A Pipeline To Profits
For many commuters, the daily traffic snarls, potholes, and bridges under repair serve as a constant reminder of the deterioration of the nation's infrastructure, much of which hasn't been updated in decades. Cash-strapped state and local governments have long deferred as much spending on roads, bridges, and water and sewer systems as possible.
The bill is coming due. According to a November study by consultants Cambridge Systematics Inc., governments will need to cough up an additional $500 billion for construction and repair of roads and bridges over the next decade just to maintain the status quo. Modernizing the nation's aging water and sewer systems, meanwhile, could cost as much as $660 billion over the next 20 years, according to the U.S. Environmental Protection Agency. At $33 billion a year, that would be a sharp increase from the roughly $10 billion that state and local governments currently spend.
Daunting though the task may be, overhauling the nation's infrastructure should create opportunity for savvy investors. Alas, finding bargains among engineering, construction, and service companies isn't as easy as it was a year ago. But infrastructure is a 10-to-20-year growth story, so there are still plenty of chances for long-term investors. Brett Gallagher, head of U.S. equities at Julius Baer Investment Management Inc., recommends the Macquarie Infrastructure Company Trust, a holding company created by one of Australia's largest banks. The trust owns everything from toll roads to airport parking lots in the U.S. and abroad and provides heating and air conditioning to such corporate customers as the Aladdin Resort & Casino in Las Vegas. Gallagher is attracted to the Macquarie trust's hefty 6.5% yield. "That's certainly better than any bond you're going to find -- and the yield is growing," he says. The Macquarie trust generated cash flow of 58 cents per share in the quarter ended Sept. 30, providing ample coverage of the 50 cents quarterly dividend. And with 85 cents a share in cash on hand following the acquisition of another airport parking facility in early October, it's possible that Macquarie will raise the payout in coming years.
In construction, big is good. Richard Rossi, an analyst for Morgan Joseph & Co., a New York brokerage, says one of the best infrastructure plays is Michael Baker Corp. (BKR ), a Moon Township (Pa.) engineering outfit that has experience tackling complex construction projects -- everything from the Trans-Alaska Pipeline System to the New River Gorge Bridge in West Virginia. "They have the brainpower to do large, complicated jobs, and once you get to large projects, the number of competitors drops off dramatically," says Rossi. He notes that Baker's backlog has already grown to $1.4 billion, or roughly double the level at the end of 2003. At just over 22 a share, Baker trades at a multiple that's just below its 15% growth rate.
The truly glistening infrastructure plays might be in water, says Daniel Boone, portfolio manager for the Calvert Social Investment Fund (CSIEX ). He cites the number of conglomerates that have been bolstering their exposure to water-related businesses. "When you see savvy companies like General Electric (GE ) buying into this business, you know they're on to something," he says. One of Boone's favorite water plays is Pentair Inc. (PNR ), a Golden Valley (Minn.) industrial company that now derives 80% of its revenues from water-related systems. These range from water pumps used to clear floodwater out of New Orleans, to filtration and purification systems used by everyone from municipal water providers to Starbucks Corp. (SBUX ), which wants to ensure that its lattes and frappuccinos taste the same around the country. Boone says Pentair is usually pricey, but that a pullback in the stock since July from 45 to 37 provides a buying opportunity.
Another company that seems flush: Insituform Technologies Inc. (INSU ), a Chesterfield (Mo.) company that makes equipment for rehabilitating municipal sewers and water mains. John Quealy, an analyst with Adams Harkness & Hill Inc., a Boston brokerage, says that as municipalities face up to the expensive task of repairing their aging sewer systems -- an endeavor that will cost the city of Atlanta as much as $3 billion over the next 12 years -- they'll flock to Insituform's cost-efficient services. Among them: a proprietary system for relining, rather than replacing, existing pipes using flexible, jointless tubes made out of resin and other materials. "It's like a catheter or stent for a sewer pipe. It becomes a pipe-within-a-pipe," says Quealy.
Boone, the Calvert fund manager, also likes FMC Technologies Inc. (FTI ), a Houston company that makes equipment for oil and gas drillers. Boone notes that despite the heavy damage suffered by the oil and gas rigs off the Gulf of Mexico from this year's hurricanes, there was no environmental damage. Many of the rigs were fortified with FMC's "subsea trees" -- essentially, pipes that connect a drilling platform on the surface to the well below. Drillers swear by the pipes because they have the ability to separate oil and natural gas from water and sand down at the sea floor -- sending only fuel to the surface -- and because the pipes are rugged enough to withstand pressure of 15,000 pounds per square inch from storms. "We didn't have any spills from Katrina that contaminated the water," notes Boone. He says oil and gas exploration in the Gulf should increase in coming years -- and that augurs well for FMC. Analysts expect the company to increase its earnings by close to 20% annually over the next five years.
EASY METER READING
The electricity crunch in 2003 revealed the degree to which the nation's power grid is overtaxed. Analysts say some of the most interesting plays are companies that help utilities stretch capacity. Quealy recommends Itron Inc. (ITRI ), a Spokane (Wash.) maker of next-generation electrical meters. Itron helps utilities save money by automating the process of meter reading. Instead of going house to house, meter readers can drive down the street and take readings from the truck. Itron also sells devices that, once installed in homes, allow consumers to see a minute-by-minute cost estimate of how much energy they're consuming -- and other devices that, with the consumer's consent, allow the utility to trim back power to certain houses and thus reduce output. "This gives utilities very good flexibility in maximizing their power generation," says Quealy. And given that 70% of all meters must be read manually, Quealy says, there's still a vast replacement cycle ahead. Analysts expect Itron to boost its earnings by an average of 20% in each of the next five years. A power crisis during that span could electrify Itron's profits even more. Infrastructure stocks always look better when things are falling apart.
By Dean Foust