Buy HICL at rare narrow premium

HICL is a popular trust and normally trades on high double-digit premiums because of its fairly low-risk profile, inflation-linked dividends and uncorrelated returns to equities and bonds. It invests in long-term infrastructure projects in three main areas – public-private finance projects (that involve government backing and are very long term), regulated assets such as water utilities and higher-risk demand-based assets such as toll roads.   

Currently, HICL is yielding 4.8 per cent and is sitting on a premium of 8.8 per cent compared with a 12-month average premium of 13.8 per cent. That puts it a way below the average infrastructure investment trust, which trades on a premium of 12.9 per cent.

Its premium has narrowed because HICL has been on an acquisitive spree in recent months and has raised a substantial amount of equity in order to fund those transactions.

In the year to date, HICL has invested in its third demand-based toll road, bought a stake in the UK’s largest water-only utility, Affinity Water, and most recently agreed to acquire a £320m stake in the High Speed 1 (HS1) rail link as part of a consortium.

In March, HICL raised equity worth £260m and £267.7m in June, increasing the market capitalisation of the trust to £2.8bn. HICL is likely to return to the market in order to fund its most recent deal and this expectation has been keeping a lid on its premium.

Its most recent acquisition to buy a 35 per cent stake in HS1 – the high-speed link running between London St Pancras and the Channel Tunnel – cost HICL up to £320m. The trust will be a member of a consortium of investors and HICL intends to bring in minority co-investors after the acquisition to invest another £120m. HICL has so far funded the deal by using its credit facility and cash reserves, but said it expected to have a net funding requirement of £140m, according to Liberum.

Numis said: "We would expect further issuance given the net funding requirement of £140m, although the timing of this is uncertain."

The potential of another share issue means that investors might want to consider drip-feeding money into this trust in order to take advantage of its currently narrow premium, as well as the potential future opportunity, if it narrows further.

The trust has performed strongly over the long term in both income and capital growth terms. It has delivered a share price total return of 158.7 per cent over 10 years compared with 75 per cent for the average infrastructure investment trust. It has also made positive share price returns each calendar year since 2007 and positive net asset value (NAV) returns in every one except 2009.

It also benefits from inflation-linked returns and income, and high yield, both of which have been boosted by the trust’s recent acquisitions. The correlation of the portfolio’s long-term returns to inflation improved during its 2016-17 financial year to 0.7 at 31 March 2017, from 0.6 at the same point in March 2016. The HS1 acquisition boosts that correlation to 0.8.

However, HICL’s correlation to wider equity markets and to sterling have also increased over the past year, as it has been forced to move up the risk scale and invest in more demand-based assets such as student property and toll roads. Fewer UK PPP deals are being commissioned today, meaning greater competition over those assets. PPP assets now account for around 75 per cent of HICL’s portfolio by value compared with 95 per cent at March 2016. Demand-based assets is expected to be 16 per cent of the portfolio following the HS1 acquisition.

Correlation to GDP has increased from 9 per cent to 16 per cent as a result, according to Numis, between March 2016 and March 2017, and the portfolio could be more correlated to market movements.

However, Alan Brierley, analyst at Canaccord says: "We believe that HICL has a key role to play in improving portfolio diversification; we expect it to continue to deliver superior long-term returns and it remains a long-term constituent of our model portfolio. The shares have experienced a sharp de-rating in the past year, but we regard this as an attractive buying opportunity.

"HICL offers an attractive yield and genuine capital preservation characteristics, and we believe these have significant value, particularly when we reach the next phase of the cycle."

Opt for HICL for inflation-linked, stable income from a portfolio of lower-risk assets all on a rare single-digit premium. Buy.

HICL INFRASTRUCTURE (HICL) 

Source: Morningstar, as at 5.9.17, *Winterflood, as at 05.09.17 & **HICL, as at June 2017

Performance 

Source: FE Analytics, as at 5.9.17

Top 10 holdings as at 31.3.17 (%)  

Source: HICL Infrastructure 

Geographic breakdown as at 31.3.17  (%)  

Source: HICL Infrastructure