This article is sponsored by Arjun Infrastructure Partners.
Nothing stands still for too long in the transport sector, which has seen plenty of disruption and change in recent years.
Covid-19 ground airports and road traffic to a halt and now the energy transition promises to radically shape the direction of travel.
Net-zero targets are compelling governments to decarbonise transport, opening the door to private investment opportunities as well as long-term challenges.
Romain Py, partner at Arjun Infrastructure Partners, examines how transport has changed and what the energy transition means for the future of the sector.
How have transport assets fared since the covid-19 pandemic?
Subsectors like ports were very robust during covid because it was essential to keep goods moving. It was the same with asset classes such as freight wagons or locomotives that benefit from contractual protection under their leases. Those that did well in the pandemic have continued to perform strongly.
Airports, like motorway services areas, have shown perhaps the greatest recovery, both in terms of passenger numbers and financial performance. Southern European airports are performing better than pre-pandemic, while northern European airports lag in terms of recovery, trading at around 90 percent of pre-covid levels.
There is still some nuance as working from home has changed the world. Leisure traffic is doing really well as people want to go on holiday, but business traffic has not fully recovered. Meetings can now be done over video and working from home has impacted public transport, especially trains.
Given the macroeconomic backdrop, how much appetite has there been from debt markets?
Not all asset classes are equal. Take toll roads, which typically benefit from inflation-linked toll charges. High inflation means revenue will grow higher, while costs will remain broadly flat. Similarly, if you look at airports, car parking or catering provide indirect inflation-linked revenue streams, so again you can take advantage of that.
What we have seen across the sector is a robust appetite from banks, which have been very supportive during covid. For example, most of the main UK airports have been successfully refinanced over the last 18 months. Nonetheless, banks have become a little more prudent on debt leverage, with leverage ratios at 6-8x for recent airport refinancings.
There is strong appetite for the port sector, too. We have held refinancing on the MSAs and rolling stock, and achieved terms that were sometimes cheaper than pre-covid.
Notably, there has been polarisation of assets. People are focusing more on individual characteristics as well as the performance of a company. If a company is seen as a top performer, you will get very attractive terms. If a company is perceived less positively, it will become more expensive.
Valuations have been impacted by interest rates thanks to debt being more expensive. Clearly, economic growth is not as high as before, which will impact EV/EBITDA multiples paid, but we have still seen trophy assets such as Edinburgh airport trading at impressive prices.
How is the energy transition shaping the transport sector?
Transport is going to be massively impacted by the energy transition. That is simply a fact; the question is how and when.
For sustainable aviation and marine fuel, the challenge is to find a global solution. Governments need to sit around the table and make a choice. There is a variety of low-carbon alternatives, and maybe there will be multiple solutions, but these need to be rolled out at scale. I think aviation and the maritime sector will take more time than with electric vehicles. That is much easier.
For rail, I don’t see anyone producing new rolling stock that is not fully electric or hybrid. For road transport, there are already a number of policies in place.
For example, in France, there is a regulation called Crit’Air where the most environmentally damaging vehicles are now banned from driving in certain urban areas called Low Emission Mobility Zones. As a result, businesses are moving towards electric or very low-emission light commercial vehicles, buses and coaches. Drivers must also display their Crit’Air sticker to their vehicles to comply with local low-emission zones.
However, there is also a need for pragmatism. In the UK for example, only 38 percent of the UK rail network was electrified as of December 2022 and Network Rail is running behind its plan, and thus a bi-modal or other hybrid solution will be needed. It is the same with the adoption of EVs as people are now more cautious and they remain expensive.
How important is government policy for strengthening the investment case?
Policy is always useful. The key is to create the right framework. Today, customers are driving change, and everyone wants to reduce their carbon footprint across their supply chains. The problem is that we need more uniform policy, particularly for globalised industry like shipping or airlines.
In shipping, China and Southeast Asia are still the main good manufacturers and ship goods to Europe, the US and the rest of the world. The solution needs to be a ‘global solution’ as the ships will sail around the world and will need to refuel at multiple locations. Governments and the private sector need to work together and co-ordinate their actions, and it cannot be done solely by the private sector.
What does that mean for efforts to decarbonise road transport?
EV charging has become very fashionable and we have seen a land grab for EV charging infrastructure. There will be winners and losers as the market sort out ideal venue, adoption rate and charging speed, but there has been a bit of a bubble as EV penetration is slowing down and it remains expensive to create a network of EV charging infrastructure. Nonetheless, charging infrastructure will become an increasingly important factor in winning over EV buyers.
Many countries have not taken a structured approach, similarly to what we have seen in the fibre sector, leading to significant overbuilt. It is hard to say that it was worth it financially. Breaking the cycle of frustrated drivers and unprofitable charge points is doable, but without subsidies, the “unit economics” are challenging unless you have a captive customer base.
For example, EV charging infrastructure rollout along the UK motorways, as undertaken by Welcome Break, one of our companies, is a compelling investment proposition due to the established traffic pattern and the needs for drivers to stop for natural needs, a coffee or charging their electric car.
The cost of living and the price of EVs are major headwinds and consumers have turned to hybrids because of worries about EV costs and charging infrastructure. Is it a temporary trend or a more fundamental shift?
If we look at China, China has been quicker in the early stages of the EV transition. Today China builds and buys more EVs than the rest of the world combined. That is because of government industrial policy.
The Chinese government pushed hard on developing the infrastructure but also created subsidies for EVs. They realise there is a cost to this energy transition and getting it right is very important to them as they have real pollution issues in the big cities.
In contrast, Germany decided to end all EV support almost overnight, cancelling its EV subsidy programme, after paying out some €10 billion since 2016, following a budget crisis last December. The abrupt end to German electric car subsidies fuels doubts about meeting green mobility targets.
Similarly, the UK government has delayed a ban on the sale of new diesel and petrol cars. Overall, incentives are having a huge effect in terms of consumers’ purchasing decisions and other European markets, including France, still offer incentives to retail customers buying EVs.
Likewise, heavy-duty vehicles might take even longer to decarbonise because there is not an obvious technical solution just yet. However, in continental Europe, switching to rail freight could be an interesting option to decarbonise trucking because of the segregated rail network.
What are the key challenges that could slow growth?
The immediate one is affordability. The energy transition requires a lot of raw materials and resources which will need to be mined, notably in Africa. Can you mine enough to do the energy transition at the speed you envisage? That is a significant question.
The other issue is that you are building an entirely new system. When you start moving one piece, you affect the entire system. If we push that to the extreme, it will not work to have everybody driving EVs if we don’t have an adequate EV charging infrastructure network in place.
How do you see the sector evolving over the coming years?
If we look at legacy infrastructure, particularly in North America, some of that is becoming very old and outdated. Recently, there have been issues with bridges and the public has become saddled with roads built in the 1950s or 1960s. The population has also grown, increasing pressures.
The key question is how to make the best use of that infrastructure. Building brand new infrastructure might not be an option, so how can you optimise what already exists? Sometimes the default from politicians is to build brand new rather than thinking ‘can I use this better?’, so again policy could play a role.
At the end of the day, the fundamentals of transport do not change much. If you need to move containers from China to London, I don’t see a significant change in the means of transport used, it is just that in the future it could be electrified or potentially propelled by sustainable fuel.
AI and automation are also expected to play a role. We could potentially see driverless buses or fully automated cranes unloading containers. The combination of data and AI will drive greater optimisation.
Which subsectors are going to see the most interesting development?
The offshore wind services sector is an interesting trend to keep an eye on. We will need lots of vessels to build those assets and service them over their lifetime. It is definitely a sector that is going to grow as the number of offshore wind farms increases.
Rail is another sector that is going to evolve massively. There is supportive regulation in Europe and we have seen freight rail car and locomotive leasing capturing a greater market share because incumbents do not have the financial strength to buy the rolling stock. Today, the average age of a freight wagon is in excess of 30 years.
The investment required to scale EV charging over the coming decades is huge. And that is not just cars but electrifying buses, light and heavy goods vehicles. It will require much more infrastructure, although the easiest may prove to be public transport or light commercial vehicles.
Digitalisation is another factor. Firms are looking to AI to plan pre-emptive maintenance, reduce accidents and make sure their fleet usage is more efficient.