Varun Anand, vice president and senior portfolio manager, Starlight Capital

FOCUS: Global infrastructure stocks

MARKET OUTLOOK:

Ongoing geopolitical uncertainty combined with elevated inflation has resulted in surging commodity prices and has left central banks with few options but to tighten through higher interest rates and scaling back quantitative easing. Stock prices have suffered as a result of elevated interest rates and concerns over growth, particularly growth equities with premium valuations. However, infrastructure equities have performed well on a relative basis in this environment, posting positive returns in 2022, despite concerns that higher interest rates will have a disproportionate impact on infrastructure equity valuations. This is due to the resilient business models of infrastructure companies, which have delivered strong results and cash flow generation in 2022, despite significant disruptions to global supply chains as well as the impact of surging commodity prices.

In the current macro environment, we do not anticipate a material demand impact on infrastructure equities, particularly those providing mission-critical services (i.e. waste collection, electricity, connectivity). In addition, many infrastructure businesses structure their contracts to include inflation pass-through or CPI-linked escalators, which limits the impact of higher inflation on cash flow and earnings growth. The Ukraine invasion has resulted in a renewed focus on reducing the reliance on Russian oil and gas while promoting energy independence. This will result in even further support and investment into renewable energy, which will be the dominant form of incremental power generation over the next century.

Infrastructure technology companies have sold off in tandem with the technology complex as a whole, despite having more reasonable valuations and lower volatility in earnings/cash flow. We have taken the opportunity to add to these names as they have continued to demonstrate strong growth in the current environment with limited inflation exposure. We anticipate infrastructure equities to outperform in this macroeconomic environment while providing superior downside protection and tax-efficient distributions. 

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TOP PICKS:

EverGen Infrastructure (EVGN TSXV)

EverGen is a pure-play small-cap company focused on renewable natural gas (RNG) infrastructure. The company acquires, develops, builds, owns and operates a portfolio of renewable natural gas projects across Canada, with two operational facilities in British Colombia. The RNG space is attractive given the positive impact it has on emissions (converting waste from landfills into natural gas is a carbon-neutral event vs. mining for natural gas, which increases emissions) and the fact that RNG producers are paid by both their suppliers (landfill owners, municipalities) and customers (utilities). Landfills account for 15 per cent of global methane emissions, which traps over 80 times more heat in the earth’s atmosphere than carbon dioxide, making companies like EverGen a key player in reducing global warming.

Utilities are also focused on increasing the amount of RNG in their existing pipelines; Fortis BC is targeting 15 per cent of its natural gas supply to be renewable by 2030 and is a key long-term customer of EverGen. In 2022, EverGen has significantly increased its pipeline, announcing two acquisitions (Growtec in Alberta and Project Radius in Ontario). Core projects and recent acquisitions create a path to generating more than $50 million of EBITDA by 2024, from the current level of $3 million, representing one of the best growth profiles in the renewable space.

EverGen trades at less than 5x 2023 EBITDA, discounting far too much execution risk and trading well below recent transactions in the RNG space. While the shares will continue to have higher beta/volatility over the short term, we believe the risk/reward is heavily skewed to the upside, and long-term investors will be rewarded as EverGen executes on its robust pipeline. The company also recently announced the approval of its NCIB program for up to five per cent of shares outstanding, which allows the company to purchase its own shares during periods of heightened volatility. EverGen is our top idea in the RNG space globally.

Northland Power (NPI TSX)

Northland Power is an Independent power producer with more than 3000 MW of operating facilities spanning renewable energy and clean natural gas in Canada/Europe as well as a regulated utility in Colombia. Northland Power has been advancing offshore wind developments in several geographies, including announced projects in Poland and Taiwan, as well as near-term auctions in Japan and Korea. The company has also expanded into the U.S. and Spain through acquisitions and is bolstering its onshore wind and solar presence.

We believe Northland Power can double its EBITDA over the next decade, fueled by a robust growth pipeline and an excellent track record of execution. NPI's growth pipeline stands at 6.5 net GW, and we believe more than 50 per cent of this pipeline has a high probability of buildout. In light of the recent invasion of Ukraine, we anticipate Europe will accelerate the development of renewables to reduce dependency on Russian oil and gas. Offshore wind will be one of the biggest drivers of renewable procurement in Europe and globally over the next decade, and NPI is positioned extremely well given its position as a top-four player in the space. NPI trades at 12.5x 2023 EBITDA and has a dividend yield of three per cent.

Infrastrutture Wireless Italiane (INW BIT)

Infrastrutture Wireless Italiane is Italy's largest cellular tower company, providing widespread coverage throughout the country and hosting transmission equipment for all of the main national carriers. INWIT operates cellular towers, where wireless carriers place their equipment on INWIT's tower in order to build out their network infrastructure and roll out technological improvements (i.e. 5G). INWIT's tower business is underpinned by contracted cash flows, through master service agreements with wireless carriers that include inflation pass-through.

As a result, INWIT is positioned extremely well should we enter into a prolonged inflationary environment, as the company has no cap on the amount of inflation it passes through to customers, even if its own costs have not increased as much. Given the recent divestment of INWIT shares by Telecom Italia to Ardian, we believe mergers and acquisitions could be a catalyst for shares given the strong appetite for European tower assets from private equity and the undemanding valuation of INWIT. INWIT trades at less than 16x 2023 EV/EBITDA, well below U.S. peers and recent transaction multiples, despite having one of the best organic growth rates over the next two years.

PAST PICKS: July 21, 2021

Canadian National Railway (CNR TSX)

• Then: $131.12
• Now: $143.65
• Return: 10%
• Total Return: 12%

 RWE AG (RWE XETR)

• Then: $29.08
• Now: $41.06
• Return: 41%
• Total Return: 44%

CargoJet (CJT TSX)

• Then: $182.59
• Now: $146.21
• Return: -20%
• Total Return: -19%

Total Return Average: 12%