A premium infrastructure fund
It’s been a choppy year for infrastructure investors, but much of the worry is overdone, says Max King.
The recent bid from a private-equity consortium for the listed John Laing Infrastructure fund has bolstered investors' confidence in the sector. Still, valuations remain attractive, and jitters earlier this year look overdone.
They were due partly to the collapse of Carillion, a sub-contractor on many infrastructure projects. Yet the company's implosion was "in many ways a positive for private-sector involvement, as alternative suppliers were brought in on the same terms and pricing with no disruption to the operation of assets", says Giles Frost, director at infrastructure fund INPP(LSE: INPP). As for the threats of nationalisation made by John McDonnell on behalf of the Labour Party, Duncan Ball,co-chief executive of BBGI (LSE: BBGI), points out that "we don't see controversy in other parts of the world".
A global footprint
BBGI is the most geographically diversified of the listed infrastructure funds, with only 35% of its portfolio in the UK, a little less than in Canada. Around 15% is in Australia, 7% in Europe, and 5% in the US. While others have moved into riskier projects with demand or regulatory sensitivity, BBGI has focused on public-private partnership (PPP) assets with availability-based returns. In other words, BBGI gets paid as long as the asset is available, regardless of its usage.
The fund concentrates on investments of this type, says Ball, because of the "stable, predictable cash flows; creditworthy public-sector counterparties; attractive returns both in absolute terms and, risk-adjusted, relative to other opportunities; assets that are not overly complex; and a big enough global market to offer opportunities".
BBGI's preferred assets are bridges and roads, accounting for 44% of assets, which are "typically straightforward you plough the snow, cut the grass and refresh the overlay". But it also manages, in ascending order of risk, health centres, schools, prisons (in Australia) and hospitals.
Since flotation in 2012, BBGI has regularly issued shares for acquisitions, taking its current market value to more than £830m. Its experience in the North American market makes it well placed to acquire more assets there, with infrastructure renewal becoming an urgent priority in the US. The financing of acquisitions gives investors the opportunity to buy shares a bit more cheaply than in the market, where BBGI shares trade at a 10% premium to net asset value (the value of its underlying portfolio). Even at that price, the shares yield 4.3%, the dividend having been increased at a compound 3.5% since flotation. In any case, the premium to net asset value is calculated by discounting future cash flows (how much money it will make from certain projects in the future) at the generous rate of 7.2%, way above the sub-2% return of 30-year gilts (UK government bonds). This provides a very significant premium for modest risk. Out of this 7.2%, investors pay ongoing charges of less than 1%, but annualised shareholder returns of over 10% since 2012 demonstrate BBGI's success in earning additional returns from operating the assets.
The comparison with gilts improves further when inflation is taken into account. Between 1935 and 1975 rising inflation annihilated the real value of gilts, while current yields are below an inflation rate that could well rise further. Infrastructure assets are protected. INPP estimates that every 1% increase in inflation adds 0.8% to returns.
Compared with BBGI, INPP offers slightly better returns for a little more risk in its assets. With 73% of its holdings in the UK, it is more exposed to inflation and political risk than BBGI, but, as one sector veteran notes, "private equity is snapping up UK assets". Overall, the political risk associated with infrastructure funds has probably been exaggerated. BBGI, with an international spread of assets, deserves its premium rating.