ipopba/iStock via Getty Images
Clean Energy A Bright Spot in Selloff
Market Overview
User-pays infrastructure and utilities continued to perform well amid a steep selloff for equities as their stable cash flows, growing dividends, essential service nature and ability to pass through inflation offered a safe haven in a volatile quarter.
Volatility came from many areas. While COVID-19 has become endemic around most of the world, its effects in China, which has maintained a zero-COVID policy and persisted in lockdowns, have hampered global growth. The Russian invasion of Ukraine continues to have an impact on commodity prices and supply, which, while felt more in Europe, also affect the rest of the world. Central banks globally are taking liquidity out of the markets by raising rates and tightening monetary policy to combat inflation, raising the risks of a policy mistake. With the hawkish turn for central banks, the probability of recessions globally has increased. This meant a tough quarter for markets, with the MSCI AC World Index down substantially (-15.66%). Throughout the volatility, the ClearBridge Global Infrastructure Value Strategy showed its defensive characteristics, outperforming global equities while only modestly trailing the S&P Global Infrastructure Index (-7.66%).
Portfolio Performance
The leading contributor for the quarter was American Tower (AMT), a leading independent owner, operator and developer of wireless and broadcast communications infrastructure. The company has 41,000 sites in the U.S. and a further 139,000 sites across 19 countries, predominantly in emerging markets (75,000 in India, 40,000 in Latin America and 18,000 in Africa). Shares outperformed as investors grew fearful of an impending recession and positioned portfolios in relatively economically insulated companies such as towers. American Tower also successfully raised equity to fund a recent acquisition, lifting an overhang that had been dragging on the stock’s performance.
Utilities with clean energy portfolios were also positive contributors in a down quarter for markets, with strong performance from U.S. electric utilities Constellation Energy (CEG) and Clearway Energy (CWEN). We bought shares of Constellation Energy earlier this year following its spinoff from Exelon (EXC). Constellation represents Exelon’s former power generation and competitive energy business, and with 21 GW of nuclear capacity across 13 plants is the largest generator of carbon-free power in the U.S. We believed Constellation Energy’s nuclear assets and free cash flow generation were mispriced by the market, with upside from any further federal/state nuclear subsidies granted, and this has so far played out.
Clearway Energy owns and operates contracted renewable generation assets in the U.S. as well as conventional generation and thermal infrastructure assets. Shares continued to show strength following the announcement that TotalEnergies (TTE) and Global Infrastructure Partners are partnering to acquire 50% of Clearway, helping to provide a longer runway for growth projects.
Amid signs of slowing growth, more economically sensitive user-pays infrastructure such as rail and airports were among the main detractors. U.S. rail operators Union Pacific (UNP), the largest listed railroad company in North America, and CSX (CSX), among the top five leading North American rail companies, were down amid concerns of an economic growth slowdown and implications for freight rail volumes outlook. Further, Union Pacific revised lower its operating margin expectations for the year due to inflation and labor shortages.
Spanish airport operator Aena (OTCPK:ANNSF) was also a main detractor for the quarter. Aena is the monopoly owner of the Spanish airport system, operating the 46 airports under a dual-till regulatory regime. Aena also manages London Luton Airport, with a 51% stake. Shares declined as the expected summer passenger recovery was curtailed by increased flight cancellations owing largely to staffing limitations combined with increasing fears of a recession and its potential impacts on future passenger volumes.
Outlook
We believe there will be a rough road ahead for equities, with risks stemming from recession fears, global political tensions, liquidity being removed from the system, high inflation and slowing growth. At the same time, infrastructure and utilities see a number of tailwinds and are at very attractive valuations, in our view.
Tailwinds include transport infrastructure benefiting from the recovery of mobility as we move into summer in the Northern Hemisphere and as COVID-19 becomes more endemic in most parts of the world. Decarbonization, a generational theme, can be accessed in a number of ways, whether through contracted renewables, global regulated utilities, or even midstream pipelines that are beginning to facilitate an energy transition through hydrogen or carbon capture and storage. There are a number of ways we can access this very dominant theme within our portfolio.
Energy security remains an issue, especially in Europe, and we see that accelerating the move toward decarbonization and greater investment in energy infrastructure, further benefiting our pipelines and utilities. Around the world, utilities continue to strategically implement changes to improve the consistency of their forward cash flows. We have seen this historically with U.S. companies like Exelon, but we continue to expect companies like Public Service Enterprise Group (PEG) and European utilities to simplify their businesses as well. Communication infrastructure also remains attractive with continued demand for data and strong tailwinds from 5G driving strong cash flows and demand.
There is no change in the listed and unlisted infrastructure dynamic: we see private infrastructure capital continuing to come to listed markets to find attractively priced assets for acquisition. Currently, with over $300 to $400 billion of dry powder, or capital waiting to be invested, unlisted players will benefit the companies in our listed infrastructure universe as these companies sell these assets, often non-core or minority interests, for well in excess of where they are currently trading. On average, we have seen these sales done at roughly a 30% premium to where they are currently trading or their implicit value.
We were active in positioning the portfolio during a volatile market, taking advantage of an attractive entry-point to buy American Water (AWK), which owns a high-quality regulated U.S. water utility portfolio, with above average EPS growth outlook driven by upgrade and expansion capex and tuck-in acquisitions. We exited U.K. electric utility National Grid (NGG), adding to existing holding NextEra Energy (NEE), where we see better risk-reward potential. We also channeled funds from the sale of French toll road operator Eiffage (OTCPK:EFGSY) into existing holding Aena, a Spanish airport operator where we see better risk-reward.
Portfolio Highlights
We believe an absolute return, inflation-linked benchmark is the most appropriate primary measure against which to evaluate the long-term performance of our infrastructure strategies. The approach ensures the focus of portfolio construction remains on delivering consistent absolute real returns over the long term.
On an absolute basis, the Strategy saw negative contributions from all nine sectors in which it was invested (out of 11 total) in the second quarter, with the electric, rail, communications and airports sectors the leading detractors and the renewables, gas and water sectors the least negative.
On a relative basis, measured against the S&P Global Infrastructure Index, the ClearBridge Global Infrastructure Value Strategy underperformed during the second quarter. Overall stock selection detracted, while sector allocation contributed positively to relative results. Stock selection in the renewables and energy infrastructure sectors, an underweight to the airports sector and an overweight to the rail sector aided relative performance, while stock selection in the rail and toll roads sectors as well as an underweight to the toll roads sector detracted.
On an individual stock basis, the largest contributors to absolute returns in the quarter were American Tower, Constellation Energy and Clearway Energy. The largest detractors were Union Pacific, Aena, Cellnex Telecom (OTCPK:CLNXF), CSX and SSE (OTCPK:SSEZF).
In addition to portfolio activity discussed above, we exited U.S. electric utility Dominion Energy (D) and US. energy company Williams Companies (WMB).
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Be the first to comment