Infrastructure Travel Diary
Tales from the Pacific
October 2013
Key Points
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We expect Japanese infrastructure companies to
produce earnings upgrades driven by a weaker yen,
stronger volumes and improving confidence levels.
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Infrastructure balance sheets in Japan remain
ungeared with significant potential for greater
distribution of cash flow to equity holders via higher
dividend payout ratios and share buybacks as
profitability and confidence continue to improve.
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Over the past few weeks I have spent time traveling in Japan,
Australia and New Zealand talking to a wide variety of
infrastructure management teams, government officials,
industry experts and of course using various infrastructure
assets. The following is a brief summary of the key issues
arising from these interactions.
Favorite quotes from this research trip
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The Japanese government is pushing ahead with
microeconomic reform in its electricity industry and is
privatizing (selected) airports but its port
rationalization plan has stalled.
We believe Australian rail and port infrastructure
operators have the ability to drive significant profit
growth from low risk cost reductions and productivity
improvements, as domestic economic growth assists
volumes.
The New Zealand economy is solid with port sector
rationalisation continuing, highlighting the productivity
and profitability gap above Australia’s ports.
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"As the economy keeps improving and the export sector
grows again, we will look to increase the dividend payout
ratio over time" - CFO of Japanese port company.
"The economic pick-up is positively impacting our rail,
retail and property businesses" – senior manager of a
Japanese railway company.
"While rice farmer protection continues, Abenomics will
not work" and "Ask not what the government can do, but
ask what the government can undo" - reform-seeking
Japanese economist.
"This land has been in the company since the Meiji
Restoration (1868); we will not sell it" - CFO of Japanese
port and warehouse company, highlighting the difference
between the eastern and western sense of time.
“We want to avoid death by committee or death by one
thousand questions and get people to take risks" - CEO
of a large Japanese consumer electronics company.
"Equity markets are like females, hard to predict" –
politically incorrect Japanese economist.
Favorite travel reading
Fukushima by Mark Willacy provides an excellent insight into
the 2011 earthquake, tsunami and subsequent nuclear accident
in Japan. It served to remind me why we don’t invest in the
Japanese electric utility sector, given the risks we find
impossible to evaluate.
Andrew Greenup
Senior Portfolio Manager,
Global Listed Infrastructure
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First State Investments
Japan
Japanese infrastructure companies are reporting stronger than
expected earnings due to the weak yen, the expanding
economy and improving business and consumer confidence.
This has translated into strong share price performance since
the election of Prime Minister Abe in December 2012.
As a value investor personally, I have naturally been attracted
to Japanese infrastructure stocks due to the significant potential
sitting on so many under-utilised balance sheets. Most
companies I met with in Japan believed that the rally in equity
markets had clearly moved ahead of where the economy and
corporate profitability is today. I would agree with them. Hence
for me, the next stage of a Japanese infrastructure equity rally
requires some of this locked up potential to begin to be realized
through higher dividend payouts (30% payout ratios are too low
for these mature assets), increased share buy backs, the
divestment of non-core assets and productivity improvements.
Unfortunately I did not receive many encouraging signs that this
was imminent from infrastructure companies I met with. Am I
impatient? Yes. Is it too early? Probably. Am I disappointed?
Yes. There are so many easy gains to be had by making small
changes in capital structures or corporate reorganisation. I am
not talking about dangerous gearing levels or large scale
redundancy programs.
the eventual restart of the nuclear power plants will remain the
biggest driver of this industry's profitability.
Earlier this year, the government passed a law allowing the
privatization of some of Japan's 97 airports. It appears that
Sendai Airport will be the first to be privately operated, under a
concession agreement which begins in 2014, followed by
Hiroshima Airport. Sendai Airport is Japan's 11th largest airport
with around 2.8m passengers per annum. The government has
also increased the number of slots at Tokyo's Haneda Airport,
in order to stimulate competition in the domestic airline market
through the introduction of low cost carriers.
However the government appears less committed to trying to
improve productivity at Japan's ports. The government has long
talked about a "super port" concept but this appears to have
stalled. Japan's ports are high cost and sub-scale, and have
been losing market share to transhipment hubs in South Korea
and Taiwan. Japan's biggest container terminal, Port of Tokyo,
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handles 5m TEUs compared to Shanghai at 32m. In 1990
Japan had the world’s fifth largest container terminal at Kobe; in
2012 the country’s largest container terminal ranked 28th.
View from my hotel of Tokyo harbour looking towards the
container port
Me at West Japan Railway’s Kyoto station
Source: First State Investments
Source: First State Investments
For example, the fund owns a Japanese port company with a
large amount of net cash on its balance sheet and a dividend
payout ratio of just 20%. The fund also owns a gas utility that
has significant real estate holdings that are not valued by the
equity markets. Further, it pays out only 30% of its profits in
dividends (compared to most gas utilities in the developed world
which have dividend payout ratios in the 50-75% range). Yes I
am talking about you, Osaka Gas! A railway company owned by
the fund has significant property development opportunities
backed by strong cash flows, as well as room to increase its
dividend payout from 30% to the 40-50% range. If Abenomics is
to succeed in getting Japan growing again, this corporate
capital hoarding must change.
The Japanese government is making small, tentative steps
towards micro economic reforms within the infrastructure space.
It is proceeding with its plans to liberalize the electricity market
by splitting the generation, transmission, distribution and
retailing divisions of Japan’s vertically integrated electric
utilities. At the margin this may increase competition; however
As an investor Japan is currently exciting. Depreciating the yen
through QE and exporting its deflation to the rest of the world
has the potential to generate significant economic growth in this
once-great economy. However there are many dangers ahead;
namely the impact of the consumption tax rise; the many
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domestic vested interest groups; the Trans-Pacific Partnership ;
and Japan’s famed bureaucracy. However for Abe and Kuroda
there can be no going back. They won't get a second chance at
this. (Abe is already on his second chance as Prime Minster).
So to quote Eminem (not something I do often):
"Look, if you had one shot, or one opportunity.
To seize everything you ever wanted. One moment.
Would you capture it or just let it slip?"
"You own it; you better never let it go,
You only get one shot, do not miss your chance to blow,
This opportunity comes once in a lifetime
It is now or never for a Japanese comeback!
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Twenty-foot equivalent unit containers.
Trans-Pacific Partnership is a proposed Asia Pacific free trade zone covering
over 790m people.
First State Investments
Research visit to a port & logistics company in Tokyo
the battle to be New Zealand's largest port and the northern
gateway to the country. Now POT appears to be making a play
to be a low cost operator in the South Island, with the aim of
taking share from both Christchurch and Dunedin's ports. In the
middle of the country, Wellington is probably best positioned to
consolidate the centre port cargos and take share from the likes
of New Plymouth, Napier and Nelson.
While New Zealand's ports may be small, their productivity is
significantly higher than Australia's long-underperforming port
sector, thanks to union-dominated work practices and
unfocused management teams. So not only is New Zealand's
rugby team thrashing Australia's but (as the chart below
illustrates) port productivity and profitability is also well ahead of
Australia’s. Asciano has a significant profit improvement
opportunity in its port division.
Lifts per crane per hour in Australasian ports
Source: First State Investments
Australia
The Australian economy is still being impacted by the unwinding
of the mining super-cycle. Within the infrastructure space this
mining slowdown can be seen in the weak earnings results from
Asciano's Melbourne-Perth intermodal railroad business and
DUET Group's Dampier Bunbury Pipeline. Recent interest-rate
cuts, higher consumer confidence and hopefully improving
business confidence post the election of a new center-right
Liberal government makes us optimistic about volume growth
for our Australian ports, toll roads, railroads and airports in
2014. In addition to the potential for volume uplift in 2014, the
centre-right government should act as a catalyst for improving
productivity levels. While we believe Australian airports and toll
roads are world class in terms of productivity and profitability,
our railroads and ports have significant opportunities to improve
work practices, productivity levels and, consequently,
profitability. We see these as major value-drivers for Asciano
and Aurizon over the coming three years.
We think Australian listed infrastructure companies will continue
to attract corporate interest in 2014. In 2013 we have witnessed
China State Grid Corporation (CSGC) acquire a 19.9% stake in
Australian electric & gas regulated utility SP Ausnet (owned by
the fund) as well as press reports of takeover interest in Sydney
Airport. Going forward we believe Asciano could well sell a
minority holding in its port business, Aurizon could sell a share
of its regulated return rail tracks and Transurban will one day be
acquired by a consortium of pension funds.
New Zealand
From my discussions with various management teams in New
Zealand, it appears the economy is performing solidly. The
construction, housing and forestry sectors are leading the
country's growth.
Within the county's port sector, positioning for the inevitable
rationalisation continues. In August the publicly listed Port of
Tauranga (POT) announced it had acquired a stake in the small
South Island Port of Timaru, as well as expanding its inland port
operation in Auckland. We have long regarded POT as the most
likely winner in the port rationalisation that will occur in New
Zealand. With Port of Auckland suffering from poor labour
relations and the council wanting to use some of its valuable
land for non-port purposes, we believe POT will continue to win
Source: NZMOT, UBS, First State Investments
EBITDA Margins of Australasian ports
Source: Company reports, First State Investments
Tour highlights
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Seeing growth return to the Japanese economy leading
to earnings upgrades and improved business
confidence.
Friendliness and politeness of the Japanese people
(except when you start demanding higher dividends) and
New Zealanders (for not mentioning another All Black
domination of the Wallabies in 2013).
Efficiency of travel around Japan in shinkansens, urban
trains or underground metros – the best I have
experienced in the world.
First State Investments
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Landing at the very efficient Wellington airport in New
Zealand (owned by publically listed Infratil) at 11.50pm,
clearing customs, getting a taxi, checking into hotel and
being asleep by 12.30am.
Turtle soup at "Gion Nishikawa" in Japan's ancient
imperial capital, Kyoto.
Tour lowlights
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Lack of corporate focus on share price performance - in
Japan, infrastructure companies’ shareholders are still a
long way down the list of stake holders behind
management, employees, customers and government. I
understand and greatly admire Japan's sense of a
harmonious society but this is not mutually exclusive
with shareholder returns.
Sangria beer cocktail (with ice) - I had to try it but it was
a little bit too sweet for my taste.
Andrew Greenup
Senior Portfolio Manager
Telephone: +61 2 9303 6720
Email: [email protected]
Trent Koch
Senior Investment Specialist
Telephone: +61 2 9303 7653
Email: [email protected]
First State Investments
For further information
Head of Institutional Distribution – Americas
Brad Thomas
Senior Manager – Institutional Distribution
Bob Strachan, CFA
Manager – Institutional Distribution
Hugh Tancred
Senior Manager – Institutional
Randy Paas
www.firststateinvestments.com
+1 (212) 848-9223
[email protected]
+1 (212) 848-9244
[email protected]
+1 (212) 848-9243
[email protected]
+1 (502) 315-9995
[email protected]
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