Utilico warrants attention

Utilico Emerging Markets offers the potential for strong long-term growth in its dividends based on investing in emerging markets coupled with with the defensive attributes of focusing on infrastructure and utilities. However, tough market conditions meant the dividend was held last year and an impending exercise of warrants is likely to mean the payout won't grow this year either. This hiatus means the shares now trade at 13 per cent below net asset value, which should be as wide as the discount gets until dividend growth kicks in again, hopefully from 2011.

The credit crunch hit the income generated from Utilico's investments and last year’s 4.8p dividend payout was not quite covered by EPS of 4.7p. Nevertheless, conditions have been improving and the trust has seen a strong recovery in both its net asset value and income from its investments.

The theme underlying the trust’s investment plan is the ongoing emergence of the middle classes in the developing world. For example, its 21.5 per cent exposure to ports, the trust’s largest sectoral bet, is a play on increased economic activity. Meanwhile, an increase in its exposure to toll roads reflects growing car ownership among the new middle class.

The trust concentrates on investing in income-producing assets, rather than building projects from scratch, which means it is at the safer end of infrastructure investment. That said, the manager is not afraid to increase risks by taking substantial positions, and the trust's top-10 holdings make up over half the portfolio.

The focus on buying functioning infrastructure has, to some extent, dictated the geographic asset allocation. So the fund has major exposure to Brazil and China, but India, another key emerging market star, doesn't feature. The group also has significant exposure to Malaysia, where a combination of good economic prospects and changes to regulation are boosting prospects.

Utilico has been buying in its shares to try to cut the discount to net assets at which they trade, but the gap remains stubbornly wide. Partly, the discount reflects the risks associated with the economic outlook and the markets Utilico is invested in. More specifically, it reflects concerns over the fast-approaching dilution as Utilico's shares in issue are increased by about 16 per cent through the conversion of warrants and special subscription shares next month.

The trust will receive £38m when it issues the new shares, but existing investors will see their pro-rata net asset value fall. The NAV in our table is adjusted to reflect this upcoming dilution. The need to pay dividends to new shareholders will also prove a drain on resources, but management anticipates that growth in the income the trust receives will enable it to maintain the dividend this year. After that, dividends should grow in line with income. While the dilution is a drag, getting the share issue done could clear the air and help the discount narrow as investors look towards renewed dividend growth.