HICL dividends on target despite Affinity and Carillion issues

The trust's rating was hit further when Carillion, which had provided facilities management to 10 of its public partnership projects, went into liquidation in January. The trust set aside a Carillion provision fund of £59.3m worth 2 per cent of its NAV, and fell to a discount to NAV. By April this year this had hit a historic low of 10.7 per cent. 

A gradual increase in the trust's exposure to overseas markets will be particularly helpful in reducing its exposure to UK political risk

HICL has made temporary arrangements with new facilities management providers at nine of the projects Carillion was involved with, and expects to have long-term arrangements in place by next spring. It already has one long-term arrangement in place for one of the projects for which Carillion provided facilities management.

But as at 19 July HICL has bounced back up to a premium of 4.7 per cent, following news of the possible acquisition of John Laing Infrastructure (JLIF), an infrastructure investment trust that also invests in public private partnerships (PPP).

And HICL's assets are still growing: over its financial year to 31 March 2018 it made a NAV total return of 5.7 per cent, albeit lower than the 10.3 per cent it made in its previous financial year. Excluding the impact of the Carillion liquidation, the trust's NAV total return would have been 7.9 per cent.

The trust also met its dividend target for the year, with aggregate dividends of 7.85p per share. And the trust's board has reaffirmed its 8.05p target for the year ending 31 March 2019, and 8.25p per share for the year ending 31 March 2020.

"What we are seeing is the benefit of a deliberate strategy to offer those classic infrastructure investment characteristics of long-dated cash flows and inflation correlated returns," says Harry Seekings, who took over as lead manager of HICL from Tony Roper in May last year. "And HICL is relatively well diversified, with relatively low single asset concentration risk. That becomes important when you have these unexpected challenges – this diversification has supported the resilience we've seen through the past financial year."

Due to a dwindling supply of PPP assets, over the past two years HICL has been making investments in demand-based assets, such as toll roads, and regulated assets.  As at 31 March, PPP assets represented 74 per cent of its assets and demand-based assets represented 18 per cent. HICL's regulated assets include Affinity Water, its largest holding, which accounted for 8 per cent of assets at 31 March.

Since HICL invested in Affinity Water last year the value of its stake in the company has been written down by £34m, or 14 per cent. This is because Affinity has incurred operational costs relating to drought, the winter freeze-thaw and the termination of an underperforming subcontractor. And the Water Services Regulation Authority (Ofwat) has changed the methodology for its latest price review covering the regulatory period from 2020 to 2025. A lower-than-expected regulatory weighted average cost of capital in the methodology, along with the incorporation of floating rate debt for the first time, has been detrimental to Affinity Water as the company is financed with long‐term fixed-rate debt.

However, Mr Seekings says it is still an attractive long-term investment. "We assume that the current price review is projected forward for the entire duration of our cash flows, so for decades, but in reality this price review is about the next five years," he says. "While this time there has been a push to reduce the costs of water to households, I think in future price reviews will have to tackle the subject of investment in the network."

HICL's demand-based assets have performed better. Its two major toll road investments, Northwest Parkway in the US and the A63 Motorway in France, have achieved better-than-expected traffic and revenue figures. In July 2017 the trust added to its demand-based assets with the acquisition of a 21.8 per cent interest in High Speed 1, the rail link between London St Pancras station and the Channel tunnel, for £202m.

This year the trust has sold its interest in the Highland Schools PPP project for £56m, more than 20 per cent higher than its value at 30 September 2017. The proceeds have been reinvested in the A63 Motorway investment.

"Our analysis made it clear that if we disposed of [Highland Schools] it would have a small but beneficial impact on the total return and inflation correlation of the remaining assets," says Mr Seekings. "If we can find opportunities to favourably dispose of assets and invest the proceeds in good accretive opportunities, we'll do that."

He also expects a gradual increase in the trust's exposure to overseas markets, which will be particularly helpful in reducing its exposure to UK political risk.

But he adds: "We're not complacent about [the potential nationalisation of assets], but there are more than 700 PPP assets in the UK and I don't think that all 700 of those will be terminated."

He points out that a nationalisation would not take place until after the next election, "and whoever comes to power will have to order their priorities in a post-Brexit Britain, with probably quite tight budgets". And even if HICL's total portfolio was terminated compensation at market value is contractually payable on 96 per cent of its assets.

How HICL has performed