After seven years of under-investment and political stasis around bumpy roads and decaying bridges, the U.S. could make infrastructure funding a reality. A look at the sector implications for investors.
While much ink has been spilled on the partisan divide among the American electorate, one consensus among voters is the need for America to rebuild crumbling bridges, patch potholes and improve public transportation.
To gauge investment opportunities, investors should likely focus less on infrastructure policy details and more on the total dollars on the table.
According to Morgan Stanley’s U.S. public policy strategist, Michael Zezas, “A confluence of forces is now taking the well-trodden subject of U.S. infrastructure from the shadows of 'one day we'll need to do this' to a potentially dominant investment theme heading into 2019.”
While a fresh federal infrastructure policy appears unlikely in 2018, repairing America’s aging infrastructure could become a hot topic during the upcoming midterm elections, and begin its legislative journey in 2019. “As a result, investors should start studying the implications of any policy-driven increase in spending today, before voters go to the polls later this year,” adds Ellen Zentner, the firm’s chief U.S. economist.
In a new Morgan Stanley Research report, Infrastructure: Laying an Investment Foundation, Zentner, Zezas and their equity analyst colleagues outline how the policy debate could play out; examine three scenarios for how much infrastructure spending could be up for grabs; and look at the sectors best positioned to benefit.
While Republican and Democrat leaders agree about rebuilding America, they differ on how to go about it.
To gauge investment opportunities, however, investors should likely focus less on policy details and more on the total dollars on the table. “We believe the policy debate is likely to coalesce around our base case of $1.1 trillion in additional spending over the next 10 years,” says Zezas.
Under this scenario, which the authors dub “Patch Up America,” Congress passes a broad infrastructure package with a gradual ramp up in spending. The effects could provide an immediate benefit for four investment sectors: auto, machinery, transportation, and metals & mining.
“Even a return to normal spending levels suggests that there are opportunities for these sectors, which are the building blocks of most infrastructure projects,” says Zentner.
Improvements are long overdue. Americans continue to log more miles, with total U.S. miles expected to grow about 70% by 2040. Meanwhile, government spending on infrastructure has been running below trend since 2010, for a total shortfall of $950 billion.
As an added driver, infrastructure spending tends to have a multiplier effect. In an analysis of federal highway grants since 1990, economists at the San Francisco Federal Reserve Bank found that every dollar spent on infrastructure increased a state's gross state product by two dollars.
Government Gross Investment Has Been
Running Below Trend Since 2010
One of the more compelling investment themes under infrastructure spending is the auto sector, specifically companies that dominate the market for pickup trucks. “Infrastructure spending will affect OEMs primarily through the sales of the highly profitable pickup truck segment,” says Adam Jonas, who heads the firm’s Global Auto & Shared Mobility Research team, adding that “private companies and municipal fleets rely heavily on pickups. Many investors don't realize how much pickup demand accounts for the profitability of Detroit auto makers.”
Historical U.S. Pickup Truck Sales (1990-2018 YTD)
Any increase in federal funds for infrastructure should also be a boon for the machinery sector. The clearest beneficiaries could be construction equipment companies with more overall revenue exposure to U.S. construction. Machinery names could also see an average revenue uplift of 1% or 2% in the report’s base case.
Metals & Mining companies could see the dual benefit of increased demand from autos and machinery, as well as for materials. Under the $1.1 trillion base case, demand for steel could increase around 4% over 2017 levels. The companies best positioned are makers of flat-rolled steel and long products, such as rebar and rails used for road and bridge building projects.
Finally, freight transportation companies also stand to benefit. Based on the increased volume of construction materials needed for infrastructure jobs alone, the trucking and rail carriers could see a 10% bump in demand over the next decade.
Although the report’s base case forecasts a $1.1 trillion federal package to repair America's roads, bridges and other infrastructure, the report also notes two additional scenarios.
The most optimistic scenario, which the authors call “Rebuild America,” more than doubles infrastructure spending to $2.4 trillion over 10 years. On the heels of recent tax cuts, however this may be unlikely.
Morgan Stanley's bear case, a.k.a. “Let America Erode,” sees Congress enacting no new spending on roads and bridges. In this case, the disrepair of America's aging infrastructure would grow more acute, and could weigh on GDP growth by as much as one-third of a percentage point. However, in the view of the report’s authors, this scenario seems equally unlikely.