London-centric: the Crossrail project is approaching completion

    London-centric: the Crossrail project is approaching completion

    Who’s selling the shovels?

    4 March 2017

    Our infrastructure is at breaking point. Most governments of the past hundred years have been able to raise their glasses to entrepreneurial Victorian ancestors who built sewers, railways and housing projects which have somehow continued to be serviceable, thanks to patching and repair work. But under the pressures of modern life, much of this now needs to be replaced.

    So too our 20th-century inheritance of airports and power stations. And then there’s the digital infrastructure that post-Brexit Britain needs to prosper in the global village. So we must hope there is a new generation of Telfords and Brunels ready for the job.

    It is tempting — but misleading — to believe that nothing much has happened on the infrastructure front since the Channel Tunnel opened. In fact, one of the world’s biggest engineering challenges, Crossrail, is nearly finished; Sir Joseph Bazalgette’s London sewer system has had an overdue makeover; and BT’s Openreach vans have brought the joys of broadband closer to many.

    But sadly it is all happening too slowly, and it has all been too London-centric from the point of view of the rest of the country.

    Hinkley Point’s new nuclear reactor, Heathrow’s third runway, High Speed 2 and the Northern Powerhouse have barely left the drawing board, and are still at the mercy of political whims.

    In the meantime the chance of cheap power from indigenous supplies of onshore gas that could give the whole country a stimulus — as coal did for the Victorians — is in danger of being wasted as we lurch towards dependency on imported gas and the unknowns of nuclear

    So there are several problems to be faced when looking for quoted companies that might benefit from a new wave of infrastructure spending. The first is the long timescale of most projects, in contrast to the short-termism of stock markets. The second, allied to this, is how profits or losses are accounted for — finance directors are too often tempted to assume a certain level of project profitability, then act surprised at the end of the contract when there turn out to be additional tasks to be completed or problems to be resolved, but no further payments due from the client.

    With these imponderables in mind, your veteran investor is reminded of an old saying about mining booms: the first money is made not by the miner but by the man who sells him a shovel. So perhaps we need to look for the engineers, architects and planning consultants who are vital to the launch of any infrastructure project and will be paid fees. Two are picked below.

    Another obvious area of endeavour that should benefit is the p-rovision of materials such as bricks, cement, and steel. And of course cabling, fibre optics and other electronics. Lastly there are the engineering contractors themselves. Increasingly specialised, they tend to undertake projects as part of consortia, not least because most individual company balance sheets are not big enough to go solo on today’s highly complex multi-billion-pound projects.

    So here goes — and, as ever, caveat emptor. (Share prices as at 27 February. I hold City Fibre*.)

    This hugely respected 78-year-old company is one of the world’s largest design and engineering consultants, employing more than 18,000 people.
    Selling at around 15 times earnings with a dividend yield around 3 per cent, the shares are certainly not at bargain basement level — and recent rumours of a possible bid by CH2M from the US have given them a boost. However, recent half-year results included a write-down of £23 million of the goodwill in the oil and gas part of the business — an accounting entry that could be reversed should oil and gases prices improve. Atkins is at the cutting edge of most of the new technology now being deployed in construction throughout the world; it will certainly be involved in all of the UK’s large infrastructure projects and should continue to reward the patient and risk-averse investor.

    At the far end of the spectrum from Atkins is Redhall. This formerly successful company offers engineering design services and manufactures specialist components for nuclear engineering, defence and other sectors. The past five years have seen the shares collapse from 110p, but the present level is an improvement from a recent low of about 6p, perhaps reflecting a changed board getting to grips with unprofitable contracts, particularly in the nuclear waste area. Preliminary results to September last year showed a manufacturing order book that has doubled to £23 million, plus £6 million of service contracts. Losses of £1.7 million are down from £12.2 million the previous year. A boom in infrastructure spending could propel Redhall towards a profitable future — if it has enough cash and credit to finance a growing order book. A gamble, but at this price the risk-reward ratio looks enticing.

    A brick manufacturer should benefit from any uptick in construction: Ibstock is the UK’s largest, and also makes concrete products, including roof tiles. Operations are mainly in the UK but there’s also a US business. It’s highly cash-generative and has been upgrading its plants — which should lower its cost base in future. 2016 was a curious year for the shares, which lurched down after the Brexit vote, along with the whole housebuilding sector. Two months later they had recovered about 70 per cent of the fall and in September the major shareholder, Bain Capital, reduced its holding by 10 per cent to 36 per cent. Since then the price has recovered further but is still lower than pre-referendum, at about ten times estimated 2016 earnings and yielding about 4 per cent — hardly an exacting rating for a company that should benefit both from an infrastructure boom and an acceleration of housebuilding.

    ‘Building an alternative digital infrastructure for the UK’ is how this company announces itself. Fibre optics allow information transfer at speeds and volumes significantly greater than BT Openreach’s copper wire. But the UK is bottom of the fibre-optic league, with only 2 per cent of homes and businesses connected, compared to 50 per cent in northern Europe. Ofcom has said the transition to optical fibre is critical for a more competitive post-Brexit Britain, and the government has allocated £400 million to assist the transition. City Fibre is small, but a leader. For 2016, brokers expect first profits of around £2.5 million on turnover of £15 million — and some predict explosive growth over the next few years. Since the company was floated on Aim three years ago it continues to have the backing of an impressive list of institutions who must believe lift-off is imminent.

    One for risk-averse long-term investors. This closed-end investment trust invests in infrastructure projects mainly in the UK and Europe. It aims to provide an annual return above 8 per cent, and has actually returned over 11 per cent since listing. Major shareholder 3i is also the investment adviser, taking a performance fee of 20 per cent of any plus-value over the 8 per cent target. Last year the company raised a further £365 million at £1.65 and invested in Wireless Information Group, owner of 2,000-plus communication towers in the UK, and Valorem, a French wind and solar venture. There’s ample credit and cash in hand for further deals. Net asset value per share of £1.65 suggests that at £1.87 they are still not cheap. Nonetheless, it would be hard to find a better balanced portfolio of projects. Management is competent and shocks are unlikely. A share to buy when the price moves nearer the net asset value.

    It’s not just the UK’s infrastructure that needs upgrading. President Trump is addressing the same problem. Besides pipelines already announced, he has a $150 billion list of priorities — including a 45,000-acre water recovery and ­storage project that is the business of Cadiz. It will provide a secure water supply to southern California by capturing billions of gallons in aquifers beneath the desert. It has faced fierce environmental opposition, but with Trump’s backing this manifestly useful project should go ahead. Los Angeles broker B. Riley suggests a share valuation of at least $17.50 — but this takes no account of wider ambitions in California’s Central Valley and State Water Project. Founded 34 years ago and with $300 million invested, Cadiz must at last be close to a showing a return. New shareholders will not need such patience — so take a bow, Mr President!