Opportunities In The Infrastructure Sector

The sharp increase in interest rate expectations in recent weeks has had a detrimental impact on many parts of the market including the various bond proxies. One such is the listed infrastructure sector, which has de-rated to the point that the average discount is now 20% with the average yield hitting 6.4%.

There have been relatively few prolonged periods where wide discounts to NAV have persisted in this part of the market, even in times of elevated macro and political uncertainty. The broker Numis says that whenever the discounts have moved into double-digits, history has shown it to be an attractive entry point and they believe that it will again.

Median implied discount rates are currently around 10%, which is notably higher than during the global financial crisis and although they could still have further to go, the positive inflation correlation should help to limit the impact. Because of this, Numis do not believe that the NAVs will decline to the level that share prices are implying.

Positive Fundamentals

It has been a difficult start to the year for investors with the sector experiencing an average share price total return of -15%. There have been some big daily moves for what is normally a fairly ‘slow and steady’ area, due to the higher than expected inflation figures and the likely consequences for interest rates.

Despite this, the NAV returns have remained relatively robust with the portfolios generally delivering solid operational performance. There has also been minimal earnings impact from higher debt costs, as the majority of structural debt is long-term and fixed or hedged at attractive rates.

The underlying portfolios typically consist of hard to replicate assets, with some trading below their replacement cost. In many cases they are essential facilities with long-term contracts underpinning their revenue streams.

Another plus point is that the sector is positively correlated to inflation and although there is a lagged effect, the recent elevated levels will continue to feed through into cash flows and returns over time. When you take into account the outlook for breakeven inflation, the implied median real returns are currently 5.3%.

Numis believe that the sector continues to offer selective value for long-term investors as the total return potential remains competitive on a risk-adjusted basis, although they accept that greater certainty over the macro backdrop would be required before there is a wholesale re-rating. They currently have five core buy recommendations in this area.

Core Buy Recommendations

The first is International Public Partnerships (LON: INPP) that provides exposure to a differentiated portfolio with high inflation protection. It is trading at a discount to the estimated NAV of 18% and yielding six percent.

Next comes Bluefield Solar Income (LON: BSIF) that has built up a consistent earnings track record and offers strong dividend cover. The shares are available at a discount of 14% and offer a yield of almost seven percent.

Their next suggestion is Aquila European Renewables (LON: AERS), which the broker describes as having undervalued, operational assets with a high level of revenue visibility and low leverage. It is available at a discount of 19% and yielding six percent.

There is also VH Global Sustainable Energy Opportunities (LON: GSEO) that Numis think offers double-digit return potential driven by asset optimisation. The shares are trading on a discount to the estimated NAV of 17% and paying 5.5%.

Finally there’s Cordiant Digital (LON: CORD), whose cash flows are undervalued and which has funding available for new investments. It is available at a 27% discount and the shares are yielding five percent.