3i Infrastructure 10 August 2023
Disclosure – Independent Investment Research
This is independent research issued by Kepler Partners LLP. The analyst who has prepared this research is not aware of Kepler Partners LLP having a relationship with the company covered in this research report and/or a conflict of interest which is likely to impair the objectivity of the research and this report should accordingly be viewed as independent.
To provide shareholders with a total return of 8% to 10% per annum, to be achieved over the medium term, with a progressive annual dividend per share.
Bernardo Sottomayor; Scott Moseley
Association of Investment Companies (AIC) Sector
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3i Infrastructure (LON:3IN) targets NAV total returns of between 8% and 10% per annum from investment in privately-owned ’economic infrastructure’ companies in Europe. As we discuss in the Portfolio section, the management team look for not only unique companies with very specific attributes, which will lend them a strong element of predictability, but also those which are capable of outperformance and upside.
It is worth noting that the managers invest in operating companies and, as such, the portfolio is closer to a private equity portfolio than a core infrastructure trust, which might invest in PPP contracts and toll roads. These tend to have fixed lives and a higher proportion of returns being delivered from income. As such, as we discuss in the Performance section, these are potentially higher-risk investments than those within core infrastructure and are represented by a much higher discount rate, and 3IN has outperformed historically in NAV terms.
With net assets of c. £3.1bn, the portfolio is relatively concentrated with 13 underlying investments. However, the managers aim to maintain diversification by ensuring companies have exposure both to different drivers and also different megatrends.
Since IPO, 3IN has so far increased the dividend every year. The board’s dividend target for the year ending 31/03/2024 is 11.9p per share, representing a prospective share price yield, at the time of writing, of 4.1%. An interim dividend of 5.575p was declared in respect of the half year and the overall target was reiterated.
There are good reasons why 3IN has maintained a relatively strong rating, even as its peer group of infrastructure trusts has traded out to mid-teens discounts. As interest rates have risen, a key issue on investors’ minds is infrastructure valuations. In simple terms, investors worry that valuations aren’t keeping up with events, and this has led to infrastructure trusts trading at discounts. 3IN’s periodic recycling of capital, with realisations usually at or above book value, helps to validate that the valuation is up to date, and in fact it has recently announced it expects to sell its stake in portfolio company Attero for a c. 31% premium to the most recent valuation.
Higher interest rates are, of course, a response to higher inflation. 3IN has always been transparently a portfolio of operational companies with strong infrastructure characteristics, but with more equity upside than most infrastructure trusts, meaning it has the ability to generate higher returns, and to adapt to different environments. Given 3IN’s long-term track record of returns is so strong, it might seem odd to say that a higher rate, inflationary environment should see the trust come in to its own, but in our view investors should place a higher value on the equity characteristics in 3IN’s portfolio that have the capability to generate real returns than the current discount of 7% implies.
- Well placed to produce real returns in a higher inflation environment
- Portfolio valuations validated by periodic realisations
- Strong dividend cover and dividend growth
- Operational businesses can also wider swings in earnings than classic infrastructure projects
- Portfolio companies are geared, which can amplify losses as well as gains
- Other infrastructure trusts are on larger discounts, which may be a brake on 3IN’s own rating