Wednesday, September 25, 2013

From Potholes to Pipelines: Investing in Infrastructure Build-out (CAT, DE, KYN, WM, XLU)

Investing in infrastructure build-out around the globe has been a primary investment theme of ours for the past few years.  Early beneficiaries of the demand for building-related equipment, supplies, technology, etc included the likes of Caterpillar (CAT), Deere (DE) and others who, in many cases, given their familiar global brands, were able to capture first-mover-advantage in Emerging Countries where infrastructure build-out has been robust.  

While much (though not all) of the low hanging fruit has already been picked, and while competition, especially from many of the Emerging Countries themselves, is making the profit potential more challenging, the trend around the globe for building new roads, tunnels, bridges, airports, train stations, pipelines for energy transport, etc is likely to remain strong.  

With that in mind, the piece below from Standard & Poor's is of particular interest, not because it presents a new case for the importance of building up a country's infrastructure to the overall economic health and advancement of that country's standard of living, but because the focus is shifted from the international stage right back here to the US!!

I've embedded the report below.  Among the many interesting facts presented, this paragraph certainly sets the stage:
 According to the World Economic Forum, the U.S. ranked seventh in competitiveness in 2012, falling from second in 2009. The World Economic Forum ranked 144 countries by assessing several economic factors. The U.S. ranked 25th in quality of infrastructure, 34th in health and primary education, and 140th in macroeconomic environment...The American Society of Civil Engineers (ASCE) assigned a grade of "D+" (poor) to the quality of infrastructure in the U.S. in its 2013 infrastructure report card. However, this is an improvement from "D," originally assigned in 1998. The ASCE study estimated that the nation's quality of transportation, energy, water, and public facility capital needs required an investment of $1.6 trillion to achieve a grade of "B" (=good) using its definitions.
Enough said?  Perhaps, though I'd still recommend a read of the whole piece, as the case is made in more detail.

From an investment perspective, one has to weigh the growing urgency of infrastructure build-out in the US against the reality of the fiscal crises being faced from virtually every level of government, from the Federal level in Washington, to the State and Municipal governments, all cash-strapped and looking for ways to NOT spend money at this time!  For example, take a look at the chart in S&P's report showing the fall off in debt financing and in overall public construction spending:

The tight money belt situation is very likely to continue for some time, especially with the hostile environment in Washington surrounding budget negotiations.  That said, it's still an investment theme that will likely not go away, for every day that the government coffers remain deficient in funds available for proper infrastructure development, is another day that allows the existing infrastructure to deteriorate further and therefore require even more remedial care.  Furthermore, 'deficient' doesn't mean 'zero'!  There are significant investments going on all the time around the US, especially in the energy sector, as more and more companies are participating in the build-out of the natural gas and oil exploration, transportation, refining and (even) exporting segments of those industries!  

The S&P report broadly categorizes the overall infrastructure needs in two ways: 
Physical infrastructure (popularly referred to as utility and transportation infrastructure) lays the groundwork for economic development whereas social infrastructure (healthcare, affordable housing, and higher education) provides health services, improves quality of life, and develops the skillsets needed for the economy.
We're constantly in search of quality companies that play to both the physical and the social components of the US infrastructure needs.  In addition to Caterpillar (CAT) and Deere (DE)  that we mentioned above, we currently own Kayne Anderson (KYN), a corporate entity that invests in Master Limited Partnerships that primarily build, develop and service energy related pipelines and infrastructure around the US.  We also own Waste Management (WM) which is involved in all aspects of waste collection, disposal and transformation into other usable sources.  We also own utilities through the ETF XLU, as many of the companies in the ETF themselves are on the front line of this issue.

We all know some form of the expression that "long journeys start with the first step", and I'd only add that whether its the first step or the whole journey, any meaningful pothole along the way makes either one very unpleasant!  The road to repair of US infrastructure is surely going to be classified as a "long journey".  The needs in the US, as cited by S&P, are clear.  The challenges in funding the fix, are equally clear.  But investigating how best to invest in companies who will turn this problem into a opportunity seems worthy of investor time and energy!

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(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves as to the appropriateness of anything said in this article to their unique financial profile, risk tolerances and portfolio goals).
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Additional Disclaimer: currently long many stocks/ETFs, including CAT, DE, KYN, WM, XLU.  Positions may change at any time without notice.

S&P: US Public Finance:  Short-Term Savings on Infrastructure Spending Could Prove To Be Short Sighted by Standard & Poor's

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