Infrastructure: Model updates ahead of August reporting season

About the author:

Author name:

By Nathan Lead

Job title:

Senior Analyst

Date posted:

11 July 2023, 8:00 AM

Sectors Covered:

Infrastructure, Utilities, Banks

• We update our modelling for infrastructure stocks under our coverage ahead of the August reporting season, particularly for the significant shift in market interest rates impacting the cost of debt.
• Dalrymple Bay Infrastructure (ASX:DBI) remains on an ADD rating. While we retain a HOLD on Atlas Arteria Group (ASX:ALX) and APA Group (ASX:APA) ahead of reporting season, we see increasing value in these stocks at current prices. We think Aurizon Holdings (ASX:AZJ) and Transurban Group (ASX:TCL) are trading in line with fair value at current prices.

Macro updates

We use forward interest rates implied in the swap curve to inform our forecasts for base interest rates and hence interest costs (after taking account of the risk mitigants within existing debt facilities and hedge portfolios). Forward rates have increased >1% since our most recent assumption reset in April, which puts negative pressure on distributable cashflows and credit metrics.

While interest rate expectations have increased, the CPI inflation outlook we apply in our modelling is relatively unchanged. The March CPI came in close to our expectation. We continue to apply the approach of using the RBA’s CPI forecasts where available (the latest being the May Statement of Monetary Policy), and to assume the mid-point of the RBA’s target 2-3% inflation range beyond this.

Also worth noting is that the decline in FX rates (particularly AUDUSD and AUDEUR) has been broadly beneficial for those stocks (APA, ALX, TCL) that hold assets or contract revenues in those currencies. It also supports the financial strength of the coal export customers of the coal logistics businesses (AZJ, DBI).

Forecast and valuation changes

APA – upgrades in the short term from higher US CPI outlook and long-dated fixed rate hedging mitigating higher interest rates. However, earnings downgrades once the initial contract term of the WGP’s haulage contract expires (end-FY36) as the higher interest rates overpower the CPI impact (ultimately what flows into our terminal value).

ALX – upgrades to A$-translated earnings as a result of beneficial FX rates offsetting the impact of the higher interest rate environment on long-term distributable cashflow. Forward DPS outlook upgraded due to the build-up of fund level cash from upgraded APRR distributions and the beneficial FX rates.

AZJ – downgrades to forecast earnings as we make adjustments to modelled debt outstanding and the amount of debt exposed to the reset of interest rate hedges in June 2023 (with a four year term). DPS outlook downgraded alongside the lower earnings outlook. Target price reduces to (login to view), with the higher debt balance and interest costs partly offset by reducing the conservative asset beta and thus discount rate we had applied to the above rail business.

DBI – immaterial changes to forecasts and target price ($2.76/share). Existing interest rate hedging largely protects against higher rates until FY26, then forward starting swaps from FY26-31. We would expect DBI to negotiate higher access charges in FY31 to reflect the higher interest rate environment than compared to mid-2022 (the environment within which access charges were last negotiated).

TCL – Existing interest rate swaps protect against higher forward rates, but the higher rate environment ultimately impacts value as they expire. A higher opex outlook than previously assumed also impacts value.

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