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Back on the road with infrastructure stocks

Infrastructure spending is not artificial stimulus, it’s needed, says this Canadian analyst, and it will make a big impact in investment markets.

Let’s get one thing cleaned up. The so-called infrastructure revolution isn’t just a make-work project. It’s work that has to be done.

Yes, governments are spending to stimulate the economy, but they’re spending on things that are in serious need of attention.

If you are in any doubt of that, just consider two tragic events. One was the cave-in of the Laval overpass in 2006, the other the rush-hour collapse of the bridge across the Mississippi in Minneapolis in 2007.

Not every piece of infrastructure that doesn’t get a rehab will result in catastrophe, but there’s an awful lot of worn-out material waiting to be revived. And new things crying out to be built.

So this is not just “feel good” money, says Mr. John Stephenson in The MoneyLetter. In fact, says this senior portfolio manager, this spending will go on for decades.

This Canadian analyst considers the full spectrum of infrastructure spending in North America and what it means to investment markets.

And he has two specific recommendations, one you’re probably familiar with, the other a little less well-known.

Not the only worry

At least $150 billion in the Obama administration’s spending package is earmarked for infrastructure. Canada won’t be spending as much of course, but it will be sending a good deal of revenue in the same direction.

And it’s about time, says this analyst. According to CIBC World Markets, the gap between what’s been spent in this country and what’s needed is a robust $120 billion.

In China, they’re spending over $400 billion in the same way (in fact, they got started several years ago, before the economy was under any threat at all).

And tragic accidents are not the only worry, adds Mr. Stephenson.

A lack of capacity in ports allows farm exports rotting on the dock. Traffic congestion isn’t just a cause of road rage, it can cost at least $78 billion a year in the U.S. from 2.9 billion gallons of wasted fuel and 4.2 billion work-hours frittered away.

Flight delays in U.S. airports cost $15 billion in lost productivity. And you know what happens when the electricity goes off.

So even if the economy were doing better than it is, it would still be dragged down if our transportation, electrical and communications systems were allowed to sink any further into obsolescence.

D+ in infrastructure

Most of what we drive on, ride on and communicate with in Canada was built in the aftermath of World War II — and it shows, says Mr. Stephenson.

The U.S. is in even worse shape. The American Society of Civil Engineers gives the country a D+ in infrastructure. No less than 72,000 highway bridges in the U.S. are “structurally deficient.”

The Department of Transportation Financing Commission said last year that America’s roads weren’t just bumpy or full of potholes, they’re in “a physical and financial crisis.”

OK, the point is made. Trillions of dollars will be spend around the world to get things fixed and running smoothly again. How does this affect the markets and investors?

Nothing to sneeze at

“Unlike a lot of government projects, infrastructure spending actually has a multiplier effect that is nothing to sneeze at,” says this analyst.

“For example, CIBC World Markets estimates that in the U.S., a one per cent increase in infrastructure spending has twice the economic benefit of a tax cut of the same dollar amount.”

In Canada, that goes even further. $10 billion of infrastructure spending can create 110,000 jobs and boost economic growth by about 1.5 per cent (and some $14 billion is slated to be spent this year).

Around the world, the biggest chunk of spending will be on roads, railways and runways. In Canada, about 40 per cent will go to energy — nuclear and hydro projects. But transportation won’t be neglected.

Until the latest market smash-up, infrastructure stocks had risen about 50 per cent. “But in Canada, the response has been much more modest,” Mr. Stephenson says, “suggesting that there still may be some profitable opportunities out there for investors to cash in on.”

Look to the engineers

Those opportunities will multiply as private money comes in to join public money, says the analyst. Pension funds are showing a heightened interest in infrastructure, which has the kind of favourable risk-return profile they love.

Even if their large portfolios tilted just a bit toward infrastructure, it would “dramatically improve investors’ prospects,” adds Mr. Stephenson. Right now, they allocate an average of 5 per cent to infrastructure and that should rise to 10 or 15 per cent in the next seven or eight years.

So what stocks should they — and you — be looking at?

Later on in the fix-up cycle, the vendors of equipment and even commodity stocks are liable to do well. But right now, says this analyst, look to the engineers.

Some times the most obvious choices are the best. In this field there is no more obvious candidate than SNC Lavalin (TSX-SNC), the Canadian engineering giant with projects in over 100 countries around the world.

It has a substantial stake in Ontario’s 407 International toll highway. And two-thirds of its backlog is in stable defensive businesses that are not dependent on commodities. The analyst has a $45 target price on the stock, which trades well below that at around $28.

Not as well known, perhaps, is Genivar Income Fund (TSX-GNV.UN). This consulting engineering firm has 55 per cent of its contracts with public sector clients, with infrastructure the largest segment. The 12-month target price, Mr. Stephenson tells his readers in The MoneyLetter, is $28 per unit. It trades around $21.

Infrastructure stocks may not be able to repair your portfolio overnight, but if this analyst is right, they will be on the job while many other companies are looking desperately for work.