HICL Infrastructure (HICL), the £3.3bn alternative income fund battling to re-rate from a 21% share price discount, insists the market is underestimating the benefit it gains from higher inflation while exaggerating the negative impact of higher interest rates.

In a recent update for 1 April to 31 July the company sought to reassure investors that while recent rises in UK interest rates would put pressure on its underlying net asset value (NAV) through uplifts in the discount rate valuing its long-term cash flows, these would be ‘materially offset’ by the positive impact of higher inflation.

Like other infrastructure funds, HICL shares have sharply de-rated this year, falling 21% to a 21% discount below Numis Securities’ current estimate for 160.5p NAV per share, prompting a round of buying by the board.

HICL updates its valuation twice a year and reported NAV per share of 164.9p for 30 March at its annual results in May. It will next report its 30 September NAV at half-year results in November.  

In the interim statement, fund manager Edward Hunt InfraRed said that current breakeven rates in inflation-linked bonds, or gilts, implied long-term annual rises in the cost of living of around 3.4%, well ahead of HICL’s long-term inflation assumption of 2%.

He said if the market inflation forecast was applied to HICL’s long-term revenue generated from the public sector, transport and energy assets it manages, it would add another 21.4p, or 13% to NAV per share.

HICL isn’t saying that will happen, but it told investors its current weighted average discount rate of 7.2% would have to jump 1.1% to 8.3% to neutralise the positive impact from inflation.

Discount rates are moving higher. In the four-month period, government bond yields rose 0.6% on average across its markets in UK, Europe and US markets in response to rising interest rates, implying a knock to HICL’s NAV. However, it said a 50 basis point (0.5%) rise in its discount rate would only reduce NAV by 9.6p per share.

In other words, the ‘valuation impact of this is expected to be materially offset by the impact of higher actual and forecast inflation.’

In further encouragement to investors HICL said there was evidence from recent transactions in core infrastructure that inflation correlation was supporting asset prices.

The recent partial sale of its stake in the US Northwest Parkway toll-road had validated its valuation. It was looking at further disposals that would have the same effect and provide cash to further reduce borrowings that are expected to fall from £650m to £370m this month.

HICL has capped the interest rate on £200m of its brrowing at 6.5% for three years, providing further protection if interest rate rises, while allowing it to benefit if the cost of borrowing falls.

Mike Bane, the investment trust’s chair, said the defensive portfolio continued to perform well and the 6.5%-yielder was on track to meet this year’s target of dividends of 8.25p per share, although there has been investor disappointment over the company’s recent guidance that the payouts would be flat for the next two years.

Bane highlighted how High Speed 1, the railway linking London with the Channel Tunnel in which HICL is 4% invested, recommenced dividends having recovered from disruption in the pandemic. Affinity Water, to which HICL is 7% weighted, had been helped by mild weather and was not exposed to the sewage pollution problems of other water companies. 

‘Over the medium-term, core infrastructure investment continues to be propelled by the powerful growth drivers of digitalisation, decarbonisation and the need to renew ageing infrastructure,’ he said.

Pinch of salt

Analysts at JPMorgan Cazenove, Liberum and Numis responded positively to the updated, but Peel Hunt analyst Tom Pocock was sceptical. ‘We take many of the marketing messages around the offsetting effect of inflation with a pinch of salt given long-term break-even inflation includes an element of inflation uncertainty and the disappointing feed-through of HICL’s stated 0.8x inflation correlation to dividend growth, which is expected to remain unchanged for at least the next two years’.

Five-year performance

Source: Morningstar