How to Invest in Infrastructure Stocks

We use infrastructure every day, often without noticing. Infrastructure supplies our water, electricity, and natural gas. It connects us on the phone and online. It helps us get from place to place on roads, rails, or in the air. Without well-maintained infrastructure, our modern economy wouldn't function.

Just keeping our existing infrastructure systems working is a massive undertaking. Governments and companies around the world need to invest trillions of dollars into maintaining existing infrastructure assets, which continue wearing down amid heavy usage. On top of that, trillions more need to be poured into building additional infrastructure to support economic growth. Those investments represent a massive opportunity for investors in infrastructure stocks.

However, before diving into the sector, investors need to understand not only the importance of infrastructure, but also the role government plays in driving the industry. That knowledge will help them make better investment decisions, which should lead them to pick infrastructure stocks that can generate market-beating returns.

What is infrastructure?

The word infrastructure literally means under (infra) something that's constructed (structure), though we use the term to refer to the physical structures and systems needed to support the economy.

There are two basic types of infrastructure:

  1. Hard infrastructure refers to the physical structures and networks a society requires to function, such as transportation networks (roads, airports, subways), energy systems (the electrical grid and pipeline systems), telecommunications (cell towers, data centers, fiber optic cables), and water and sewer systems.
  2. Soft infrastructure refers to the backbone institutions of an economy -- government and law enforcement, banking, and emergency services.

Who owns infrastructure?

Because of the high up-front costs of building hard infrastructure, as well as its importance to the economy, governments have long been a crucial investor in the infrastructure industry. As such, governments tend to own and operate many critical infrastructure assets. In the U.S., for example, government entities control most ports, toll roads, and airports.

However, because of the high costs of maintaining infrastructure assets, as well as building new ones, governments have been steadily privatizing infrastructure assets by selling them to investors. Electric utilities were among the first subset of the infrastructure industry to move from public (government) to private (investor) hands, though many other classes of infrastructure assets such as toll roads and ports have slowly made that transition as well.

Types of infrastructure investments

Infrastructure investments generally focus on hard infrastructure. While we can invest in some soft infrastructure systems -- credit-card networks, for example -- investors tend to lump those in with other financial stocks. Likewise, most investors would classify companies that build infrastructure more as engineering and construction companies. Because of that, when investors refer to "infrastructure stocks," they mean the companies that own and operate hard infrastructure assets.

Investors can break the infrastructure industry down into three categories:

  • Transportation infrastructure, the physical assets needed to move people and goods from one place to another (i.e., airports, railroads, roads, and ports).
  • Commodity infrastructure, the physical assets and systems necessary to produce and transport commodities used by the economy such as water, oil, natural gas, and electricity (i.e., the electric grid and interstate pipeline system).
  • Data infrastructure, the physical networks and components required by modern society to communicate as well as move and store data (i.e., communication towers and data centers).

Transportation infrastructure

Airports: While government entities own and operate most passenger airports in the U.S., several public companies operate airport infrastructure in other countries. In Mexico, for example, three publicly traded companies (on U.S. exchanges) -- Grupo Aeroportuario del Sureste, Grupo Aeroportuario del Pacifico, and Grupo Aeroportuario Centro Norte -- operate airports across that country as well as others in Latin America. Groupo Aeroportuario del Sureste, for example, operates nine airports in southeastern Mexico, six in Colombia, and one in Puerto Rico. These companies hold concessions with the government to operate these airports, paying a fee in exchange for the right to earn the revenue generated by these facilities.

Toll roads: While private citizens built many of America's first toll roads, state highway systems took most of them over by the turn of the 20th century and still control the bulk of them today. However, some, like the Dulles Greenway in Virginia, are in private hands (in this case, Atlas Arteria, which trades on the Australian exchange and also operates toll roads in eastern France and a tunnel in Germany).

Railways: The U.S. federal government owns Amtrak, which provides passenger train services throughout the country, while private companies operate most freight lines. There are seven Class I freight railroad companies (defined as of those that generate more than $447.6 million in revenue, as of 2017's inflation data) operating in the U.S. -- BNSF Railway (owned by Berkshire Hathaway), Canadian National Railway, Canadian Pacific Railway, CSX Transportation, Kansas City Southern, Norfolk Southern, and Union Pacific -- that investors can own as well as several smaller regional railways.

Ports: There are two types of ports: operational and landlord. State or local government port authorities run operational ports, owning the port infrastructure as well as overseeing all operations. Major operational ports include those in Houston, Savannah, and Charleston. Meanwhile, government agencies such as a port authority own the land and basic infrastructure of landlord ports. However, they lease the property out to private companies that operate parts or all the port. Examples of landlord ports include those in Los Angeles and Oakland, where Brookfield Infrastructure Partners (NYSE: BIP), for example, operates container terminals, part of the 37 port assets it holds around the globe.

Commodity infrastructure

Electric and gas utilities: Investors have several options when it comes to investing in electric and natural gas distribution infrastructure, since there are dozens of publicly traded companies that own these crucial assets. Some companies focus on owning and operating electric-generating facilities such as hydroelectric dams or wind farms. Others not only own those assets, but also the transmission infrastructure needed to get the power from plants to homes and businesses. Meanwhile, some utilities focus on owning natural gas distribution systems, while others operate across the entire spectrum. Dominion Energy (NYSE: D) is one of the largest electric and gas utilities in the country, serving nearly 7.5 million customers in 18 states as of 2018.

Water and wastewater utilities: Several publicly traded utilities own and operate water and wastewater infrastructure, such as pipelines, sewage treatment facilities, and desalinization plants. American Water Works (NYSE: AWK) is the largest water utility in the U.S., providing water, wastewater, and other services to more than 14 million people in 45 states as well as Ontario, Canada, as of 2018.

Oil and gas midstream infrastructure: The U.S. has the largest energy pipeline network in the world, at more than 2.4 million miles. In addition to that, the energy industry requires several other mission-critical midstream infrastructure assets to transport, process, and store oil, natural gas, and refined petroleum products. Canada's Enbridge (NYSE: ENB) is the largest energy infrastructure company in North America. It operates the world's longest crude oil and liquids transportation system, and it's also the North American leader in the transportation, processing, and storage of natural gas.

Data and communications infrastructure

Data centers: Data centers are the backbone infrastructure of the internet as these centralized facilities house the servers and other systems needed to store, manage, and transmit data. While many technology companies own and operate their own data centers, several companies focus on owning these centralized hubs. Equinix (NASDAQ: EQIX) is the world's largest data center operator, with 200 properties in key locations such as Silicon Valley that it leases to nearly 10,000 customers.

Telecommunications towers: Antennas are crucial infrastructure for the broadcast and wireless industries as they enable companies and people to transmit voice, data, and video. One of the largest companies focused on tower infrastructure is American Tower (NYSE: AMT), which operates more than 170,000 sites around the globe. The company is also working hard to "take advantage of our unique position in the industry to lead the way into a 5G future," according to its CEO. For example, the company could build wireless network infrastructure inside of buildings and stadiums.

What's driving the infrastructure industry?

Three major factors drive the need for new infrastructure. First, governments have underinvested in their infrastructure over the years, causing existing assets to deteriorate and become obsolete. As a result, governments need to replace a significant amount of infrastructure so they can continue supporting the global economy.

The second factor driving the infrastructure industry forward is a growing global economy. As the gross domestic product (GDP) expands, -- which is a measure of economic growth -- it fuels the need for additional infrastructure to support the increased movement of people, commodities, and goods. For example, a growing economy uses more energy, driving the need for new oil pipelines, power-generating facilities, and other energy-related infrastructure. It also propels demand for more transportation infrastructure capacity such as bigger airports, wider roads, and additional port capacity.

Finally, shifting demographic trends such as population growth, the expanding middle class, increased urbanization, and the aging of certain populations such as baby boomers in the U.S. increases the need for new infrastructure to support these changes. For example, an expanding middle class has more disposable income to spend on things like travel -- driving the need for additional transportation infrastructure -- and entertainment, which requires more communication infrastructure.

Why invest in infrastructure?

Governments have finite budgets to spend on maintaining and expanding infrastructure. However, with the need for infrastructure rising, there's a widening gap between spending and the investment required to adequately meet the global economy's infrastructure needs. According to one estimate in 2018, the infrastructure funding gap in the U.S. alone stands at a staggering $3.6 trillion. Meanwhile, significant gaps remain in other developed nations like Canada, Australia, and across Europe.

Because of that, governments are increasingly seeking private sector help to bridge this gap in two major ways. First, they're privatizing infrastructure assets by either selling them outright to investors or leasing them under operating concessions, which enables companies to earn income from operating infrastructure assets in exchange for paying the government a fee. Those options bring in cash so that governments can fund other critical projects. Second, they're forging public-private partnerships (PPPs) to get private capital to invest in government-driven infrastructure projects.

Countries like Brazil and Australia have been actively selling infrastructure to the private sector over the years to help fund new projects. Brazil, for example, sold concessions in several toll roads to Brookfield Infrastructure Partners, which will not only invest capital to maintain those roads, but expand them. Australia, meanwhile, has been privatizing assets to finance the construction of new ones. It entered into a 99-year lease with a company to operate a state-owned electric grid, using the proceeds to pay for improvements to the Sydney Metro.

The U.S., meanwhile, is hoping to take the PPP approach to address its infrastructure spending shortfall. The Trump administration unveiled a $1.5 trillion infrastructure plan in 2018 designed to repair and upgrade the country's aging infrastructure. The proposal would see the federal government spend only $200 billion of that amount, with the rest coming from state and local governments as well as private investors that would invest in projects in return for a stake in the revenue they'd generate. Given the significant need for infrastructure spending around the world, governments will likely continue seeking ways to incorporate PPPs to bridge the infrastructure spending gap.

How government affects infrastructure

Government entities play a crucial role in the infrastructure industry. Not only do they invest heavily in the sector, they also oversee it. As such, they set or regulate the rates many infrastructure companies charge for using their assets. In the U.S., for example, the Federal Energy Regulatory Commission, FERC, regulates the transmission and sale of electricity and natural gas by helping set tariffs and rates. The FERC also reviews proposals to build new liquified natural gas terminals, interstate natural gas pipelines, and hydropower projects.

This oversight limits competition, which allows infrastructure companies to earn a return on their investment in new projects. However, it also prevents them from charging higher market-based fees. Governments can also prevent infrastructure projects from moving forward or delay them by undertaking additional reviews to ensure they're actually needed. Because of that influence, investors need to understand that governments can inhibit infrastructure growth projects as well as push them forward.

The top infrastructure stocks

Because governments can't meet the global economy's infrastructure requirements on their own, they will need to increasingly rely on private investment. As a result, investors will likely see their opportunity set expand over the coming years as more companies focus on this opportunity. In the meantime, investors already have several compelling options worth considering.

Here are the 10 largest global infrastructure companies as tracked by the S&P Global Infrastructure Index:

Infrastructure Stock Ticker Symbol Market Sector Country of Origin What It Does
Transurban Group (ASX: TCL) Industrials Australia Toll roads

(NasdaqOTH: ANNSF)

Industrials Spain Airports
Enbridge (NYSE: ENB) Energy Canada Oil and natural-gas pipelines and natural-gas utilities
NextEra Energy (NYSE: NEE) Utilities U.S. Electric and natural gas utilities, wind- and solar-power generation
Atlantia (NASDAQOTH: ATASY) Industrials Italy Toll roads and airports
Duke Energy (NYSE: DUK) Utilities U.S. Electric and natural gas utilities
TransCanada (NYSE: TRP) Energy Canada Oil and natural gas pipelines
Kinder Morgan (NYSE: KMI) Energy U.S. Oil and natural gas pipelines
Iberdrola (NASDAQOTH: IBDRY) Utilities Spain Electric and natural gas utilities
Getlink (NASDAQOTH: GRPTF) Industrials France Railroads

Next, we'll drill down a bit deeper into one of these infrastructure behemoths, then take a closer look at another enticing option.

Enbridge: The king of North American energy infrastructure

Enbridge is the largest oil and gas midstream infrastructure company in North America. As of early 2019, the Canadian company transported 25% of the oil produced in North America and 16% of the gas consumed in the U.S., and it was the largest natural gas distribution company in Canada. Enbridge gets paid a fee as oil and gas flows through its various pipeline systems, which allows the company to generate steady cash flow that it uses to pay a lucrative dividend as well as expand its infrastructure footprint.

While Enbridge is already the largest midstream infrastructure company in North America, it's not stopping there. The company invests billions of dollars per year to grow its asset base. That growth should continue for many years to come, since the U.S. and Canada need to invest $800 billion in building new energy-related infrastructure by 2035 to support production growth in both countries. That leads Enbridge to believe it can invest 5 billion Canadian dollars to CA$6 billion ($3.8 billion to $4.5 billion) per year in expansions in the coming years. As those projects come online, they'll supply Enbridge with a growing stream of cash flow, giving it the fuel it needs to continue increasing its dividend at a healthy annual rate, as it has done since 1997.

Because of its massive scale, Enbridge offers investors the opportunity to benefit from the growth of the entire North American energy infrastructure segment, since it operates both oil and gas pipelines in the U.S. and Canada, as well as a meaningful utilities business. That diversification makes it a low-risk way for investors to add some exposure to the fast-growing energy infrastructure segment in their portfolios.

Brookfield Infrastructure Partners: Your one-stop shop to invest in infrastructure

Brookfield Infrastructure Partners is one of the largest owners and operators of infrastructure assets in the world. The company owned stakes in 32 infrastructure businesses at the end of 2018, spread across North and South America, Europe, and Asia Pacific focusing on utilities, transportation, energy, and data infrastructure.

The company's infrastructure assets are critical to support the movement of energy, data, water, goods, and people. For example, its coal terminal in Australia handles 20% of global seaborne metallurgical coal exports from Australia, making it a key player in supplying the steel industry. Meanwhile, its rail network in Western Australia is the sole freight system to move commodities like iron ore from mines to global markets. The company also operates a vital communications network in France, an important natural gas pipeline system in Brazil, and critical toll roads in Brazil, Chile, Peru, and India.

Brookfield makes most of its money by allowing customers to use its assets for a fee. Drivers, for example, pay tolls to use its toll roads. Energy companies pay tariffs to use capacity on its pipeline assets. Telecom companies, meanwhile, rent space for their equipment on its communication towers. Because these assets are important to customers and global commerce, Brookfield tends to collect a steady stream of fees as customers use its infrastructure, enabling the company to generate a stable income stream.

As the economy grows, it fills up the capacity of Brookfield's assets, which provides the company with opportunities to expand them as well as build new ones. Brookfield Infrastructure aims to invest several hundred million each year to move more people, energy, data, and goods. Those investments support Brookfield's long-term goal to grow the cash flow of its infrastructure portfolio at a 5% to 9% annual rate, which should allow the company to grow its dividend at a similar growth rate.

Brookfield Infrastructure wants to take advantage of the global infrastructure funding gap by investing money to either build assets that meet a need in the economy or buy them from those that need capital to construct new infrastructure. This approach should allow the company to earn lucrative returns as demand for infrastructure investment increases. That makes it an ideal way for investors to gain broader exposure to the global infrastructure market.

Top infrastructure ETFs

In addition to those two infrastructure stocks, investors also have the option of choosing an infrastructure-related exchange-traded fund, an investment that holds a basket of stocks in many different companies. The SPDR S&P Global Infrastructure ETF and the iShares Global Infrastructure ETF, for example, both own more than 75 global infrastructure stocks. Among their largest holdings are North American pipeline companies Enbridge, TransCanada, and Kinder Morgan; U.S. utilities Duke Energy and NextEra Energy; Australian toll road group Transurban; Spanish airport operator Aena; and Italian motorway and airport infrastructure operator Atlantia. As such, both of these ETFs offer investors broad exposure to the global infrastructure sector.

Another option is the Alerian Energy Infrastructure ETF, which focuses on holding energy infrastructure companies in North America. This ETF holds roughly 40 companies, led by Enbridge. Meanwhile, the Invesco S&P Global Water ETF focuses on owning water-related infrastructure companies. It holds more than 50 such companies, including American Water Works.

Risks of investing in infrastructure

Like all segments of the market, investors should keep risk in mind before investing in infrastructure stocks. Three risk factors in particular stand out in this sector:

  1. Government involvement
  2. Cost overruns on projects
  3. Access to capital to fund infrastructure expansions

The government, for example, not only has the authority to approve projects and permits to move infrastructure forward, but it can also withhold them if it wants more information about the impact construction could have on an area.

Meanwhile, infrastructure is costly to build and maintain, which means companies need to have access to funding to construct new projects while also keeping a close eye on the budget. A huge cost overrun on a large-scale project, for example, could significantly affect investment returns and impair a company's balance sheet.

One way investors can reduce the risks of investing in the sector is by focusing on companies with a top-tier financial profile and a history of completing projects on time, since that makes it less likely that a government-related delay will significantly affect their operations.

The benefits of infrastructure investments

The world needs more infrastructure to support continued population and economic growth. However, with government budgets already stretched thin, the private sector will likely play an important role in building the infrastructure needed to support global growth. That should open up many opportunities for investors to profit as infrastructure-related companies expand their operations, which should grow their earnings and dividends as well as boost the value of their stocks, likely enriching investors in the process.

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Matthew DiLallo owns shares of American Tower, Berkshire Hathaway (B shares), Brookfield Infrastructure Partners, Enbridge, Equinix, and Kinder Morgan. The Motley Fool owns shares of and recommends American Tower, Berkshire Hathaway (B shares), Canadian National Railway, Equinix, Grupo Aeroportuario del Sureste, and Kinder Morgan. The Motley Fool recommends Brookfield Infrastructure Partners, Enbridge, Grupo Aeroportuario del Pacifico, and Union Pacific. The Motley Fool has a disclosure policy.