Capital Markets is the global investment banking division of RBC. ♦

1 Based on market capitalisation at 20 May, 2021. 2 Source: RBC 2020 Annual Report. Subject to

Bail-in regime.