RARE Infrastructure as at 29 February 2012 1. TransCanada(TRP): Market Capitalisation US$60.4b TransCanada operates natural gas and oil pipelines in Canada and the US. It also has interests in several power stations in the US and Canada. The company is investing in its pipelines from the oil sands in Alberta to the refineries in the US. Regulated pipelines offering stable long term take or pay contracts Opportunities to leverage off its size and expertise to build extra pipelines Is in pole position to build the Alaska gas pipeline- projected cost circa $30bn Exposed to attractive power markets with declining reserve margins Has low cost nuclear exposure through the Bruce nuclear facility in Canada 2. Transurban Group (TCL): Mkt Cap AU$7.5b Transurban Group is a toll road owner and operator with interests in Australia and the United States. It has an ownership stake in eight roads (five in Sydney, one in Melbourne and two in Virginia in the United States). The group has a diversified mix of asset lifecycle stages with a number of mature intra-urban Australian toll roads providing strong free cash growth. The reasons we like Transurban: Inflation protection is strong Toll price escalation at or above inflation for Australian assets CPI toll price escalation stipulated by concession deeds Proven traffic growth Improving cost management Organic growth pipeline in place, including network enhancements A focus on maximising cashflows from existing assets, while remaining open to value accretive opportunities A disciplined and proven investment appraisal process 3. National Grid PLC (NG/ LN): Market Capitalisation US$34.2b Grid owns regulated energy networks in the United Kingdom and the northeast United States. As the UK incumbent the company has deep experience in operating electricity and gas networks, in both transmission and distribution. The reasons we like National Grid, and why it has defensive characteristics are:
Robust, well understood and transparent regulatory frameworks Regulatory reviews are spaced over time, reducing the risk of materially surprising the market Investment plans agreed with their regulators incorporate 18b of growth to the Regulated Asset Base over the six years to March 2012 Significant additional capital expenditure is also required in both the UK and US to expand and reinforce energy networks, this includes increasing renewable energy capacity, additional gas transmission and potential new nuclear builds Underutilised workforce and depots that have already been paid for with regulated revenue Solid and highly regarded operational management teams 4. American Water Works (AWK US): Market Capitalisation AWK American Water Works is a diversified US water utility with assets in over 15 states across the US & Canada. AWK s demand is less price elastic and less political than other utilities, due to steady consumption and water being a smaller component of the household bill than other utilities. AWK s capital program going forward will be focused on ageing infrastructure replacement, capacity projects, source of supply needs and acquisitions. The reasons we like AWK are: Strong organic capex growth, with ageing Infrastructure needing to be replaced; Portfolio optimisation initiatives continue to increase efficiency and lower costs, with management redeploying value into core growth markets; Arguably less political, with water a much smaller component of household bills; The market opportunity for privatisations represent circa $11bn in total revenues and AWK will likely get their share of the pie; American Water Works see current regulatory environments they operate in as improving, increasing the timely recovery of costs; and Demand is more price inelastic than electric or gas. 5. Sydney Airport (SYD): Mkt Cap $5.0b SYD (previously MAp) owns 85% of Sydney Airport. It actively manages this asset at a strategic and operational level. Towards the end of 2011, MAp completed an asset swap (exchanging its interests in Copenhagen and Brussels airports for an increased interest in Sydney), capital return and simplification (transition from a triple stapled to a double stapled structure, while changing its name and ticker to SYD to reflect the sole focus on Sydney Airport). Sydney Airport is operated under a dual-till regulatory framework, which allows for excess returns in the unregulated non-aeronautical operations. It has explicit inflation protection in its current aeronautical charges agreement, as well as in a number of its commercial revenue drivers. The airport
has a proven ability in maximising revenues (aeronautical and non-aeronautical) while maintaining tight control on operating costs. It has capacity to cater for medium to longer term traffic growth. SYD management has been successful in improving the financial and operational performance at its airports with growth in EBITDA, which typically outperforms traffic growth. Capital expenditure is managed to limit excess capacity while maximising returns on capital. 6. Southern Company (SO): Market Capitalisation US$33.6b With 4.4 million customers and more than 42,000 megawatts of generating capacity, Southern Company is a United States electric utility that owns businesses in Georgia, Alabama, Mississippi and Florida. Southern Company operates in some of the most attractive regulatory jurisdictions in the US Going through a period of higher than normal capital expenditure with projects such as Vogtle Nuclear plant, Ratcliffe IGCC and environment compliance spend, earning an attractive regulated return Early signs of an industrial recovery appear to be coming through in strong industrial sales in Georgia and Alabama The majority of non-regulated generation is gas fired, positioning Southern Company well for improving electricity prices and a carbon conscious environment 7. Northeast Utilities (NU): Market Capitalisation US$4.1bn Northeast primarily operates electricity distribution businesses in the North-Eastern US states of Connecticut, Massachusetts and New Hampshire. In addition, Northeast has a growing FERC regulated electricity Transmission business. Proposed merger with NSTAR combines strong balance sheet (NSTAR) with attractive investment opportunities (NU), and will offer some synergies Market does not recognise value in growing FERC regulated transmission business Transmission returns are low risk with returns guaranteed by the regulator, regardless of volumes Distribution business are under-earning their regulated returns this creates upside risk as regulators allow price increases to improve returns Lots of Transmission projects within New England (New England East West projects) 8. Spark Infrastructure (SKI AU): Market Capitalisation A$1.7 billion Spark owns stakes in three regulated electricity distribution networks, in two states of Australia. In South Australia, ETSA s territory covers Adelaide and the whole state. In Victoria, CitiPower s territory covers the Melbourne Central Business District and Powercor s territory covers the western half of the state and the outer suburbs of Melbourne. About 94% of earnings are from the regulated distribution of power to households, businesses and other customers. Plus about 6% of earnings are from unregulated businesses,
which complement the core business. Spark s asset companies have primary economic regulation by the Australian Energy Regulator (AER). The reasons we like Spark Infrastructure, and why it has defensive characteristics are: ETSA is just over one year into a five year regulatory period (from 1 July 2010 to 30 June 2015) CitiPower and Powercor are less than one year into their five year regulatory period (from 1 January 2011 to 31 December 2015) Their asset companies have a successful track record of finding efficiencies in their expected operating expenses and capital expenses ETSA has successfully appealed their regulatory parameters, leading to over A$300 million of extra revenues from 2011-2015 SKI pays out significantly less than the operating cashflows being generated by their share of the asset companies RARE s forecasts show a substantial ability to increase distributions, and our valuation shows substantial upside from current security prices 9. Severn Trent plc (SVT) Market Capitalisation GBP3.559bn Severn Trent is one of the UK s largest water and sewerage companies. Its main regulated business, Severn Trent Water, provides water and sewerage services to over 3.7m households and businesses in the Midlands and mid-wales, and accounted for over 95% of EBITDA in the year to March 2011. The business is regulated by the Water Services Regulation Authority (OFWAT), which re-sets price caps every five years, with the last determination taking effect in April 2010. Its other business, Severn Trent Services supplies water and waste water treatment solutions in Europe, the Middle East and Asia. We like Severn Trent because: the regulatory framework for UK water and sewerage is relatively transparent. Revenues are determined to allow companies to cover costs and a reasonable return on Regulatory Capital Value (RCV). In its communications with the financial markets OFWAT has demonstrated that its decisions will have regard to the need for investors to finance the future large capital programmes in the sector; under the price cap formula, price rises are linked to inflation, giving a high degree of inflation protection to investors. In addition, companies are incentivised to improve operating efficiency, capital spending efficiency, and customer services. Severn Trent has indicated it expects to outperform OFWAT s targets over the current five-year price control period. This underpins management s promise of 3% annual real dividend growth dividend to 2015; and OFWAT is currently consulting about possible changes to the regulatory framework, and published a consultation document in November 2011. We believe that these changes will be evolutionary rather than revolutionary. Many aspects of the current framework will be retained, and in particular the role of the regulatory capital value will continue for the bulk of the business. Severn Trent is at the
forefront of the debate about future regulatory change, and we believe it to be well placed to exploit any opportunities that may arise. 10. SES : Market Capitalistion $11.0b SES Global owns and operates a fleet of geostationary satellites providing transmission services to television broadcasters, communication companies and government clients. In the EMEA region SES serves over 125m households either directly or through cable. In North America SES provides transmission services to the largest direct to home broadcaster as well as the major cable networks. The reasons we like SES Global, and why it has defensive characteristics are: The geostationary satellite business has natural monopoly characteristics with large barriers to entry (access to orbital slots and capital) Customer switching barriers are also very high with satellite receiving dishes locked to an orbital spot without physical adjustment Returns on investment are high with IRRs of 15%+ on individual satellite investments Operating and cashflow margins a very high with EBITDA margins of nearly 80% The company has relatively conservative gearing at less than 3x EBITDA Satellite transmission costs represent a low percentage of broadcasters total cost base. This allows SES to charge premium prices in return for providing quality and continuity of service guarantees