Hockey’s $116 Billion Australia Program Cuts Builder Risk

The Australian government’s plan to spark A$125 billion ($116 billion) of infrastructure investment over six years is cutting bond risk for building companies reeling from a waning mining boom.

The cost to insure the debt of Lend Lease Group, the nation’s biggest construction and infrastructure contractor, slid to a 3 1/2-year low of 161 basis points on May 15, from as high as 538 in 2011, according to CMA data. Leighton Holdings Ltd, the second-biggest, saw the yield premium over the swap rate for its 2022 U.S. dollar bond narrow to the least in more than a year on May 16.

Treasurer Joe Hockey announced an A$11.6 billion infrastructure package in last week’s budget, which he expects will spur an increase in state and private-sector funding for roads and rail by 2020. Spending on urban transport in Australia “is set for a substantial increase,” with previous commitments taking the federal government’s allocation alone to A$50 billion over six years, Leighton Chief Executive Officer Marcelino Fernandez Verdes said yesterday.

“This really helps the big engineering, construction firms, because the mining and liquefied natural gas construction that’s going on at the moment is declining pretty rapidly,” said Ross MacMillan, Sydney-based analyst at Morningstar Inc. “The next real catalyst will be who wins the tenders for these projects. They’ll be so large, there’ll be very major consortiums formed and there’ll be a lot of winners.”

Falling Risk

Credit-default swap contracts on Lend Lease slid 18.2 basis points this quarter, the biggest decline among the 25 companies tracked by the Markit iTraxx Australia index, which fell 11.2 basis points. A gauge of costs to protect against non-payment by Asia-Pacific builders and real-estate companies, including Singapore’s CapitaLand Ltd. and Hong Kong’s Sun Hung Kai Properties Ltd. has fallen 3.2 basis points.

The spread over swap on Lend Lease’s A$250 million of November 2018 bonds was at 1.55 percentage points from this year’s high of 1.72, according to BNP Paribas SA pricing. The gap for Leighton’s $500 million of November 2022 note fell to as low as 2.88 percentage points on May 16, the least since March 2013 and down from 3.44 on Jan. 6, the data show.

Leighton increased construction revenue in 2013 from the previous year, while reducing mining services.

Order Book

The planned infrastructure investment “will help Leighton maintain an order book that would otherwise come under increasing pressure as resource-related spending decreases,” Maurice O’Connell, senior analyst at Moody’s Investor Service, said by telephone. “There are the usual execution risks but road-related construction is a core competence” for companies like Lend Lease and Leighton, he said.

Leighton is preparing to pursue construction, operation and maintenance opportunities in public-private partnerships, Fernandez Verdes said in an address at the company annual general meeting yesterday.

The government said May 13 that its infrastructure package would aid in the transition to non-resource-driven growth. It committed A$5 billion to provide incentives over five years to states and territories to sell assets and reinvest proceeds in infrastructure.

Still, much of the funding allocated in the budget isn’t new, with new money of as little as A$600 million of additional spending in fiscal year 2015, Tim Toohey, head of economics, commodities and strategy research at Goldman Sachs Group Inc. wrote in a May 14 report.

Mining Downturn

“We would caution against overstating the infrastructure implications,” Toohey said. “Neither the timing nor the magnitude of these new projects is sufficient to provide meaningful offset to the imminent sharp unwind in mining construction investment.”

Australia’s benchmark 10-year bond yield rose two basis points, or 0.02 percentage point, to 3.70 percent after touching a nine-month low yesterday. The local dollar declined 0.3 percent to 93.04 U.S. cents as of 1:21 p.m. in Sydney, paring this year’s advance to 4.3 percent.

Lend Lease in December 2010 agreed to buy Valemus Ltd., the Australian unit of Germany’s second-biggest builder, for A$1.06 billion to expand its construction capacity. Valemus’s presence in road, rail, social infrastructure, commercial and industrial building, was a driver behind the takeover, Lend Lease said.

Leighton reported a 13 percent increase in profit in the year ended Dec. 31, helped by A$2 billion of new infrastructure contracts. Germany’s Hochtief AG in March offered A$1.16 billion to increase its stake in Leighton to as much as 74 percent.

“More diversified players have been able to mitigate the impact of a smaller mining sector by focusing on other areas like civil and electrical works, as well as infrastructure maintenance contracts,” Johann Kenny, director of corporates at Fitch Ratings, said in a note dated May 14.

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