HICL Infrastructure 20 December 2023
Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by HICL Infrastructure. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
HICL Infrastructure (HICL) is the sector bellwether, having delivered steady returns of 8.7% per annum on a NAV total return basis (since IPO to 30/09/2023). Since the recent interim results, which gave cause for optimism on several different fronts, the discount to NAV has narrowed. That said, as we discuss in the Performance section, the current share price discount to NAV implies the market’s estimation is of a further increase in the discount rate of 1.5%, from which we can derive an attractive prospective net total return for shareholders of 8.4%.
As we highlight in the Gearing section, £324m of divestments have been agreed so far during the current financial year at or above their respective valuation at 31/03/2023, which we estimate will bring gearing down to 10% of net assets. One might argue that the discount to NAV at which the shares currently trade implies that the discount rate used to value the assets should be higher. On the other hand, disposal activity is occurring at or ahead of valuations, signifying that the current discount rate is justified by market transactions.
In terms of income, HICL’s interim results provided grounds for some pre-Christmas cheer. HICL’s dividend cover has been relatively thin since COVID-19 negatively impacted several demand-based assets. However, as we discuss in the Portfolio section, on a few fronts, there are grounds to expect revenues to materially improve. As well as operational performance, inflation is an important factor that the managers highlight that should provide a lasting tailwind to revenues and, with contractual lags, see a meaningful improvement in dividend cover in 2024.
HICL’s portfolio continues to evolve. Aside from reporting improving dynamics from some significant assets, the manager’s disposal activities are improving the mix. With capital markets effectively closed, the board and InfraRed have stated it is their priority to reduce short term gearing. They have made good progress so far.
We believe there is evidence that HICL’s dividend cover is on an improving trend. We discuss in the Portfolio section that is a result of operational improvements, investment activity that actively increases the exposure to inflation, and also contractual time lags increasing revenues as a result of last year’s inflation. If the discount to NAV remains once debt has been reduced, there is clear potential for some surplus cash to find its way into buybacks, providing support to the share price.
With the share price implying a net prospective total return from the portfolio of 8.4%, HICL therefore offers a material return premium when compared to bonds. However, HICL’s cash flows have a high correlation to inflation, which is part of the reason that we believe there are strong signs of green shoots to a recovery in HICL’s dividend cover. As we discuss in the Discount section, if achieved, this could provide a catalyst to a re-rating in the shares, enhancing returns to shareholders. Given the underlying risk characteristics that HICL exhibits, the prospective returns must surely be considered attractive in absolute terms and on a risk-adjusted basis.
- Lower-risk, institutional-quality infrastructure assets within a liquid vehicle that has scale
- Steady and resilient yield, with a dividend that is cash-covered
- Returns are positively correlated to inflation
- Evolution of the portfolio is exposing shareholders to new risks
- Capital is at risk if the manager is unable to continue to extend the weighted average asset life
- Dividend cover is relatively low, at 1.05x on a cash basis