Shares in the three largest listed infrastructure stocks – HICL (HICL), 3i Infrastructure (3IN) and International Public Partnerships (INPP) – today stand on respective premiums of 8.6%, 27% and 6.3% above net asset value (NAV).
Eighteen months ago they traded at discounts after shadow chancellor John McDonnell scared investors with a speech at the 2017 Labour Party conference in which he claimed private finance initiatives (PFI) were draining resources from the NHS and vowed to bring these contracts back ‘in-house’.
McDonnell compounded investors’ concerns in February last year with a statement that parliament might decide some PFI contracts could be nationalised without compensation. In between those dates, the sector had been left reeling by the collapse and liquidation of Carillion, a leading supplier of outsourced services to a range of PFI/PPP projects.
With a market value of £3 billion, HICL Infrastructure is the largest and oldest in the sector, having launched in March 2006. Over three-quarters of the portfolio is based in the UK, with the balance in the rest of the European Union and North America.
Just over 70% is in public-private partnership (PPP) projects ranging from schools and hospitals to prisons and police stations. These are ‘availability-based’ assets in which HICL earns money if the project is available for use and is maintained to the required standard.
The rest of the portfolio is divided between ‘demand-based’ assets – for example, it owns some toll roads where the revenue depends on how many drivers use the road – and ‘regulated assets’ – including HICL’s investment in Affinity Water, which is regulated by Ofwat.
The underlying themes with HICL’s investments are that it invests in physical assets that cost a fair bit to build, have high barriers to entry or a monopolistic position and where the cash flows are long-term and predictable in that they are either contractual or determined by regulation.
Another attractive quality is that a high proportion of these cash flows are inflation-linked.
For an investor in search of income, infrastructure funds are an obvious choice. HICL offers a yield of 4.9% on its current year dividend and we know that this will rise to 5% in its next financial year. These dividends are covered by the cash flows from the portfolio and HICL knows, with reasonable certainty, what cash flows will be generated by its portfolio for the next few decades.
This predictability of income is especially attractive to long-term investors such as pension funds and they make up a substantial proportion of its shareholder base.
Infrared Capital Partners, HICL’s investment adviser, stresses that the long-term nature of the portfolio, which at its most extreme includes a concession for the Northwest Parkway toll road in Colorado running until 2106, means that they have to act as responsible stewards of these projects.
That means a strong focus on the environmental and social impacts of their activities. Short-term cost-cutting measures are likely to be counterproductive in the long-term.
Labour’s argument is that the public sector is better placed to finance infrastructure investment, PFI deals have proved overly profitable for the private sector and the future cost of servicing PFI contracts is too high. To be fair, even former Conservative chancellor Philip Hammond concluded in his budget last year that there should be no new PFI/PF2 deals.
The main problems, as I see them, were that the massive expansion of PFI model under Labour governments from 1997 to 2010 was predicated on a desire to massage the public borrowing figures rather than a belief that PFI was a better way of delivering infrastructure investment.
The private sector then sought to minimise the threat of construction cost overruns – leading to supernormal profits for the construction companies; and while contracts for operations and maintenance provision set strict standards, outsourcers such as Carillion were left with very thin margins. That’s why I agree there should be no more PFI-type deals in the UK.
However, that does not mean that I would back Labour’s idea of nationalisation. Above all, it would hit savers and pensioners, and terrify overseas investors who are already running scared from the Brexit shambles.
It would also likely jeopardise the long-term viability of those assets as future governments prove unable to resist cutting back on crucial maintenance expenditure – look no further than the Houses of Parliament for an example of this, where successive governments have kicked the maintenance can down the road to the extent that the building now needs billions spending on it.
The end of PFI/PF2 still allows infrastructure investment by regulated businesses. One example of this are the Ofto (offshore transmission) projects that Ofgem is encouraging to connect offshore windfarms to the national grid. HICL made its first investment in this area last year as part of a consortium with Mitsubishi Corporation which was awarded the contract to connect the Burbo Bank Extension wind farm. The consortium is now preferred bidder on three more Ofto projects.
Affinity Water, which provides water to areas of London and the South East, is another regulated business. These companies are allowed to earn a return on their asset base and part of the attraction for HICL is that Affinity needs to keep investing to meet the challenges of our changing climate. The negotiations between the companies and the regulator are tough, however, and HICL has warned that it might have to reduce the value of this asset and take between 1.1% and 1.4% off the NAV.
A majority Labour government appears unlikely but many stranger things have happened over the past few years. Nationalisation, especially nationalisation without compensation, seems a more remote prospect. It is regrettable though that there should be any doubt over the ability of an investor to rely on a contract made with the UK government.
I would expect that, when an election is eventually called, HICL’s share price might have a wobble. I bought HICL in the wake of the 2017 Labour conference and sold them after the bounce. I could be tempted back once the picture is clearer. HICL would love a return to normality and the chance to grow once again. It sees opportunities in the secondary market for existing assets and overseas.
HICL Infrastructure features in an article on 'Wealth managers' top 10 favourite trusts' in the latest issue of e-zine.
James Carthew is a director at Marten & Co, operator of the QuotedData website. The views expressed in this article are his and do not constitute investment advice.
Investment company news brought to you by Citywire Financial Publishers Limited.