Tempted by cheap ASX infrastructure stocks as a defensive play? Read this

Whether you're seeking income or you're seeking capital appreciation, the ASX infrastructure stocks within Morgan Stanley's universe are down 6% year to date, compared to the 3% appreciation of the ASX 200. 

Analysts Rob Koh, Samantha Edie and Samantha Kerr say it's all down to bond yields:

"The Australian government 10-year bond yield stands at 4.6%, up from 4.0% at the start of this year, raising discount rates for infrastructure investors, and required yields for income investors. Morgan Stanley forecasts 3.65% for the Dec-2023 quarter" they said.

But that's only one part of the story for Koh, Edie and Kerr, who added:

"Debt costs in this stock grouping are well hedged, in our view Transurban (ASX: TCL) 96%, Auckland International Airport (ASX: AIA) 63%), and liquidity is benign according to our industry channel checks. As a reminder, there are offsets to rising bond yields within our stock coverage, e.g., inflation-linked tolls, and WACC allowance resets for airports and rail networks." 

Sensitivity to bond yield movements 

The analysts believe three stocks in the coverage universe are particularly sensitive to bond yields. In addition to Transurban and Auckland international Airport noted above, they also view Atlas Alteria (ASX: ALX) as sensitive, as the chart below indicates. This analysis suggests the freight and logistics infrastructure companies, Aurizon Holdings (ASX: AZJ) and Qube Holdings (ASX: QUB) are still sensitive to rising bond yields, just not as sensitive. 

Source: Morgan Stanley Research

The analysts offer a clear explanation as to why:

"Economic infrastructure stocks remain the most sensitive to bond yields (long asset lives, stable cash flows, higher gearing), and freight and logistics remain the least (cyclical cash flows, lower gearing)," according to Koh, Edie and Kerr. 

They also note the dearth of unequivocally positive events this year for the stocks in the Australian infrastructure coverage. Management transitions, the potential for policy intervention, a general slowing in growth projects, and corporate activities all play their own roles.

But it's not all bad news. Based on their regular dialogue with investors and industry, they do think mobility recovery is appreciated across the sector, although this is against a backdrop of diverse working-from-home rates impacting toll road traffic. For example, Atlas Alteria's Dulles Greenway traffic in 1HCY23 has fallen 28% compared to the same period in 2019, whereas the same period for Transurban Queensland saw a 13% increase. The impact of construction activities is also noticeable - albeit at the margin. For example, Transurban's June-2023 quarterly traffic fell 1% versus this time last year in NSW.

In terms of airport infrastructure, they observe that while the aviation recovery has been encouraging, "the problems with the Pratt & Whitney Geared Turbofan (GTF) is limiting seat capacity growth at the margin".  For Auckland International Airport, A320neos were ~11% of FY22 domestic landings and ~1% of international. 

The analysts also call out the recovery of coal volumes with a positive impact for haulage. Not only is the Department of Industry, Science & Resources forecasts a 12% increase in Australia coal export volumes in FY24 year-on-year, they note that the level of rainfall in Queensland is down 59% so far in FY24 versus the same period in FY23.

Morgan Stanley's preferred infrastructure investments 

On their risk-adjusted valuation, Morgan Stanley's order of preference is Atlas Alteria, Qube, Transurban and Auckland International Airport, although it should be noted that they remain cautious about the infrastructure sector overall.  

The reason for liking these stocks relates to their views of future dividend yields as illustrated in the chart below. 

(Source: Morgan Stanley, as of October 2023)

This article was originally published on Livewire Markets on Tuesday, 10 October 2023.