Four winners from economic stimulus

Global companies that should profit from increased government infrastructure spending around the world

By Alanna Petroff
Globe Investor Magazine online
Dec. 30, 2008

Looking for a safe haven amid the market chaos? Try global engineering and construction companies that will benefit from a rush of new government funding as politicians try to spend their way out of a recession.

A 2007 study by consulting firm Booz Allen Hamilton estimates $40-trillion (U.S.) will be needed over the next 25 years to maintain, modernize and expand basic infrastructure like utilities and transportation.

“There’s massive pent-up demand to fix existing infrastructure and there’s massive demand for new infrastructure … There will be tremendous opportunities for engineering and construction companies to participate in building new infrastructure and rebuilding existing infrastructure,” says James Cowan, managing director at Macquarie Capital Markets Canada.

But buyer beware: Investing in these companies is not without risk. Governments are notoriously slow and fickle when handing out money and projects, says Zainul Ali, infrastructure consultant with Towers Perrin.

Besides, says Frederic Bastien, infrastructure analyst at Raymond James, governments often have good intentions but not enough money, as other sectors reach out for help too.

For investors who want stability, the dependable power and utility companies provide a relatively steady cash flow that is generally immune to consumer downturns. You can give up your Starbucks latte, but you still need your gas pipeline and electricity grid, says Mr. Cowan.

Ben Heap, head of infrastructure in the Americas at UBS, says that defensive investors love utilities because they are generally monopolistic and have a built-in inflation hedge through government regulation. Unfortunately, these companies are not foolproof either, because stocks are still at the mercy of market fluctuations, he says. However, the upside is you have enough liquidity to pull your money out when you need it.

Here are four large-cap global infrastructure companies chosen by fund managers and equity analysts who specialize in the field:

Tokyo Electric Power
Market capitalization: ¥4-trillion ($54.5-billion Canadian)
12-month stock performance: Down 2 per cent

International investors may overlook Japanese companies because of the country’s notoriously sluggish economy, but Tokyo Electric Power is a force to be reckoned with. Its shares have risen more than 30 per cent in the last five years, compared to the Nikkei 225, which has sunk more than 20 per cent in the same period.

John Stephenson, senior vice-president and portfolio manager at First Asset, says he likes holding this stock in his infrastructure fund because it provides something that everyone needs: electric power.

Right now, the utility is not operating at full capacity because one of its major nuclear plants is down for earthquake-proofing. While restarting the plant may take longer than expected, Mr. Stephenson isn’t up nights worrying.

“They’re not exposed to the same risks as other companies,” he says. “Right now is the time you want to buy these things. There are not a lot of alternatives … The world is struggling economically and something like a pipeline or utility tends to do well in these times, because everyone sells their Tiffany & Co. shares and goes into these shares because they’re regulated.”

One concern is that the company is overpriced as investors jostle to get a stake in a well-managed, monopolistic corporation. Mr. Stephenson admits the shares, currently trading around ¥2,895, could be considered pricey, but “it’s a relative game. Given that the alternatives are so crappy, this doesn’t look that bad … You’re not going to make 20 per cent, but … at least you get a modest dividend yield.”

Currently, the dividend yield is around 2.1 per cent, which is on par with other Japanese electricity companies.

An alternative to Tokyo Electric Power is Kansai Electric Power, which Mr. Stephenson also owns in his infrastructure fund. This company operates in a differentpart of Japan but has a very similar business model, and its dividend yield is slightly higher, at almost 2.5 per cent.

Fluor
Market cap: $8.1-billion (U.S.)
12-month stock performance: Down 40 per cent

As the largest publicly-traded U.S. engineering and construction firm, Fluor shares have got a boost from talk of an influx in infrastructure spending from the incoming Barack Obama administration.

Fluor will almost certainly secure many potential government-funded projects because of its prominence in the infrastructure industry, says Andy Kaplowitz, analyst at Barclays Capital, who has a “buy” rating on the stock.

Even if U.S. funding is slow to materialize, the company is diversified outside of North America and has a record $36.5-billion backlog. Another bonus: the company has expertise in alternative energy infrastructure, which means as long as Mr. Obama keeps pushing for sustainable energy, Fluor benefits, says Mr. Kaplowitz.

Of course, it is important to note that, despite its visibility in the infrastructure sector, only about 20 per cent of Fluor’s revenue comes from infrastructure projects, while about 60 per cent of revenue comes from its oil and gas business.

“You have to be patient because the energy component will provide a lot of volatility,” says Mr. Kaplowitz. For the short term, he predicts the stock will get a boost from excitement over infrastructure prospects,andover the long term, when energy prices bounce back, the company will continue doing well.

“It’s closer to its 52-week low, so it seems more reasonable at these levels, even if you have to deal with energy volatility.”

China Railway Construction Corp.
Market cap: 126-billion yuan ($23-billion Canadian)
Recent stock performance: Down 1 per cent since IPO in March 2008

As the name spells out, this partially state-owned company is a leader in building Chinese railways, and is positioned to benefit from the recent Chinese stimulus package. Beijing has already pledged a trillion yuan (more than $180-billion U.S.) for infrastructure projects like railways, with the expectation that private companies will pitch in another 3-trillion yuan.

Railways are the lifeblood of the Chinese economy. This year alone, $42-billion was earmarked specifically for Chinese railway construction, says Levi Folk, an economist at Excel Funds Management. That is before the stimulus package was even announced.

His colleague, Agnes Deng, the lead investment manager for a China fund at Excel Funds Management, says she likes this company because of its growth prospects. The Chinese construction sector grew 35 per cent in 2008, and the company continues to gain market share within the industry, she says.

Better yet, growth expectations for 2009 are forecast to be just as strong as 2008, even before factoring in the stimulus money.

Of course, there are some risks: The potential for rising raw material costs could hit the company’s margins. As the economy slows, building contracts could be cancelled, says Ms. Deng. The company also has a presence in the Middle East and Africa, where there may be political risks.

Over all, Ms. Deng says she has not seen any project cancellations yet, and is confident the stimulus package will give the company a big boost. Na Lui, a Scotia Capital analyst who deals with Chinese strategy, also points out that China’s government will be quick to approve projects and distribute funding to ensure China’s economy keeps chugging along.

Royal Boskalis Westminster
Market Cap: €1.65-billion ($2.66-billion Canadian)
12-month stock performance: Down 54 per cent

Boskalis is the largest harbour-dredging and reconstruction company in the world, dealing with everything from expanding and maintaining harbours and ports to building islands. Norman Levine, managing director at Portfolio Management, says he has been advising clients to invest in Boskalis for years, especially now that shares are more reasonably priced.

“This one caught our eye as a company that was growing quickly with some fabulous projects. They finish one, and more keep coming. It’s a well-run company in a sector that’s just going to keep growing.”

The company benefits from increasing global trade, which requires bigger and better harbours. Even global warming is a boon for Boskalis, because it fixes shorelines.

Like most companies, Boskalis faces short-term setbacks because private and public projects could be postponed or cancelled in the face of a slowing global economy. But Mr. Levine says he still likes the long-term growth prospects, and has been encouraging clients to buy.

Furthermore, Mr. Levine says, you get the best of both worlds when you invest in a Dutch company with operations in Europe, Africa and the Middle East. The company is based in a developed country with regulated accounting standards, but has access to large growth markets. And while you’re waiting for the shares to rebound, Boskalis also pays a healthy dividend of about 5 to 6 per cent, depending on the company’s results.

Special to The Globe and Mail