How credit investors can help plug SA’s infrastructure gap

Why infrastructure investment presents an opportunity both to support growth and provide good long-term returns.

May 26, 2021

8 minutes

Simon Howie
Nkhumeleni Thavhiwa
Why infrastructure investment presents an opportunity both to support growth and provide good long-term returns.

The fast view:

  • Lack of investment in critical infrastructure such as energy, rails, roads, and ports has been one of the contributing factors to poor economic growth in SA.
  • In order to “catch up” on the investment required, the SA government has to establish partnerships with the private sector.
  • According to the National Development Plan, SA should boost infrastructure spending to at least 30% of GDP. Over the last ten years, this number has hovered below 20%.
  • Infrastructure investment is a clear priority for the government, which will pursue a blended financing model to help augment depleted state coffers. Currently, 55 ‘bankable and shovel-ready’ projects have been identified for expedited approval.
  • We see opportunities across sectors – from renewable energy, telecommunication, transport & logistics, to housing.
  • The two biggest risks are execution risk and the extent to which capacity has been eroded.
  • Notwithstanding the limited scale, the infrastructure opportunity is still compelling enough to make up a significant portion of a credit portfolio

If we want to fulfil our great potential as a country, sustainable, inclusive economic growth is critical. Sustainable economic growth requires availability and accessibility of reliable infrastructure. Lack of investment in critical infrastructure such as energy, rails, roads, and ports has been one of the contributing factors to poor economic growth in South Africa.

In order to “catch up” on the investment required, the South African government has to establish partnerships with the private sector, whereby the government plays the role of enabler by implementing favourable reforms to the regulations. This model has proven to be effective, as demonstrated by the highly successful Renewable Energy Independent Power Producer Procurement Programme (“REIPPPP”).

In order to “catch up” on the investment required, the South African government has to establish partnerships with the private sector.

The implementation of the public-private partnership model in the roll-out of infrastructure projects establishes two things:

1

Project developers and equity investors who have expertise in designing and constructing infrastructure projects are involved. These stakeholders do not only bring technical expertise, but they can also guide the government on aspects of bankability.

2

It limits the funding required from the project owners (either corporate, state or equity funds) as the projects are typically financed with debt. The amount of debt varies depending on the type of project, but the debt funding can be as high as 80% of the total project costs.

As credit investors, we have a key role to play in ensuring funding is available for viable projects. Infrastructure investment presents a clear opportunity to support growth while providing good long-term returns for our clients. It is notable that in the rest of Africa a large proportion of credit is to infrastructure and other real assets. South Africa has clearly lagged.

The magnitude of the problem

According to the National Development Plan, South Africa should boost infrastructure spending to at least 30% of GDP. As Figure 1 shows, this number has hovered below 20% over the last ten years, so not only have we underspent in terms of new infrastructure build, we have also neglected basic infrastructure maintenance.  Beyond the obvious issues with the energy crisis, the impact of low investment has been noticeable in areas like water and sanitation, the roads network (particularly provincial and municipal roads outside of the major cities), and the massive backlog in human settlements.

Figure 1: The infrastructure investment gap in South Africa  

The infrastructure investment gap in South Africa  

Source: Reserve Bank

The Infrastructure Commission from the Office of the Presidency estimates that we need to allocate about R1.5 trillion over the next five years just to deal with the backlog. Given its scale, the R1.5 trillion is probably too conservative an estimate, but more likely an amount that Government believes is feasible to mobilise given the fiscal constraints of our country.

Is there political will to address the infrastructure deficit?

We believe the 5th Administration of President Cyril Ramaphosa has two key priorities: one, to address poor governance, an area where we have started to see positive developments. The second is infrastructure. The fact that the Investment and Infrastructure Office, led by Dr Kgosientso Ramokgopa, is located in the Office of the President, signifies the importance President Ramaphosa has placed on infrastructure investment.

Dr Ramokgopa has hosted infrastructure summits with various stakeholders, and one of the key outcomes of those engagements has been the proposal to pursue a blended financing model to help augment depleted state coffers. In this model, the government would take an equity stake in the project, development finance institutions and multilateral development banks would participate in the second tranche and commercial lenders would participate in the last tranche.

The government equity tranche will be financed through the proposed Infrastructure Fund, which will be managed by the Development Bank of South Africa. The Fund will be seeded with R100 billion and the intention is to use that to mobilise a further trillion rand into the infrastructure space through the blended finance model. The government aims to play an enabling role, with 55 ‘bankable and shovel-ready’ projects already identified for expedited approval.

Where are the near-term opportunities?

  • Renewable energy

    Renewable energy has been an excellent example of how a government can create an environment for private capital to participate. It has been the one single success story over the last decade. As we ramp up renewable energy spend the opportunities for credit investors will increase.

    One of the drawbacks of renewable energy is its unreliable supply, being largely generated during the day but unavailable during the evening, when demand is high. An opportunity within the sector therefore is battery storage, whereby renewable energy can now migrate to the base-load category, storing energy during the day when it is generated and released in the evening when it is required.

    We also believe there are opportunities in the self-generation space, with the National Energy Regulator of South Africa (NERSA) now able to provide approval on self-generation application licences. This is a significant development, as it will shorten the lead time between application and approval. Previously, secondary approval was also needed from the Department of Mineral Resources and Energy. Several mining and industrial companies have announced that they would be developing renewable energy with combined capacity to the tune of approximately 1 600 megawatts.

    Finally, with the price of renewable energy technology coming down, there are growth opportunities in the small-scale embedded generation sector, which are power facilities being connected to residential and commercial sites, such as offices, shopping complexes and malls. Once this growth happens, there will be opportunities to invest across the value chain.

  • Telecommunication

    This sector has already seen tremendous growth from the private sector – from the mobile network operators (MNOs) rolling out 4G infrastructure to improve connectivity, to tower companies building additional capacity and fibre companies rolling out fibre. As a team, we were comfortable with the growth prospects across the sector and have invested across these industries for several years.

    We believe the roll-out of 5G will present another exciting prospect to invest in the sector. With 5G more widely available, we could also look beyond telecommunication to interesting opportunities that will be enabled by more stable internet connectivity, such as education. The COVID-19 pandemic has only just begun to illustrate the potential of e-learning and online learning.

  • Transport & logistics

    Port, rail and road infrastructure are the basic systems that underpin the structure of the economy. With the recent signing of the Africa Free Trade Agreement, we have created the largest free trade area in the world by number of countries. This presents a significant opportunity for South Africa to play a meaningful role in regional trade and logistics.

    However, infrastructure development is not just large-scale greenfield project finance. For truly inclusive growth, we need effective and efficient means of transporting not only goods but people too. Take the minibus taxi industry for example. More than 15 million consumer trips are made daily, which equates to 69% of South African households making use of minibus taxis. The private sector has already stepped up here, with the likes of SA Taxi providing access to finance for many South African entrepreneurs to enable them to own and operate their own minibus taxis.

  • Housing

    Social housing is focussed on uplifting individuals and communities through the provision of a place to live that provides both a safe shelter and access to places of work or study. A further advantage can be home ownership. Certain home loan providers, such as SA Home Loans, have entered the higher loan-to-value space, providing finance to a segment of the population that was previously underbanked. These structured investment opportunities not only provide attractive risk-adjusted returns to us as investors, but also go a long way towards crowding in more of the South African population to become active economic participants.

What about risk?

The most obvious risk in South Africa is execution risk, as we have seen with the implementation paralysis since the dawn of our democracy. The prioritisation of infrastructure by President Ramaphosa should help mitigate the risk.

Do we possess the requisite skillset to build a major project?

After ten years of limited infrastructure and construction activity, the second big risk is the extent to which capacity has been eroded. Do we possess the requisite skillset to build a major project? Our view is that the skills do exist, and that infrastructure spending is the perfect catalyst to rebuild the construction sector and refresh the significant skill base within South Africa.

Accessing the opportunity

The investment opportunity in infrastructure is in both equity and credit. Equity offers the potential for long-term investments underpinned by real assets, with the potential for upside. But the bulk of the opportunity will be in credit, not only because the debt component is far larger in most projects, but also because many projects will be owned by government, state-owned entities, or corporates.

A final consideration is the nature of the credit investment. Rated and listed debt will be necessary to truly unlock the full depth of capital markets. There is an important role for funds that can invest in private debt, however private debt requires specialised financial and legal expertise.

At Ninety One we have been investing in infrastructure skills across our SA and Africa Credit Team for a number of years. For over five years we have managed the Emerging Africa Infrastructure Fund, a debt fund that focuses on sustainable infrastructure across the continent. With 42 investments and over $1 billion in committed capital the team has gained invaluable experience. This experience has added value to our multi-fund Credit Opportunities strategy, where infrastructure is a key sector. The locked-up nature and flexibility of this strategy is ideally suited to infrastructure. In time infrastructure issuance may increase to support standalone infrastructure portfolios.

Notwithstanding the limited scale, the infrastructure opportunity is still compelling enough to make up a significant portion of a credit portfolio.

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Simon Howie
Co-Head of SA & Africa Fixed Income
Nkhumeleni Thavhiwa
Investment Specialist​

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