Brexit: the resilience of the infrastructure sector

Wed 27 Jul 2016

In previous weeks, I have commented mostly on early signs and emerging risks in the banking sector, including some early warning shots in the property space in particular. But banks and funds invest in many other types of assets and one sector – infrastructure and energy – may even be feeling some benefits from Brexit.

M&A activity linked to UK energy and other infrastructure assets remains strong. Fund-raising has continued unabated (and have even been over-subscribed in some instances) and the appetite of lenders (both commercial lenders and debt funds) to lend to infrastructure and energy assets remains red-hot.

So what are the main post-referendum trends?

Well, firstly, historically low swap rates have allowed lenders and funds to apply slightly higher margins and risk premiums, whilst keeping the overall cost of capital steady. Only for sub-investment grade investments have we seen the rise in spreads exceed the fall in gilt rates.

Secondly, predicted higher inflation (the counter-effect of currency devaluation) is already feeding through into valuations. For infrastructure projects, characterised by long-term relatively predictable cash flows, higher inflation means higher revenues (either directly or via higher power price forecasts) and higher coverage ratios.

And, thirdly, the logic of infrastructure investment has, if anything, increased. Ever lower gilt yields and an uncertain commercial property sector leave pension funds and other institutional investors with fewer areas to look at. Infrastructure, offering long-term yield and inflation linkage, is an increasingly attractive alternative. So expect the direct investment trend of recent years to continue and accelerate.

The combined effect of these trends is that prices for assets may actually increase in the near term. It is no accident, for example, that share prices of listed infrastructure funds have increased since the referendum decision.

Aren’t there Brexit-related risks as well? Yes, of course. Policy uncertainty could hit some sectors. The cost of equipment priced in euros – such as wind turbines – may well increase sharply, threatening planned greenfield projects (including large offshore wind projects). And whilst resilient, the sector would not be completely immune from a wider economic downturn – especially if accompanied by a credit crunch.

But for now, infrastructure is demonstrating very well its defensive qualities as a sector.