Australian Infrastructure

Here is an update on the Australian infrastructure sector provided by Australian market analyst UBS.

Australian Infrastructure

Return to fundamentals on the horizon

Infrastructure & long-duration interest rate relationship broken...for now:
From 1995 to 2005, the Australian Infrastructure & Utilities Index (AIUI) exhibited strong -ve correlation (-0.77) with Australian 10-yr Bonds (BON10). However since 2005 this relationship has significantly deteriorated. This is due to attractive interest rates/credit spreads fuelling demand for higher yield, resulting in manufactured distributions & yield based pricing metrics (& $10bn of new IPO's).

Credit markets, risk-aversion & structural issues drive sector performance:
Over the last 12 months, the AIUI has experienced near perfect negative correlation with the BBSR3M (-0.86) & negligible correlation with the BON10. In addition, the sector weighted equity beta has sky- ocketed (currently 1.67 year-to-date vs long-term avge of 0.52). We argue these shifts are largely the result of the mark-to-market of pricing of debt books and elevated equity risk premiums.

Interest-rate easing cycle possible catalyst for the sector....but not yet:
We expect the AIUI to continue to trade around credit market whilst volatility driven by risk aversion persists. Our economics team is forecasting the BON10 to be 6.4% by mid-year (currently 6.3%) before settling toward 6.0% into 2009 as rate cuts materialise. US, Canada, UK & Europe forecasts also highlight further upside for sector valuations (particularly for MIG, MAP, MCG, & BBI).

Attractive opportunities for long-term investors:
Our key picks are still MAP (TSR +35%), MIG (TSR +27%) & TCL (TSR +20%). We expect the sector to return to fundamental valuation metrics as credit markets stabilise, risk aversion diminishes & forecast interest rate easing cycle materialises.