NAB’s Chief Economist, Alan Oster provides his thoughts on the Australian and Global economy.
Industry participants are exploring a range of different approaches to support Australia’s infrastructure needs as the economy faces into a higher inflationary environment.
Australia’s growing population and ambitious 2030 energy transition targets highlight the urgent need today for strong industry collaboration and flexible approaches in order to deliver the country’s infrastructure requirements.
After a period of relatively low inflation and rates, Australia’s traditionally mature and stable infrastructure market is being tested with greater uncertainty as central banks seek to find a path to a soft landing for global economies.
In recent discussions with stakeholders across the infrastructure value chain, these industry participants indicated that today’s higher inflationary environment is presenting a range of challenges needing innovative approaches and the right support to enable delivery of vital projects for the nation’s future prosperity.
Given the burgeoning demand, public infrastructure spending continues apace. But with lengthy bid processes running into escalating costs and supply shortages, arriving at an acceptable price is proving increasingly difficult. For live projects, inflationary pressures have meant potential cost overruns and delays for contractors that had signed up to fixed time, fixed price contracts.
Although inflation is proving an ongoing challenge for developers and their partners, some infrastructure investors are finding relative safe harbour in projects with long-term CPI-linked contracts which lock in revenue and costs with appropriate structures.
James Hann is a Managing Director at leading fund manager Palisade Investment Partners, which recently celebrated 15 years of investing in the mid-market core infrastructure space.
Palisade manages a number of open-ended funds which typically seek to acquire mid-market infrastructure assets at values up to about $A1.5 billion. These equity investments are typically made on behalf of superannuation or pension fund clients, which align to the long-term obligations of their superannuants.
Image: Granville Harbour Wind Farm is a Palisade asset operating in Tasmania.
Hann says most of the investments they make are in physical assets which are underpinned by strong, predictable revenues and cash flows. The key focus for Palisade is on transport, energy and future-facing tech infrastructure in Australia, New Zealand, and more recently the US, with their portfolio comprising investments in ports, renewables, public private partnerships (PPPs) and digital infrastructure assets, among other things.
“We are looking for assets where there are relatively high EBITDA margins and resilience to demand shocks or other events which could adversely affect the cash flows of the business,” Hann says.
This means finding essential assets that deliver a tangible benefit to the communities they operate in, while also being difficult to replicate or subject to long-term concessions. PPPs are a good example, Hann says, or strategically-located assets like seaports or airports.
The nature of many of these infrastructure assets is that they have in place inflation protection through long-term contracts both to secure revenues such as power purchase agreements, as well as costs for maintenance and operations services.
“A key feature of a lot of those long contracts is that they are inflation-linked,” Hann says. “So it is fairly standard that on an annual basis the tolling charge or the price per megawatt hour will escalate according to whatever the inflation metric or CPI is for that particular year. This is an important feature we look for in potential investments given the need to provide long-term sustainable income to superannuation fund investors in particular.
“Because they are relatively high EBITDA margin businesses, you are pretty well-insulated against inflationary pressures, with an inflation-linked revenue stream or at least one where revenues are highly corelated with inflation outcomes. For those assets, at least as far as revenue and inflation is concerned, the economic change has generally been a neutral story for us.”
NAB has been a banking partner to Palisade across various infrastructure assets. NAB’s Global Head of Infrastructure, Energy and Utilities, Specialised Finance, Ally Bonakdar, says in an inflationary environment, lenders are focused on project cash flow volatility and counterparty quality.
“Businesses with linkages between inflation and revenue cash flows and which allow pass through of operational costs, will remain resilient in these challenging times,” Bonakdar says. “In addition, there is greater focus on refinancing risk and the appropriate level of hedging given the increases to the ‘all in’ cost of debt.
“The inflationary environment which has resulted in higher interest rates has impacted valuations and materially impacted the level of mergers and acquisitions activity. That said, certain sub sectors, such as those identified by Palisade, continue to receive investor interest. Ongoing challenges for projects include the costs and complexities of bidding, supply chain certainty and increases to the capital costs on new projects.”
Bonakdar says the macro themes driving infrastructure investing today include population growth, sustainability, energy transition, and the increasing demand for data in our digital lives. In the context of renewables, NAB is the leading Australian bank provider of project finance to the global renewable energy segment1 and is approaching the milestone of successfully closing 200 renewable energy transactions globally since 2003. In doing so, the bank has committed funding for A$15 billion2 in renewable energy transactions globally. Palisade is now one of the largest owners of operating renewable energy assets in the country, which Bonakdar says aligns well with NAB’s goals in this space.
Palisade’s Hann says that in the past, where these renewable assets have mostly been individually project financed, an exciting recent development has involved an initiative to amalgamate assets into an integrated platform called Intera Renewables. The launch of Intera Renewables positions Palisade to support the enormous capital requirements associated with the energy transition, Hann says, adding Palisade is actively raising money aligned to its key investment themes in the local market and similar opportunities in the US.
When it comes to infrastructure developers, the difficulties in construction since the COVID-19 pandemic have been well-documented.
For NAB-client Tetris Capital, the key to success in today’s challenging environment is to put the right partners together by using flexible, innovative approaches and having enough expertise on the ground to ensure solutions are being implemented to reduce execution risk.
Tetris works to finance and manage infrastructure assets with co-investors, including in PPPs, social and affordable housing and renewables projects among others.
Co-principals Stephen McDonough and Ryan Slocombe say higher inflation is compounding affordability issues which can make it hard to arrive at a construction price during bids.
“The price is ending up exceeding a lot of people’s expectations including ours, the builders, and government,” McDonough says. “That’s having knock-on effects on affordability.”
Slocombe says it’s important to take an objective view of the realities of the project, so the partners involved have realistic expectations on cost delivery and timeframe at the end.
But he says in today’s changed economic conditions, a number of projects will not happen unless there are innovative structures adopted. Housing is an example which could be potentially more viable when looked at on a portfolio basis or by working with smaller partners to see through the project delivery, he says.
“Seeing more projects get done with good partners and being able to help those partners step up into these projects is an important part of success. The idea of an investment grade contracting partner for all projects is not possible – that is an important mind shift. The ability to work with new partners is of greater importance.”
NAB Executive Director, Infrastructure, Energy and Utilities, Specialised Finance, Joy Leet says: “It’s important to us that we partner with clients like Tetris on innovative structures from a first principles basis, in order to continue delivering on important infrastructure in a changing landscape.”
Given the genuine need for strong public infrastructure, there are still many government-related projects coming through in the housing and energy transition space, as well as a backlog in health and education, the Tetris principals say.
Image: Artist impression of social housing project New Street, Brighton, a Tetris Capital partnership project for the Victorian Government.
Slocombe says: “The pipeline of projects is very strong. The question is whether it tightens up if execution gets a little bit harder but there’s a huge amount of work to be delivered around the country.”
Despite today’s challenging environment both McDonough and Slocombe say delivering Australia’s infrastructure needs is an exciting and valuable task to be working towards.
“We’ll see a lot of the change in the industry coming through and we’re looking at this end to end,” Slocombe says.
“When you look at areas like health, housing and energy, this is going to be nation-changing over the next 10 to 20 years. It’s a pretty exciting time for us, and our banking relationship with NAB is an important part of helping get us there.”
1. 2023 Full Year Results Investor Presentation (nab.com.au)
2. NAB internal data.
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