The Q4 2020 release of the EDHECinfra indices incorporates the views and asset-level revenue forecasts of our team of financial analysts. This report updates the Q3 2020 report and is presented following the TICCS® taxonomy of infrastructure companies. Each quarter, the team reviews the revenue forecasts of 650 companies that are currently living in the EDHECinfra universe, based on the latest reports, historical data, sector knowledge, and contributed data.
by Jack Lee and the team
1. Overview: Continued cash flow projection downgrades in the wake of the continued impact of Covid-19
Despite progress with developing and rolling out Covid-19 vaccines, there is little visibility of the evolution of lockdown restrictions in 2021 in any of the 25 countries of the EDHECinfra universe. On this basis, the expected impact on the future revenues of infrastructure companies remains depressed for the next 12-36 months.
The UK is a particular point of focus given the combined effect of the so-called tier-4 lockdown and of Brexit, which takes effect on 1 January 2021, especially for the transport sector. We return to this in Section 4 – IC60 Transport.
The majority of the forecasts made in Q3 2020 remain applicable, with the exception of airports, road companies, and some rail companies. These amendments are based on changes in traffic data.
As before the most impacted segments are merchant (BR-20) and regulated (BR-30) companies. IN the absence of long-term revenue contracts, these investments are susceptible to external economic forces. In contrast, contracted business models (BR-10), have been far more insulated from the impact of Covid-19 on Cash flows. However, marked-to-market indices like the infra300 also show that risk premia and discount rates have contributed to increasing investment risk even in the more stable parts of the infrastructure sector.
As of this quarter, companies in all geo-economic segments (TICCS Pillar 4) are included in our revision of the revenue forecast due to Covid-19, as the pandemic has spread.
In what follows, we consider the following sectors that are also the most impacted:
|TICCS® industrial superclasses most affected by Covid
||Power Generation x-Renewables
||Energy and Water Resources
2. IC10 Power Generation ex-Renewables
Q4 2020: According to an updated analysis by the International Energy Agency (IEA), the global electricity consumption is expected to remain below the pre-Covid level at -2% in 2020 compared with 2019, particularly in Europe where new restrictions on activity were implemented in the fourth quarter. Elsewhere, few of the other countries analysed have eased restrictions either. Given our prior write-down in expectations for power revenue, we see no need to adjust the forecasts further.
3. IC40 Energy and Water Resources
Q4 2020: Q4 forecast for IC40 infrastructure assets does not deviate much from Q3. Across the board, we hold a pessimistic outlook of a 3-5% revenue decline in 2020. Further, we maintain that Merchant IC40 companies will see large declines (as high as -30%) in their revenue streams for 2020, and subsequently, we expect a gradual recovery to pre-Covid level in 2022.
Our Q4 revenue projections for IC40 companies are unchanged from our Q3 2020 assessment.
4. IC60 Transport
4.1 IC6010 Airport Companies
Q4 2020: Q4 witnessed stalling recovery in air travel growth with global passenger kilometers flown (RPKs) estimated to decrease by 66% in 2020 (IATA, 2020), aligned with our own estimates in most of our airport constituents. We expect UK constituents to experience a more significant decrease of 63%-69% in 2020 compared with the rest of the population due to the 2nd Covid wave. Heathrow, a UK airport operator, decided to close one of its terminals until the end of 2021, after the airport’s passenger numbers dropped by 88% in November compared to the same period in the prior year (Heathrow, 2020).
We currently expect a gradual recovery in travel demand in late 2021 and subsequently to pre-Covid level in 2022.
The final Brexit agreement means that commerce between the UK and EU will keep flowing without tariffs or quotas from 2021 onwards. Notable changes include an added layer of custom checks that constrain persons and goods’ free movement. The UK no longer participates in the fully liberalised EU aviation market, and UK airlines are no longer part of EU carriers (European Commission, 2020). As a result, UK airlines no longer enjoy the same level of traffic rights across EU airspace. All EU-level bilateral Air Services Agreements (ASAs) will be withdrawn and renegotiated with Third Countries.
Airport revenue is closely tied to passenger demand and the ability of airlines to service that demand efficiently. Any downturn in traffic in the short to medium term will affect airport revenues. For instance, airlines that operate a large number of services around the EU and to and from neighbouring countries would base fewer aircraft in the UK, leading to fewer rotations to and from UK airports and fewer ancillary services based in the UK (PwC, 2020). This will apply to the EU as well.
Based on the above, we see no significant impact on UK airport revenues due to Brexit since any substantial drop in revenue is already considered as part of the impact of Covid-19.
4.2 IC6030 Port Companies
Q4 2020: Even though safety measures from the pandemic have hindered global port efficiency, trading activity increased gradually in Q4, where the average weekly global trade started to recover and decreased by 3% below the pre-Covid level (UNCTAD, 2020). The United Nations Conference on Trade and Development (UNCTAD) has revised their estimate in the current quarter to a -5.6% fall in 2020 from the previous estimate at -9% (UNCTAD, 2020). The recovery of the trading activity to the pre-Covid level is expected to continue into 2021.
Our projections for European Port Companies following a merchant business model (subject to demand risk) will be maintained at -25% and -10% for 2020 and 2021, respectively. For Australia and New Zealand, we have revised forecasts to -15% for 2020 and -5% for 2021. For regulated and contracted Port Companies, minimum volume guarantees or fixed revenue arrangements will continue to assume little to no impact on expected revenues from the pandemic. Revenue growth rates applied at the company level typically range from -5% to -10% in 2020 first, depending on the proportion of contracted capacities.
According to Richard Ballantyne, CEO of the British Ports Association, trading delays are likely to follow during the post-Brexit period (Bloomberg, 2020). Businesses delaying or maintaining minimal trading volumes in order to avoid the risk of un-ending queues is a plausible explanation for the quiet days observed at the start of the new year.
The Brexit free-trade arrangement does not mean that the two trading partners can automatically resume trade to pre-Brexit levels. Brexit has made it harder administratively for companies to trade goods, requiring firms to file customs declarations and comply with other new formalities. With new paperwork comes efficiency issues and frictionless trade becomes more challenging. It’s too early to tell the full extent of the consequences arising from the new trade arrangement, and vaccinations in Europe, but trading delays are likely inevitable, making forecasted revenue take longer to recover to the pre-Covid level than expected for the region.
4.3 IC6040/60 Rail and Urban Commuter Companies
Q4 2020: We have adjusted the forecasts made in Q3 2020 for some companies, incorporating updated data from mobility report and the new release of flight traffic data relevant for airport rail links.
In France, the government has begun to ease the restrictions on access to public transports, with people able to start commuting to work in early June. Based on the latest Mobility trends from Apple Maps application data, we have estimated a 12% reduction in 2020.
Another example is the airport rail link connecting the Stockholm Central Station with Stockholm Arlanda airport: we have apply a revenue fall based on passenger traffic flows, which incorporates traffic flight data at -74% in 2020 compared to the same period last year (Swedavia, 2020). Likewise, for Australian airport links based on forecasts made in the Australian Airport sector.
4.4 IC6050 Road Companies
Q4 2020: In Europe, the revenue forecast is down by an additional -5% compared with Q3 2020. This is mainly due to the second wave of Covid-19 that began in early October, which led to new lockdowns and travel restrictions in most European countries, adversely affecting revenue generation.
While road concessionaires receiving availability or performance-based revenues face minimal impact from these new lockdowns, merchant road companies (BR-20, IC6050) that generate revenue from toll or shadow toll collection are impacted. Although Heavy Goods Vehicles (HGVs) traffic has been robust (Johnson, 2020), passenger vehicles have decreased as evidence by traffic data: we expect declines in revenue in the 6-34% range based on recent traffic data. According to rating agencies, these issues may persist until the middle of 2022 (Fabrizio, 2020).
In the US, the expected decrease in revenue for 2020 has deteriorated by a further 3% compared with Q3 2020 to 26%. Like Europe, the US has also experienced a second wave of Covid-19 that began in early October. According to the mobility indicators produced from Google Maps application data, traffic volume has decreased by 11% since as a result.
We keep our revenue forecasts unchanged for all other affected countries: Australia, Brazil, Chile, and the Philippines, as subsequent changes in government measures and worsening of the Covid-19 situation are in line with our expectations. However, considering the recent lockdown in Malaysia, we plan to revise our forecast for Malaysia in Q1 2021.
Brexit impact: As the UK and EU have agreed that checks will not take place at the border between Northern Ireland and the Republic of Ireland, motorway companies in the UK and Ireland are less subject to increased traffic risk due to Brexit. We do not change our current Covid-adjusted revenue forecast for these companies.
5. IC70 Renewable Power
Q4 2020: In 2020, global energy demand is set to have declined 5%, according to the International Energy Agency’s latest analysis (IEA, 2020).
Long-term contracts, priority access to the grid, and continuous installation of new plants all underpin the growth of renewable electricity consumption: an overall increase of 1% in renewable energy demand is expected in 2020 (IEA, 2020), in line with our analysis of the sector when a contracted (BR-10) or regulated business model (BR-30) is in place.
Despite the priority granted to renewable energy sources in most countries, this fall can impact those companies with a merchant business model (BR-20) where revenue is directly linked to market demand and the spot price. KS SPV 5, one of our constituents that operates solar power facility in the UK, mainly derives revenue from the sale of electricity produced would have been impacted by the low demand. However, the company also derives partial revenue through power purchase agreements on a fixed-term basis, which would lower the impact. In the prior quarter, we projected that the revenue drop for these firms would range between -2% to -9 %, depending on the location and the revenue composition of the firm. No further revision on this forecast is required.
Our Q4 revenue projections for IC70 companies are unchanged from our Q3 2020 assessment.
6. IC80 Network Utilities
Q4 2020: A common trend emerged in network utilities in 2020 across the countries that make up the Universe: while this sector usually enjoys a consistent revenue stream, the pandemic has brought in a dynamic change to consumption patterns. Lockdown measures imposed by governments led to an increase in household consumption but a decrease in industrial and office usage, with the latter normally generating a greater share of network utilities’ consumption. This combination resulted in an overall reduction in consumption.
The increase in the unemployment rate and accumulated losses from the temporary closure of commercial businesses have also led authorities to introduce relief measures, which include permitting deferred utilities settlements for a significant range of businesses and households. Regulators may also mandate lower utility prices across the board for an extended period, in the interests of users (Booth, 2020).
We largely maintain our Q3 2020 view. The negative impacts on the economy and further imposed restrictions on movement in many regions suggest that utility demand will continue to be dampened and remain below pre-Covid levels at least until the first half of 2021. In line with prior observations, many governments in continents such as Europe and South America have also continued to grant tariff exemptions and suspend service cuts and late fees for low-income utility users (Schwartz et al., 2020). The consequences would depend on the extent to which the companies will recover these revenue losses – whether they are compensated through deferred payments, government transfers or tariff adjustments. By comparison, electricity transmission networks are less impacted in terms of revenue compared with distribution networks due to the more contractual nature of transmission businesses. Hence, we are of the view that the revenue growth for utilities will remain below pre-Covid levels up until mid-2021, before a slight normalisation with growth increasing in line with a discounted historical median rate.
Utilities have large fixed costs and the reduction in revenue may give rise to liquidity issues that might not be mitigated fully by government schemes, especially in emerging markets (IFC, 2020), though the more developed European utilities are likely to maintain robust credit quality (S&P Global, 2020). In the UK, Ofgem is still determining how to recover the potential bad debts arising from Covid-19 related deferred network charge payments (Ofgem, 2020). Large water utilities such as Thames Water and Severn Trent are likely to maintain strong liquidity and remain compliant with their financial covenants for the coming year ahead despite the reduction in operational cash flows. (Severn Trent, 2020; Thames Water, 2020).