Higher inflation could help HICL Infrastructure (HICL) to overcome a 1.8% hit to its net asset value (NAV), caused by the collapse of Carillion, the investment company said in a trading statement this week.
If inflation remains above manager InfraRed Capital Partners' long-term inflation assumption of 2.75% during the financial year, it could result in an upwards revision to the March 2018 portfolio valuation. Inflation has remained at 3% or above since September of last year.
Infrastructure funds typically benefit from higher inflation because a large portion of the cashflows derived from the underlying infrastructure investments are inflation-linked. Depending on the contracts that are in place, infrastructure funds typically offer investors some inflation protection.
HICL, for example, has 116 investments. These are long-term contracts to operate schools, universities, roads and hospitals, which are paid by governments.
An upwards revision could go some way towards countering the 1.8% hit to its NAV (as of the end of September 2017) caused by the liquidation of Carillion. In an interim update, HICL's board re-affirmed its estimate that the collapse of Carillion would wipe £50 million off the portfolio value.
Counting the costs of Carillion
HICL had entered into facilities management sub-contracts with Carillion on 10 projects - and the company's subsequent collapse has triggered loan agreement defaults on most of these projects. Meanwhile, Carillion was the original construction contractor on another five of HICL’s projects. The board said these are technically in default under their loan agreements.
‘Projects will be unable to make distributions whilst they remain in default, which is expected to remain the case for a number of months until negotiations with lenders are completed, after which any residual locked-up cash should be capable of being distributed,’ HICL noted.
The £50 million hit to HICL’s NAV relates to the transition phase and anticipated costs of securing long-term replacement facilities management contractors. It also reflects a potential increase in discount rates used to value affected projects at the end of March this year, assuming negotiations to resolve the issues continue.
'The investment adviser's asset management team is working with Carillion's liquidator to ensure funds continue to flow to staff and suppliers, and to pursue the twin objectives of enacting a smooth transition of services to interim arrangements and securing long-term replacement contractors,' said Ian Russell, chairman of HICL.
The board said it had made good progress implementing its contingency plans to transition over to new contractual arrangements for facilities management. In the short term, it said affected projects were stable, with services running as normal. One project, which represents 1.3% of the portfolio, has already terminated its contract with Carillion and has transferred to an interim arrangement with a new provider.
However, the board expects to see a reduction in the valuation of its Affinity Water investment, which accounted for 9% of portfolio at the end of September. This has been caused by regulator Ofwat’s PR19 finalised methodology for 2020 to 2025, which could adversely impact Affinity’s business plan.
HICL said it remains on track to deliver aggregate dividends of 7.85p to the end of March. During the next financial year, it will continue to target a 8.05p dividend, equating to a 5.5% prospective yield. This rises to 8.25p in 2020.
The board expects to see marginally positive uplifts to the valuation of the portfolio due to positive traffic and revenue numbers from its demand-based toll roads. Meanwhile, a corporation tax cut in France from 33% to 25% will provide a boost to the value of the fund’s French assets.
With the exception of projects affected by Carillion, chairman Ian Russell said the majority of the portfolio continues to perform in line with expectations.
HICL Infrastructure is the only fund in the Association of Investment Companies’ infrastructure sector that currently trades at a discount to NAV. On 7 February, it was on a 2.9% discount, which compares to a 5.8% premium by the sector average. This represents a fall from grace for the UK’s largest listed infrastructure fund, which traded on an 18% premium last April.