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HICL Infrastructure coming home to offer Brexit risk hedge

28 November 2018

Political risk remains high but with plans to move back to the UK and after strong half-year results there are other reasons to like the 5%-yielding, £2.9 billion listed, social infrastructure fund.

HICL Infrastructure (HICL) is coming home with plans to relocate from Guernsey to the UK next year in a move aimed to avoid any fall-out from likely OECD changes to cross-border taxation.

This comes at a time when the £2.9 billion alternative income fund is back in favour with strong half-year results last week underlining why with investors have returned to the stock after the furore over private finance initiatives (PFI) earlier this year.

Data from Thomson Reuters shows that four of the company’s five biggest shareholders – wealth managers Investec (5.7%) and Brewin Dolphin (5%) and fund managers Legal & General (3%) and Fidelity (2.9%) – added to their stakes in the past five months. They bought the shares as they recovered from their lows over fears of Labour’s threat to abolish PFI and consternation at the collapse of public sector contractor Carillion.

Schroders reduced its stake in May but remains HICL’s biggest investor with a 6.3% stake.

The purchases by the other leading investors – as well as many private shareholders – helped re-rate the shares, which moved from a 9% discount below net asset value (NAV) in April to a 9% premium over NAV in the summer.

‘Red October’ and ongoing Brexit uncertainty restored some caution and have lowered the premium again to under 5%. The shares are a long way off the heady days after the 2016 EU referendum when they stood as much as 31% above their underlying value.

Nevertheless, the interim results demonstrated why HICL deserves a modest premium when shares in 3i Infrastructure (3IN ) and BBGI (BBGI ) – rivals with far smaller exposure to UK PFI and public-private partnerships (PPP) projects – have returned to 13% above their NAVs.

For the six months to 30 September HICL reported a 7% total return on net assets – with dividends included on top of a 6.8p rise in NAV to 156.4p per share.

This beat analysts’ forecasts and was driven by the £1.4 billion bid by two pension fund managers for John Laing Infrastructure Fund (JLIF) in July. This demonstrated how much investors valued the long-term cash flows from HICL’s investments in contracts to run public sector facilities in schools, hospitals, prisons, military housing and toll roads in the UK and abroad as well as its big stake in Affinity Water.

Another boost came from the reduction in the £59 million provisions HICL made for finding replacements for Carillion, after transferring six projects and 40 facilities to new operators.

Political risk remains high though, with Labour committed to nationalising water companies and scrapping PFI in the NHS should it win the next election, while Conservative chancellor Philip Hammond declared in the last Budget he would never approve a new PFI contract.

That last point wasn’t as alarming as it sounded, however, given there have been few new PFIs in the UK for five years.

HICL chairman Ian Russell reiterated the hope that the cost of scrapping PFI would make Labour more pragmatic in office and took some reassurance from Hammond’s pledge to ‘honour existing contracts’. However, the likely crackdown on privatised water companies that have borrowed heavily to finance big dividends and fat cat salaries is clearly a worry for the Affinity owner.

Russell acknowledged that punishing water company excesses was ‘tempting in the current political climate’ but warned doing so would be ‘retrograde and risk undermining the confidence of long-term, responsible investors.’

Meanwhile, HICL fund manager Harry Seekings declared his passionate belief in the role of private sector operators in providing critical infrastructure and said he looked forward to discussing the matter with the Treasury.

Notwithstanding the political clouds, HICL’s cash flow from its 117 investments continues to be strong and that supports visibility and full coverage of the dividends. These are expected to grow from 8.05p per share this year to 8.25p in 2019/20 and 8.45p in the year after that keeping HICL on a forward yield of just over 5%, according to Winterflood Securities.

Seekings trimmed the portfolio with the sales of the Highland Schools PPP2 project in the UK and the AquaSure Desalination PPP project in Australia, fetching good prices that he reinvested in demand-based assets such as the A63 motorway in France.

In the past two years ‘enhancements’ like these have enabled HICL to lengthen its average investment term from 20 to 30 years, improve the inflation link of its returns and increase to 30% the amount invested outside core social infrastructure assets such as schools and hospitals.

The latter may be HICL’s biggest suit, according to RBC Capital Markets’ analyst John Musk who said the ‘encouraging’ results left HICL trading ‘at a discount to peers and we believe the next rerating should come from the market getting more comfortable (and giving more value) to HICL’s non-PPP and more diverse infrastructure investments.’

And with the government today publishing forecasts of the long-term impact of Brexit on the UK economy - with growth down and the cost of living up - there’s case for seeing HICL as a good hedge against the divorce from Europe given Seekings’ summary of the investment proposition as providing ‘long-term investors with returns that have strong inflation linkage and relatively low correlation to UK GDP.’

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