Stocks for the US$1 Trillion Infrastructure Bill

In one of the biggest market-moving events this past week, the U.S. House of Representatives passed a US$1 trillion bipartisan infrastructure bill in what is regarded as one of the biggest steps towards fulfilling U.S. President Joe Biden’s agenda which includes rebuilding the nation’s creaky infrastructure.

The historic spending is expected to be particularly focused on sectors such as transportation, utility, road and bridge construction industries, among others.

The following stocks are in sectors that are the biggest beneficiaries of the infrastructure investment and President Biden’s larger economic agenda. As leading players of their respective industries, these quality names offer attractive growth potential for investors looking to play U.S. infrastructure spending.  

Union Pacific (UNP) is the largest public railroad in North America with operations in the western two-thirds of the U.S. The firm generated about US$20 billion of revenue in 2020, hauling coal, industrial products, intermodal containers, agriculture goods, chemicals, and automotive goods.

UP also owns about one-fourth of Mexican railroad Ferromex and generates about 10% of its revenue hauling freight to and from Mexico. 

Class I railroad behemoth Union Pacific continues its long-running profitability improvement. The company’s operating ratio improvement and strong incremental margins have for years defied economic and sector weakness. “UP eliminated unprofitable routes and gained efficiency during industry consolidation,” says a Morningstar equity report, noting that “even an 18% coal carload decline in 2015 couldn't keep UP from reaching record margins.”

However, the biggest profitability boost occurred in 2019 when UP implemented precision scheduled railroading (PSR) strategy and clocked an annual operating ratio of 60.6% and a prodigious US$5 billion of free cash flow.

Union Pacific, like its North American railroads peers, enjoys a wide economic moat underpinned by cost advantages and efficient scale. “Cost advantage is a key factor in UP's wide economic moat,” says Morningstar equity analyst Matthew Young.

While barges, ocean liners, aircraft, and trucks also transport goods, railroads are by far the low-cost option where no waterway connects the origin and destination, says Young, who recently raised the stock’s fair value from US$183 to US$190, incorporating solid third-quarter results.

UNP’s third-quarter revenue grew 13% year over year, slightly ahead of Morningstar forecast, on yield improvement and higher fuel surcharges.

One of the largest U.S. utilities, Duke Energy (DUK) delivers electricity and gas to more than 7 million customers. The firm operates in three major segments: electric utilities and infrastructure; gas utilities and infrastructure; and commercial renewable segments.

“Duke Energy is one of the largest regulated utilities by market cap in the United States,” says a Morningstar equity report, stressing that Florida is Duke's most constructive and attractive jurisdiction.

The region’s higher-than-average load growth and best-in-class regulation allow for higher-than-average returns on equity, forward-looking rates, and automatic base-rate adjustments, the report adds.

The utility major’s US$60 billion, five-year capital investment plan is focused on clean energy while pursuing ambitious goals of net-zero carbon emissions by 2050 and net-zero methane emissions by 2030.

“Management notes growth opportunities beyond its five-year forecast, noting expectations for US$65 billion to US$75 billion of capital expenditures helping to support 7% annual rate base growth,” says Morningstar equity analyst Andrew Bischof, who recently slightly raised the stock’s fair value from US$99 to US$100, boosted by Duke’s third-quarter adjusted earnings per share “that put the company on track to meet our full-year expectations.”

All three of Duke’s regulated business jurisdictions - Florida, Indiana and North Carolina – provide highly constructive regulatory settings. “Duke's regulatory environment is consistent with its peers and is supported by better-than-average economic fundamentals in its key regions,” Bischof notes.

These factors, he adds, contribute to the returns Duke has earned and have led to a constructive working relationship with its regulators, “the most critical component of a regulated utility's moat.”

Emerson Electric (EMR) is a multi-industrial conglomerate that operates two businesses: automation solutions (which includes process manufacturing solutions) and commercial and residential solutions (which comprises climate technologies and tools and home products). The U.S. represents about half of the firm’s geographic sales.

“Emerson Electric is the undisputed powerhouse in process manufacturing on the west side of the Atlantic,” says a Morningstar equity report, noting that despite near-term headwinds caused by geopolitical uncertainty and COVID-19-related disruptions, “Emerson is poised for several years of positive organic growth after a slow recovery in early 2021.”

Even as Emerson holds either first or second share in a variety of product categories in the fragmented automation market, (where Emerson holds roughly midteens market share) the company boasts a large runway for growth, the report says.

“Properly applied, automation can add more to manufacturing firms’ bottom line than any other investment,” notes Morningstar equity analyst, Joshua Aguilar.

Predictive analytics, he argues, will augment these results given the mission-critical nature of manufacturing services--particularly in process manufacturing given the catastrophic risk of failure in Emerson’s end markets’ plant facilities.

The firm’s wide economic moat, or sustainable competitive advantage, is built on switching costs and intangible assets, points out Aguilar, who recently lifted the stock’s fair value from US$102 to US$107, prompted by higher operating margins and earnings assumptions reflected by recent quarterly results.

“Despite the considerable supply chain, logistics, labour, and raw material headwinds plaguing the entire industrial sector, Emerson improved upon non-GAAP, segment operating margins by 30 basis points during the fiscal fourth quarter,” he contends.