Results analysis: Sequoia Economic Infrastructure Income

• Sequoia Economic Infrastructure Income (SEQI) has released its financial results for the year ending 31/03/2024. Over the year, the trust saw its NAV increase by 8.1% on a total return basis, in excess of its target return of 7-8%.
• SEQI paid a total dividend of 6.875p per ordinary share which represents a yield of 8.7% on the share price at the time of writing. The trust delivered a total share price return of 9.6%, helped by a modest narrowing in its discount from 13.8% to 13.5%. The discount has since widened to 16.2%.
• The managers have been active in portfolio management, increasing the proportion of fixed rate investments from 42% to 58% over the financial year to position the portfolio to take advantage of the expected fall in interest rates.
• The managers and board also continue to take a proactive approach to capital allocation, repaying the revolving credit facility to reduce net debt to zero and returning £88 million to shareholders via a share buyback programme.
• The trust has an upcoming continuation vote in August 2024.
• Chair James Stewart commented: “I am pleased to announce another resilient year of performance, despite ongoing challenges in the macroeconomic backdrop. We have continued to prioritise the credit quality of our portfolio and this strategy which, combined with ongoing market demand for infrastructure debt, enables the managers to be extremely selective as they consider the strong pipeline of future opportunities.”

Kepler View

Sequoia Economic Infrastructure Income (SEQI) generates a high yield for investors by lending against infrastructure projects backed by the security of tangible physical assets. The infrastructure sector is forecast to enjoy strong growth from mega-trends such as digitalisation and decarbonisation, which require trillions of pounds of investment in data centres, fibre networks, renewable energy and storage infrastructure amongst others. This has led to a significant growth in private sector financing as a means of plugging the gap from government spending.

We think SEQI is well-positioned to take advantage of this opportunity as the only listed economic infrastructure debt vehicle in the UK. Private debt accounts for the vast majority of the portfolio as this offers an illiquidity premium to publicly-traded debt. However, the trust is proactive in risk management, focusing on projects with a substantial equity buffer and limiting projects with construction risk to a small proportion of the overall portfolio.

One of SEQI’s strengths is the diversification of its portfolio, with around 55 investments across 30 sub-sectors. This number fell over the year, as the managers de-geared and cash was used for buybacks. SEQI is also differentiated from many closed-ended infrastructure vehicles in offering substantial exposure to the US market which is characterised by high demand for, and low supply of, financing.

A strong pipeline of investment opportunities allows a high level of selectivity, with the managers favouring defensive sectors providing significant barriers to entry, such as digitalisation, utilities and renewables. Added to this, short loan duration (weighted average life of four years) enables regular refreshing of the portfolio by recycling capital into new reinvestment opportunities.

Against a challenging backdrop for alternatives, SEQI has delivered a strong set of results with a NAV and share price total return of 8.1% and 9.6% respectively. This was primarily due to its focus on credit quality through the year. Almost 60% of the portfolio is allocated to senior secured debt and no single investment accounted for more than 4% of NAV at the time of investment. The allocation to senior secured debt rose over the year, and loans to projects in construction fell from 14% to 7%.

Rising interest rates weighed on the valuation of the loans over the year. However, these are mark-to-market effects, and assuming loan balances are repaid in full, this means there is a baked-in capital uplift (referred to as pull to par) to the NAV, which the managers estimated to be 4.1p per share at the financial year-end. The dividend continues to be cash covered, and although this cover fell from 1.21x to 1.06x, this was largely due to the timing of the repayment of capitalised interest, and cover is back to the level it was in 2022. There is also considerable uninvested cash on hand of c. £99m to fund further income-accretive investments.

In terms of downside risks, it’s also worth mentioning the managers’ expertise in recovering loans on non-performing investments, with lower portfolio loss rates than its infrastructure benchmark.  Substantial progress was made on three material non-performing investments during the year, including the expected recovery of all, or substantially all, of the loan to Bulb Energy. Average annual credit losses remain very low at 0.54% to date over the life of the fund. This is despite the difficult economic environment and speaks to the defensiveness of the investment strategy.

In our view, SEQI could be an attractive proposition for investors seeking exposure to the infrastructure sector, which offers defensive qualities in addition to strong secular growth themes. While there would be some negative impact on income from falling interest rates, the managers’ decision to build up fixed rate exposure has counteracted some of this. We think the dividend looks sustainable over the coming year, thanks to the high amount of liquidity available and the current outlook for rates. Given the likely positive impact of falling rates on the valuation of the portfolio, we think there is the potential for strong total returns in such an environment from the 8.7% dividend yield plus capital upside from pull to par and a possible narrowing of the discount.

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