Lazard Global Listed Infrastructure (LAZ0014AU) Report & Performance

The global equity markets’ 2023 rally continued in July. With the start of a new corporate earnings season and inflationary pressures continuing to exert themselves, the focus during the month was squarely on the two levers that set stock prices— interest rates and company profits. In the US, the Federal Reserve, as expected, resumed its rate-hiking campaign in July. In Europe, where economic uncertainty has gripped the eurozone, the European Central Bank (ECB) lifted interest rates for a ninth consecutive time. While the ECB reported progress in its efforts to rein in price growth, it also acknowledged that inflation in the common currency bloc was expected to remain “too high for too long.”

The Lazard Global Listed Infrastructure Fund returned 1.37% (net of fees) during the month of July 2023, outperforming the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned 0.92%, but underperforming the MSCI World Local Currency Index, which returned 2.92% for the same period.

Contributors to Performance

• Despite US freight railroad Union Pacific reporting Q2 23 results below consensus expectations and lowering FY23 earnings guidance the share price rose strongly on the appointment of Jim Vena as CEO, which will become effective on 14 August 2023. Vena had been Union Pacific’s COO from 2019-21, having previously spent 40 years at Canadian National Railroad. He is widely regarded to be an excellent operator.

• Infrastructure owner and operator Ferrovial performed well following the release of Q2 results for its key asset the 407ETR toll road in Ontario Canada, which indicated that traffic levels had significantly improved. Ferrovial also reported H1 2023 results ahead of consensus estimates. The success can be attributed to the Managed Lanes (MLs), with the recently opened I-66 which exceeded our forecast for the entire year’s EBITDA forecast. We believe this is due to higher tolls and stronger traffic.

• US freight railroad Norfolk Southern added to performance despite reporting Q2 23 results below consensus expectations. The company lowered its full year FY23 earnings guidance and updated investors on its recovery from the East Palestine derailment in February, but otherwise continued to demonstrate steadily improving service metrics.

• UK water utility United Utilities contributed to performance despite losing its coveted four-star UK Environmental Agency rating after being downgraded to three stars. We continue to assess the company’s environmental performance as strong, given it was only one of two companies in the UK not to have a serious pollution incident in 2022, and had top green status in all but one metric.

Detractors from Performance

• US freight railroad CSX fell after reporting results which were in-line with consensus expectations and maintaining its previously stated FY23 earnings guidance. CSX management noted falling coal yields, weakness in intermodal volumes, and higher labour cost inflation – these were also recurring themes at the other railroads’ results presentations. All three railroads remain focused on improving service levels and trying to attract volumes from the trucking market.

• UK diversified utility National Grid detracted from performance despite holding a robust investor day in July. The event focused on its electricity distribution network which confirmed our expectations that investment opportunities are ample in this business to accompany the electrification of domestic heating (heat pumps), transport (EVs), and the increased resilience required by a growing proportion of renewable power. National Grid also completed the sale of a further 20% in its UK Gas transmission business. We expect the company to dispose of its remaining 20% stake in the coming year. While already known, we believe the disposal price of GBP 0.7 billion is attractive.

Global equity markets rallied in June, which pulled the second quarter into positive territory. While the overall news on global inflation showed slowing across the globe, the absolute level remained high, despite lower energy prices and slowing economic growth. US markets gained as corporate earnings declined for a second straight quarter but much less than initially feared. European markets rallied as inflation continued to recede and the job market remained strong, though affected somewhat by weak consumer spending.

The Lazard Global Listed Infrastructure Fund returned 2.09% (net of fees) during the quarter ending 30 June 2023, outperforming the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned -0.68%, but underperforming the MSCI World Local Currency Index, which returned 7.15% for the same period.

Contributors to Performance

• US freight railroads CSX and Norfolk Southern added to performance despite no reported results over the period. For the group, freight volumes remain slightly below levels from last year and success in improving operating metrics remains mixed. Given the railroads’ large additions to staffing and wage increases over the past year, we do not expect significant improvements in profitability from this point. The railroads remain focused on improving their service levels and winning volumes from the trucking market.

• Global infrastructure owner and operator Ferrovial rose during the quarter after releasing their Q1 2023 earnings with headline group EBITDA broadly in line with expectation. The key takeaway was that the US Managed Lanes (MLs) now account for around 70% of consolidated EBITDA. Ferrovial’s MLs have grown from less than €200mn EBITDA in 2018 to an annualized run-rate of close to €800m today. Coupled with continuing recovery in the traffic of Ferrovial’s key asset the 407 in Ontario Canada and our expectations of a return to its pre-pandemic EBITDA growth rates by the year’s end, we believe this strong performance may continue in the medium term, given the valuation upside.

• Italian utility Terna performed well as the regulator confirmed that the allowed return was set to increase due to rising interest rates. The regulatory framework is evolving towards a UK-style total expenditure (Totex) incentive that should enable the company to continue to benefit from increased efficiencies both on operating and capital expenditures.

Detractors from Performance

• Severn Trent, Pennon, National Grid and United Utilities detracted from performance as the market continued its aggressive rally. The uncertainty surrounding the future of the UK’s largest water company, Thames Water, created some tension for the regulated sector at a time when household incomes remain squeezed. We believe that our listed regulated utilities in the UK are very different from Thames Water. Firstly, their levels of debt are significantly lower; secondly they do not use tax efficient vehicles in tax haven countries; and finally their operating performance, albeit not perfect, remains towards the top of the industry. As such, we believe that the continued strong regulatory framework in the UK should enable strongly performing operators to create value out of the significant investment programmes they need to upgrade their networks to transition towards Net Zero.

The global equity markets gave back some of their recent gains in May. Speculation over a potential pause in central bank tightening continues to dominate investor thinking. European economies began to show signs of disinflation, with sharp declines in annual inflation rates in Germany, France, and Spain. The United States continues to show strength, reporting a surprising increase in job vacancies, causing inflationary pressures to persist. Last-minute passage of a debt-ceiling relief package necessary to avoid a government default looked likely. US utilities dropped 6% (as measured by the S&P 500 Utilities Index in USD) and underperformed both the S&P 500 and MSCI World indices by a substantial margin. Most of the weakness occurred in the second half of the month alongside a renewed spike in short-term rates.

The Lazard Global Listed Infrastructure Fund returned -1.94% (net of fees) during the month of May 2023, outperforming the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned -5.10%, but underperforming the MSCI World Local Currency Index, which returned -0.22% for the same period.

Contributors to Performance

• Global infrastructure owner and operator Ferrovial released their Q1 2023 earnings in mid-May with headline group EBITDA broadly in line with expectation. The key takeaway was that the US Managed Lanes (MLs) now account for around 70% of consolidated EBITDA. Ferrovial’s MLs have grown from less than €200mn EBITDA in 2018 to an annualised run-rate of close to €800m today. Coupled with continuing recovery in the traffic of Ferrovial’s key asset the 407 in Ontario Canada and our expectations of a return to its pre-pandemic EBITDA growth rates by the year’s end, we believe this strong performance can continue in the medium term given the valuation upside.

• Italian utility Hera benefitted from the continued perception that risks are receding in its gas business, and that the new management team will provide continuity in the disciplined management of the business.

Detractors from Performance

• French concessions and construction company Vinci gave back some of the strong performance since the start of the year as motorway traffic levels in April were only 1% above 2019, slightly tapering the recovery momentum. We believe that the market is overly focused on short-term traffic data.

• UK utilities United Utilities, Severn Trent and Pennon fell as the market rotated towards the technology sector. The largest financial backer of the Labour party, the union Unite, called for nationalisation of the water sector. Coincidentally, the industry body Water UK, released an apology for the poor level of pollution management of the industry and endeavoured to step up investment in the short and medium-term. Susan Davy, CEO of Pennon, decided to forego her variable compensation for 2022/23 in light of the disappointing environmental performance. We believe that the recent improvements, including a 50% reduction in pollution incidents and a 30% reduction in combined sewer overflows, suggests that the long-term investment plan of the company is starting to bear fruit.

Global equity markets recorded a modest gain in April, as investors adopted a cautious posture amid growing uncertainty about the global economic outlook. In the US, economic news continued to be mixed as corporate earnings remained above lowered expectations halfway through the reporting season. Economic growth eased but inflation, particularly wage pressures, remained stubbornly high as US unemployment claims declined in April. Meanwhile, high inflation led to stagnant consumer spending in the eurozone economy. The European Central Bank matched the rate increases of the US Federal Reserve and investors expect it will raise rates for the seventh consecutive time in May.

The Lazard Global Listed Infrastructure Fund returned 2.64% (net of fees) during the month of April 2023, outperforming both the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned 1.95%, and the MSCI World Local Currency Index, which returned 1.60% for the same period.

Contributors to Performance

• French concession and construction company Vinci performed strongly after reporting first quarter revenues that were well above expectations across all divisions, especially in energy services and Cobra Industrial services (IS). Vinci Energies reported 16% organic growth, and Cobra IS reported 20%. Airport traffic recovered to only 12% short of Q1 2019, after increasing 54% YoY. We believe this should underpin another year of strong cash flows for the group.

Detractors from Performance

• US railroad Norfolk Southern was a detractor to performance in light of the continuing aftermath of the East Palestine, Ohio, derailment in February. 1Q23 results included a US$387m provision for costs associated with the derailment (not including possible claims against insurance policies), flat volumes, increased prices, and a similar operating ratio to last year. The network is operating poorly at the moment, with dwell times high and train speeds low. Despite these immediate issues, the company is being very clear about the need for a long-term service quality driven growth strategy, without the overly lean staffing of previous years.

In a quarter marred by bank failures and a state-backed bank merger, optimism still won out. Fueling the optimism, many investors believed that central banks would pivot from their hard line, anti-inflation stance. Easing inflationary pressures, especially in Europe, and the sudden fragility in the banking sector after the second largest US bank failure (Silicon Valley Bank) and the merger of Credit Suisse and UBS supported the expectations of a central bank pivot.

The Lazard Global Listed Infrastructure Fund returned 4.07% (net of fees) during the quarter ending 31 March 2023, outperforming the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned 0.01%, but underperforming the MSCI World Local Currency Index, which returned 7.44% for the same period.

Contributors to Performance

• French concession and construction company Vinci performed strongly over the quarter as the company’s planned tariff increase in its French motorway business was implemented and the company also defied its own conservative guidance on free cash flow for 2022 to deliver record levels of cash generation. While motorway assets continue to perform well and airports rebounded stronger than expected, the services businesses, especially in energy, showed their ability to maintain high levels of margins and a strong ability to weather inflationary pressures. A move over the last 10-years to higher value-add, higher engineering content services is proving instrumental to this achievement.

Detractors from Performance

• Norfolk Southern (NSC) fell on the back of the East Palestine, Ohio derailment on 3 February 2023. As a result of the derailment, on 6 February 2023, Norfolk Southern in conjunction with the Environmental Protection Agency (EPA), conducted a controlled vent and burn of hazardous vinyl chloride, which resulted in the images reported in the press. There were no direct fatalities or damage to third party property, and NSC is taking responsibility for the clean-up. The National Transportation Safety Board’s (NTSB) preliminary findings were that an overheated bearing triggered the crew to stop the train which was what caused the derailment; all in accordance with existing safety protocols. A final NTSB report will take 12-18 months. At this stage, we believe the likely financial impacts are small relative to overall valuation and include around US$100m self-insurance for third party damages and their own property, and some disruption to the network which was cleared relatively quickly. Longer term, there is the possibility of greater capex and/or opex to reduce the prevalence of future accidents (there have been around 1000 derailments in the US since 2019), although any extra costs in our view, would likely be passed through to shippers.

Global equity markets retreated in February, as investors were forced to re-set their expectations for the current global rate-hiking cycle. The optimism that fueled last month’s market rally evaporated and was replaced by concerns that persistent inflationary pressures and a resilient global economy would force central banks to press on with their monetary tightening campaigns. The European Central Bank lifted interest rates by 50 bps and vowed that there would be no let-up in its aggressive efforts to wring high inflation out of the eurozone. The Bank of England also increased interest rates 50 bps as inflation in the UK slowed for a third consecutive month in January, though it remained in double digits. Investors cheered the US Federal Reserve’s announcement that it was raising its benchmark interest rate 25 bps, its smallest increase since March 2022, and that it was seeing improvements in inflation.

The Lazard Global Listed Infrastructure Fund returned -1.51% (net of fees) during the month of February 2023, outperforming both the MSCI World Core Infrastructure 100% Hedged to AUD Index, which returned -4.22%, and the MSCI World Local Currency Index, which returned -1.57% for the same period.

Contributors to Performance

• Vinci shares continued to perform well as the company defied its own conservative guidance on free cash flow for 2022 to deliver record levels of cash generation. While motorway assets continue to perform well and airports rebounded stronger than expected, the services businesses, especially in energy, showed their ability to maintain high levels of margins and a strong ability to weather inflationary pressures. A move over the last 10-years to higher value-add, higher engineering content services is proving instrumental to this achievement.

• National Grid shares were strong on continued high inflation in the UK that is helping the pace at which its UK regulated businesses compound regulated asset growth.

Detractors from Performance

• Norfolk Southern (NSC) fell on the back of the East Palestine, Ohio derailment on 3 February 2023. As a result of the derailment, on 6 February 2023, Norfolk Southern in conjunction with the Environmental Protection Agency (EPA), conducted a controlled vent and burn of hazardous vinyl chloride, which resulted in the dramatic images seen in the press. There were no direct fatalities or damage to third party property, and NSC is taking responsibility for the clean-up. The National Transportation Safety Board’s (NTSB) preliminary findings were that an overheated bearing triggered the crew to stop the train which was what caused the derailment; all in accordance with existing safety protocols. A final NTSB report will take 12-18 months. At this stage, the likely financial impacts are small relative to overall valuation and include around US$100m selfinsurance for third party damages and their own property, and some disruption to the network which was cleared relatively quickly. Longer term there is the possibility of greater capex and/or opex to reduce the prevalence of future accidents (there have been around 1000 derailments in the US since 2019), although any extra costs in our view, would likely be passed through to shippers.