Written by Damen Kloeckner, Associate Analyst
Security price: $1.93
Industry: Utilities
Forecast distribution: 12.0 cents per security
Spark Infrastructure is a specialist infrastructure fund which invests in regulated utility infrastructure both within and outside of Australia. This primarily consists of electricity distribution and gas distribution, and regulated water and sewerage assets, all of which offer relatively reliable and low risk cash flows. Spark’s current portfolio consists primarily of minority (49%) stakes in three electricity distribution companies – SA Power Networks, CitiPower and Powercor. If you live in South Australia or Victoria, there’s a good chance a Spark company supplies your electricity.
Electricity volumes demand is a primary driver of revenues of all three of Spark’s major underlying assets. As a result, colder weather, population growth, economic activity and the building cycle all determine Spark’s earnings growth trajectory. Electricity prices are determined at the state level and are periodically reset, in line economic indicators such as GDP growth, inflation and interest rates. Investors cautious about the possibility of lower regulated rates on electricity distribution at the next price reset may seek a greater margin of safety when considering investing. However, should prices fall, Spark’s high cash coverage of distributions eases any strain in sustaining distribution growth.
This cash flow stability has typically facilitated payment of high and predictable distributions, with Spark’s yield set to climb above 6% in 2015. Its relatively conservative balance sheet and high free cash flows support the sustainability of its distributions, in contrast to many of its listed peers. Furthermore, Spark is currently trading in line with its estimated book value ($1.88) and at a relatively low forward price to earnings multiple of 17.2 times. In our view, Spark offers additional capital upside below $1.88, supplementing its attractive yield.
Spark also represents a 14%, $645m holding of DUET Group (ASX:DUE), one of its most significant investments and entitles shareholders to a share of the company’s high distributions. This has the effect of diversifying cash flows which further supports Spark’s own distributions. DUET represents a portfolio of gas and electricity distribution assets and is set to yield 7.7% in its own right in FY16. Whilst impressive, this yield is not fully cash covered and has been supported by very high gearing of the balance sheet.
In the current low interest rate environment, Spark should be on every income focused investor’s radar. It offers compelling, cash-covered distributions derived from high quality, regulated utility assets and maintains modest gearing, paving the way for future investments.