HICL Infrastructure 07 July 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.
Since 2006, HICL Infrastructure (LON:HICL) has aimed to deliver enduring, sustainable dividend and capital growth by investing in the highest-quality core infrastructure assets. The team have increasingly been diversifying away from UK PPP investments in a bid to extend the average life of the portfolio, improve the inflation linkage and broaden the exposure of the portfolio to minimise investment risk.
This process continues, with the manager of HICL having made several new significant investments during the last financial year in the electricity transmission, communications and transport sectors. As we show in the Portfolio section, the portfolio continues to evolve and, in a number of ways, the portfolio metrics have improved considerably through the manager’s activity.
As we discuss in the Gearing section, another development came in May 2023, which saw the board and manager of HICL arranging long-term, fixed-rate debt. This is the first time HICL has borrowed long term, and in doing so has reduced the cost of borrowings, as well as reduced the risk to the portfolio of further rises in interest rates. The board sees it as crucial that HICL retains a strong balance sheet.
With a dividend target of 8.25p, despite not seeing an increase since 2020, this still represents the highest cash dividend in absolute terms compared to the immediate core infrastructure peer group, and was fully covered last year. At the current price of 134p, HICL offers a prospective yield on the current share price of 6.2%. We continue to expect that dividend cover should gently rise. The board’s dividend policy has been to pay out at least as much as the prior year’s dividend, but has balanced a desire to see increases in the dividend with the “need to protect the longer-term interests of shareholders and future-proof HICL’s investment proposition”.
With inflation rearing its head in a significant way for the first time since the trust’s launch, it is perhaps understandable that there may have been expectations of a more direct impact from inflation on higher-dividend guidance. However, as we discuss in the Portfolio section, HICL’s manager has been rebalancing away from PPP assets to capture longer-term cash flows with greater growth and/or inflation linkage, which tend to initially provide lower yields. We understand that these investments have been made with a view towards building out HICL’s earnings base for the future.
The annual results released recently illustrated the portfolio’s ability to capture inflation, principally in the NAV, which has helped act as a counterbalance to the negative of rising interest rates. As the managers highlight, the benefit of inflation compounds over time and, alongside the investment activity, has significantly enhanced the portfolio’s cash flow and earnings profile over the long term.
The discount to NAV now stands at 18.6%. In our view, the derating reflects short-term sentiment and rising short-term government bond yields, rather than reflecting the long-term attractions of the trust. As we discuss in the Dividend section, there is a case to be made that HICL shareholders are forgoing jam today in order to build the foundations of future dividend growth, long into the future. With dividend cover improving over time, HICL will be a direct beneficiary, in total-return terms, of any increase in long-term expectations for inflation. Long-term investors may see the current discount as being a potentially interesting entry point.
- 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 and/or correlation to economic activity
- Capital is at risk if the manager is unable to continue to extend the weighted average asset life
- Dividend cover is relatively low, at 1.03x on a cash basis