Regulators generally provide an allowed return regarding the underlying asset base of these essential companies, though how this occurs varies by region. If the regulator provides steady allowed returns on a growing asset base, we expect earnings to increase at the same pace as the underlying asset growth.
Second, infrastructure offers inflation protection. Infrastructure assets are designed to provide long-term benefits for their communities and stakeholders, and, as a result, allowed returns are generally linked to inflation.
This inflation “pass-through” mechanism allows prices paid by the asset users to adjust periodically and ensures that the returns to equity investors funding these assets are not eroded over time due to the effects of inflation. Importantly, this inflation pass-through can take anywhere from three months to three years to impact reported earnings, depending on the type and location of the assets.
With early 2024 returns for most investors dominated by momentum related to the Magnificent Seven stocks or, more recently, cyclical stocks surrounding the US presidential election, infrastructure’s differentiated returns offer some diversification away from the risks of concentrated trades. And with Trump’s policies leading to a second round of inflation, infrastructure’s inflation pass-through mechanism will likely be all the more valuable in 2025.
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Total returns still catching up to strong earnings
Peaking interest rates are a good sign for infrastructure, as we have seen it outperform global equities following the last Fed rate hike before cutting cycles (Chart 1). Following global central banks kicking off easing in late 2023, market breadth has continued to improve.
As this has occurred, the market has begun to recognise the infrastructure asset class’s strong fundamentals and secular themes. These include decarbonisation, growing power demand from AI and data growth, and significant network investments to replace ageing assets, improve resiliency and meet the needs of realigning supply chains and onshoring trends.
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User-pays infrastructure assets are more tied to GDP growth, which is projected to stay at 3.1% globally in 2024 and rise to 3.2% in 2025, per the IMF. This bodes well for economically sensitive assets such as toll roads, airports and ports. Freight rail in the US should also see increasing momentum as US economic growth continues to stand out among its peers. Meanwhile, the risk remains that reflation could hinder some consumer-driven services, such as travel at the margin.
Zooming out, we are still seeing a catch-up of a gap between infrastructure earnings and total returns, which has been in place since 2022, and valuations are attractive for this reason. Even though there is a strong positive correlation between infrastructure earnings growth and infrastructure total returns, increasing earnings and strong fundamentals have yet to fully offset the dislocation in valuations due to the rise in real bond yields in 2023 (Chart 2). We expect this gap to close over time as the market recognises the strong long-term infrastructure themes.
Infrastructure Opportunities Across the Globe
Opportunities continue to be widespread across the infrastructure landscape, with utility fundamentals among the best we have ever seen. The market is still massively underestimating the growth in electricity demand driven by artificial intelligence (AI) and data growth and any pro-growth fiscal policy that would boost manufacturing. Utilities with exposures to these strong themes and a high likelihood of earnings upside surprises look well positioned.
For example, Entergy, a pure regulated electric utility in the US Gulf region — today’s industrial heartland of the US — is seeing significant tailwinds from decarbonising the industrial footprint there. Entergy is building 312 MW of solar power to support US Steel’s decarbonisation efforts and will also be delivering power to and connecting Amazon’s US$10 billion ($13.4 billion) data centre investment in Mississippi. Growth in the region is structural, driven by onshoring trends and electrification, and as Entergy’s industrial base grows, it should lead to accelerating sales and earnings growth. The company recently upgraded its annual earnings growth guidance from 6%–8% to 8%–9% in the medium term.
North American energy infrastructure assets also have an outstanding growth trajectory, driven by consolidation in the sector, rising AI-related demand for gas infrastructure and the essential role gas fuel plays in stabilising the grid as coal plants retire. Canadian Energy infrastructure company TC Energy is a clear example of this, with 90% of its assets now natural gas pipelines where tailwinds persist for LNG exports (especially after Trump’s election), coal-to-gas conversions, utility reliability and high power demand, all of which could accelerate growth.
North American rail is expected to see dynamic growth, with pricing pressure from the trucking market counterbalancing improving volumes, company network and operating efficiencies.
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In Europe in 2024, long-duration assets underperformed outside select countries like Spain and Italy. Anemic economic growth, slow-to-respond central banks and a weak currency have pressured the region.
However, there is an apparent disconnect between valuations and where infrastructure assets are trading. European utilities continue to benefit from drivers similar to US ones, where utilities have seen greater share price gains. E.on, a German-regulated utility, is investing heavily in its regulated network and is expecting 10% annual growth in its asset base and over 6% annual adjusted earnings out to 2028.
In Spain, Redeia Energia, primarily an owner of electricity transmission grids, expects much improved regulated returns and a strong grid development plan out to 2030 to support increased electricity demand and the continued rollout of renewable energy.
European transport infrastructure, particularly airports, may see some economic headwinds in 2025, but with idiosyncratic drivers and the removal of overhangs, these assets are expected to remain attractive. German airport group Fraport is one such example. A new tariff agreement, the ramping up of Boeing’s deliveries to Lufthansa and a cash flow breakout in 2026 were all positive catalysts for the company.
Elsewhere, utilities and infrastructure assets continue to suffer in Brazil as monetary policy tightens, Mexico will likely suffer from Trump policies and a weakening currency, and Australia, while yet to kick off its rate-easing cycle, will likely see this occur in the first half of 2025, creating a positive environment across infrastructure sectors. New political leadership in the UK, France and the US will lead to some volatility as governments wrestle with high deficits and differing global economic conditions and political priorities.
Overall, the opportunity set for global infrastructure remains highly attractive in 2025 as an expanding and more demanding population and multi-decade megatrends such as decarbonisation, reindustrialisation and digitalisation drive growth.
Charles Hamieh, Shane Hurst and Nick Langley are managing directors and portfolio managers at ClearBridge Investments
