The infrastructure sector (defined by the S&P Global Infrastructure TR USD) has had a reasonable first half of the year with a performance of +4.3% YTD. The two key sources of performance for the index were the power generation and the midstream energy sectors.
The key underlying reason was the expectation that AI will require a substantial amount of power which drove power and gas prices higher, especially in the US. This is because the US is home to ~50% of the total data centre capacity worldwide, and even more so of the total capacity to be developed. The rationale behind this move in power prices is that, according to a study by Morgan Stanley, if all data centres in the pipeline are to be built, they will consume > 300 TWh of power or ~5% of total US power consumption by 2027. This is massive. Because it takes more time to build power generation capacities than to build a data centre, the power market is expected to become tighter in certain regions like Northern Virginia or Texas. Although we agree with this analysis, we are not keen to chase the few listed US power generators, some of which are up >100% YTD or trade at >25x PE.
We have been exposed to that theme for quite some time now, historically through a mix of generators and grid operators. We gradually sold out our generators exposure as power price volatility increased and some valuations became hard to justify. However, we increased our exposure to grid operators in countries and US states where 1/ our expectation that the investment will accommodate additional renewables and data centres is the strongest and 2/ the political support is the most constant: the UK, Germany, Texas. We do not want to get ahead of ourselves and we remain mindful that the key point most regional US regulators focus on is affordability. We therefore expect some local pushback if power prices go too high due to data centre consumption (recall that data centres create very few local permanent jobs as opposed to industrial sites).
The second major event in the first half was the European elections which saw a massive rise of far-right parties across the continent. This led to the French president calling for a dissolution of the National Assembly and an earlier than expected legislative election that will take place on 30 June and 7 July. This made the market nervous, sending the French-German spread to the highest level since 2012 as the French far-right party is expected to get a relative majority and has a very expansionary budget policy, including among others a willingness to nationalise toll roads and spend billions into nuclear energy at the expense of wind.
This led us to sell our exposure to the French toll roads (Vinci and Eiffage). To be clear, we don’t expect the French government to have the financial means to spend >€50bn on buying toll roads when running a 5.5% of GDP annual deficit, but as we do expect the news flow to remain negative and stocks volatile and as the situation could well get worse before getting better, we are staying away from most French stocks for now.
We are constructive for the remainder of the year and have a well-diversified portfolio which is evenly exposed to several sub-themes: Power sector transformation (31%), sustainable water and waste management (23%), increase in data consumption (18%).
We expect the strong performance of the power generation and midstream energy sectors to be less important while the attention should gradually focus on the current key bottleneck in the power sector worldwide: the grid. Numerous grid operators have seen their allowed returns boosted over the last 12 months to account for higher interest rates which, combined with all-time high investment programs and rock-bottom valuations, should enable these companies to perform well over the medium term. Lower interest rates over time should further contribute to it. In addition, we expect the waste sector to continue performing well as there is quite a divergence in performance between stocks within this sector. Our top pick is Waste Connections.
Lastly, we are positive on our data centre companies NextDC and Infratil, both of which recently raised capital to accelerate their growth.