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16 April 2021

Infrastructure: The Foundations for Growth

While the heightened tax burden may have taken the headlines, and for good reason, Chancellor Rishi Sunak’s grand plans for infrastructure, and its implications on investments within this concrete arena, seem to have evaded the spotlight.
 

THE BACKGROUND

The UK is set to see the formation of a new £12bn National Infrastructure Bank, which will be used to facilitate the clean energy transition, concurrently supporting economic growth “through better connectedness, opportunities for new jobs and higher levels of productivity”. Based in Leeds, and thus simultaneously ticking the levelling-up agenda item off the list, the Government expects the bank to support “at least £40bn” of investment, by focusing on clean energy and transport. The project also includes £10bn of debt guarantees with which to lever private investment. The Government has already announced £600bn of infrastructure projects over the next five years and, following the Budget announcement, Prime Minister Boris Johnson unveiled a “union connectivity review” of road, rail, air, and sea links, led by Sir Peter Hendy, the former chairman of Network Rail. As above, the aim is to improve the nation’s connectivity and invigorate growth within the regions. A link between Scotland and Northern Ireland is one such proposal which has already emerged from the review.
 
While industry experts may have disputed the figures involved in the bank, infrastructure is a buzzword on everybody’s lips, anticipated to supercharge growth and the movement towards a greener future, while improving connectivity and working efficiency.
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THE MARKET

While the above provides a strong tailwind for infrastructure investments, the proposed increase to Corporation Tax from 19% to 25%, which is to kick-in from 2023, will somewhat counteract this force. Analysts at market maker firm Winterflood estimate that this will knock 3.4% off HICL’s (a large and relatively liquid infrastructure company with a £3.1bn market cap) Net Asset Value (NAV), with the latest published NAV coming in at 154 pence-per-share. When freezing other factors, we can thus assume a drop to c.148 pence-per-share in the coming years. The impact is likely to be somewhat more ominous given the Winterflood study is ignoring HICL’s 7% of assets based in North America, with the US also set to witness a spike in taxes. Another factor which has hampered the wider infrastructure sector has been the rise in Gilt yields; the Ten-Year UK Gilt, which is also known as the risk-free rate, has seen its yield increase from 0.19% to 0.77% since the start of the year. While this remains well-below its long-term average, we should not underestimate such a dramatic shift.
 
The rumbustious response to the Coronavirus crisis, led by both central bankers and their respective governments, which together have injected huge levels of monetary and fiscal stimulus into the global economy, sits alongside the high levels of consumer and business savings and the immense levels of pent-up demand. These factors have fused to propel inflation expectations towards the upside, subsequently pushing yields higher.
 
Although the heightened discount rate may push down the value of future cash flows, concomitantly narrowing the risk premium, investors in infrastructure assets should breathe some sigh of relief given its cashflows are often linked to inflation, and thus offer protection against this force.
 

HICL

HICL invests primarily in UK infrastructure assets. The portfolio is split into three different segments: 72% of the portfolio benefits from long-term, availability-based Public– private partnership (PPP) contracts; 19% is exposed to user demand, and regulated assets comprise 9% of the portfolio. The former is where companies and the Government work together to build and maintain assets such as roads, hospitals, and communication networks.
 
The portfolio has performed well despite the challenging market backdrop, notwithstanding the negative impact on assets such as the Eurostar train-line High Speed 1, (5% of portfolio), and two toll-roads, the A63 Motorway in France (6%), and Northwest Parkway in the US (5%). All three assets have experienced a drop in demand given the restrictions on movement and quarantine legislations over the past 12 months.
 
Looking forward, HICL continues to see an attractive asset pipeline which focuses on critical infrastructure (fibre networks) and the energy transition (smart meters, district utilities). In the past year, the Trust added two windfarm projects to the portfolio, further diversifying HICL’s offering,
while supporting the UK’s transition to a low carbon economy.
 
Yet, as with most infrastructure vehicles, investors should expect an equity raise to fund such developments. Furthermore, despite its ‘progressive’ dividend policy, the total dividend for the year to full year 2022 will be unchanged from the 8.25p in full year 2021, while dividend cash cover over the six months to September 2020 was only 0.83x, compared with 1.05x in the prior year. Notwithstanding this, the c.5% dividend yield remains extremely attractive, and the wide spread over the risk-free rate seems to somewhat defend the uncovered dividend.
 
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The reopening of the global economy should propel growth in the demand-based assets, while driving the NAV higher, and possibly offsetting the negative impact from higher taxes. This, alongside the inflation-protected and Government-supported cashflows, and the thematic trends driving the demand for green assets, fashions a robust bull case. Once the inflation engine starts to rumble, this case will only be further intensified.

Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Please note that investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.
 
Infrastructure: The Foundations for Growth
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