Sequoia ‘California Dreaming’ as Stifel upgrades debt fund

Stifel analysts lift Sequoia Economic Infrastructure to ‘buy’ from ‘hold’ with £1.5bn debt fund trading below asset value and announcing a California licence two weeks before a continuation vote.

Broker Stifel has upgraded Sequoia Economic Infrastructure (SEQI ) from ‘hold’ to ‘buy’ ahead of its 1 August continuation vote as the £1.5bn debt fund wins a California lending licence. 

Stifel analysts Iain Scouller, Sachin Saggar and Will Crighton said the shares’ wide 16% discount to net asset value was ‘attractive’ and undeserved given the portfolio’s stability over the last 18 months and its high 8.6% dividend yield.

The board chaired by James Stewart faces the three-yearly continuation vote on 1 August, which the three analysts expect to pass, but noted that a ‘sweetener’, such as formalising the amount to be returned to shareholders via buybacks or a tender could help drive a rerating.

The company returned £88m to shareholders in the year to 31 March through buybacks, but these made little impact on the discount, suggested more was necessary, they said.

The largest shareholders include Investec, Fidelity and Gravis Capital, with respective stakes of 9.5%, 3.6% and 3.1%, according to Refinitiv data.

‘Even if no proposals along these lines materialise, we think the shares are attractive at current levels. We upgrade our recommendation to Buy with a fair valuation of 86p, a 10% discount to NAV. Clients focused on income should also note the shares are expected to go ex-dividend by 1.72p next week,’ the analysts said.

The upgrade came as the board announced the fund’s wholly-owned subsidiary, Sequoia IDF Holdings, had received a finance lender license under the Californian Financing Law, increasing the number of opportunities in the Western US state and giving an advantage over non-licenced lenders.

California is one of the largest and fastest-growing markets for infrastructure finance in the US and were it a country, it would rank as the world’s fifth largest economy, the investment company said. Target sectors in the state include energy transition, digitalisation and transport infrastructure.

The shares rose 1.2% to 81.53p on Tuesday, putting them on a 14% discount to the June net asset value of 95.29p.

Under fund managers Randall Sandstrom and Steve Cook, NAV per share gained 0.99p to 95.29p in June, driven by interest income, asset valuations and the buybacks.

The portfolio consisted of 54 private debt investments and two infrastructure bonds spread 52% in North America, 27% UK, 21% Europe and 0.1% in Australia and New Zealand.

Over 94% of assets are in private debt on which it can charge a higher yield to reflect their illiquidity, while 41.5% is in floating rate loans whose coupons rise and fall in line with interest rates.

Sandstrom and Cook said yields on benchmark five-year government bonds softened 0.1% in Europe, where interest rates were cut last month, and by 0.2% in the US and UK, where central banks are poised to follow suit. With the fund’s loans, particularly in the energy and utilities sectors, narrowing their yield spread to government bonds, the net effect was a rise in prices.

‘In keeping with this, the pull-to-par has also reduced from 3.8 pence per share in May 2024 to 3.7 pence per share in June 2024,’ they said.

The pull-to-par is when the price of a bond, or loan, that has fallen bounces back to its launch price as it approaches its repayment date, assuming there are no write-downs or hits to their value.

They emphasised that inflation falling back down to central banks’ 2% targets would steady credit markets, while the long-term outlook on inflation and base rates would prove a tailwind as falling rates typically increase asset valuations.

Since launch in March 2015, the portfolio has delivered total returns of 67%, according to Morningstar. On an annual basis, the board believes it has outperformed long-term benchmarks including the global high yield bond sterling-hedged ETF by 3.9% over its life with less volatility, the Stifel analysts pointed out. Sequoia’s shareholder returns total 33%. 

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