Infrastructure Stocks Face Austerity Cold Shower

European infrastructure stocks that rode high on spending stimulus euphoria are feeling the brunt of public works cuts, and investors are on the lookout for companies with deep pockets and revenues in growing markets.

Already seen as a challenging sector within equities due to low margins and often limited visibility on the profitability of projects, European infrastructure now has to contend with austerity weighing on the valuation of many of its companies.

"Most of the infrastructure is funded with public money and budget restraints are now forcing governments to cut public works investment," said Herman Klein, a senior investment analyst at ING Investment Management, which runs 376 billion euros in assets under management.

"Even if valuations may seem attractive, we are cautious on the whole space, particularly when it comes to companies with exposure in southern Europe, such as Spain," he said.

Shares of construction and material companies in developed Europe average an enterprise value to core earnings ratio of 7.6 times, compared to the 9 times average across all sectors, according to Thomson Reuters Starmine data.

Investors have reversed their bias towards exposure to public works and are looking for companies that are not so dependent on government spending.

"Given our bearish stance on non-residential and government-related construction in Europe, we prefer companies that either have exposure away from this region, or away from non-residential/government construction or both," Goldman Sachs said in a note.

It has a "buy" rating on material supplier Saint Gobain and Vinci, a builder which relies on concessions for much of its earnings.

For companies that still have large exposure in civil engineering, strong balance sheets, such as those of builders Skanska and Strabag, and an emerging markets presence, such as with cement makers Holcim and Italcementi, are favoured most in the sector.

"Europe is not the best place to be for a construction company at the moment....avoid the companies that have a large footprint in Europe and concentrate on companies which have big exposure to growth markets which are mostly in Asia," said WestLB analyst Ralf Doerper.