(Updated with analyst comments) The financial difficulties at Carillion (CLLN) and other construction groups has prompted HICL Infrastructure (HICL) to take steps to ensure it is not hit by the failure of a contractor at one of its many public sector investments.
As an operator of schools, hospitals and other buildings in the UK under public private partnerships (PPP), HICL has service arrangements with many facilities management firms.
Half-year results from the £2.8 billion infrastructure fund on Wednesday revealed 15% of its assets are linked to contracts involving Carillion, which is fighting for survival after a series of cost-overruns on projects in the UK and the Middle East and the ousting of its chief executive and the axing of its dividend in the summer.
Carillion’s plans to sell its healthcare division to Serco (SRP) will reduce HICL’s exposure to the company to 8%, with Serco increasing to around 6%. Outside healthcare, Carillion will continue to work with HICL on defence projects, such as Allenby and Connaught, a 35-year private finance initiative (PFI) providing four garrisons to the army in Salisbury Plain and Aldershot.
Following profits warnings from other construction and facility operators, the issue of counterparty risk has risen up HICL’s agenda. ‘Contingency plans are in place to ensure continuity of operations if one or more of the group’s PPP projects are affected by the failure of a subcontractor,’ the company said.
Harry Seekings, infrastructure director at Infrared Capital Partners, HICL’s investment adviser, said: ‘This is not just about Carillion.’ He declined to give more details but said the company had a range of options, according to circumstances, from switching to another contractor or managing a facility itself.
PFI risk minimised
The risk of a contractor failure follows a period in which political uncertainty has been uppermost in HICL shareholders’ minds. Shares in HICL have slipped, lowering their premium rating, since last month when Labour shadow chancellor John McDonnell threatened to bring PFI contracts ‘in-house’.
Stella Creasy, a prominent Labour backbencher, has intensified the political pressure with a call for a windfall tax on PFI operators which she said had benefited from successive cuts in corporation tax.
HICL today sought to reassure investors that in the unlikely event that a future Labour government terminated all PPP and PFI contracts, the maximum hit to its portfolio would be 4%. The company said it had deliberately restricted its exposure to contracts where compensation on termination by the government or local authorities was linked to a formula and not their market value.
As a result, 88 of its UK investments - out of a global total of 115 - worth £1.9 billion ‘are in PPP projects and demand-based assets that have contracts where either a) the public sector counterparty has no right to voluntarily terminate or b) where the public sector counterparty has a right to terminate, compensation payable would be calculated by reference to the prevailing market value of the investment,’ HICL said.
‘We caution against drawing firm conclusions from analysis based on scenarios that are unrealistic and extrapolated to precisely quantify the effects of portfolio-wide voluntary termination,’ HICL added.
Possible move onshore
Amid heightened sensitivity of offshore companies following the leaked 'Paradise Papers, HICL's board is following the cue of fellow Guernsey-based JLIF in considering moving to the UK and becoming an investment trust.
Both London-listed funds originally domiciled in the Channel Islands to ensure that private investors would not pay more tax than the institutional investors in their infrastructure projects.
'We would not expect this to have any material impact for the company itself, although we note that the tax treatment of interest income for certain UK shareholders would, under current legislation, be different in this scenario,' HICL said.
Tax rise, no problem
On tax, HICL has calculated that a 5% rise in corporation tax would knock 4.6p from its net asset value (NAV) per share. This rose to 151.6p from 149p in the six months to 30 September, partly helped by rising inflation lifting the value of its UK index-linked investments.
Although Seekings admitted the calculation did not address the impact of a possible windfall tax, he said it showed the limited exposure that it - and all other businesses - would face from any future tax hike.
The half-year period was busy for HICL which raised money from shareholders for big investments in Affinity Water and High Speed 1. Seekings said acquisition activity would be ‘muted’ for the remainder of the year as the company bedded down these investments and responded to a decline in new PFI contracts due to political uncertainty after this year’s general election.
Early next year HICL hopes to win a contract to run a transmission link between North Sea wind farms and the national grid, which will require a £10 million investment. Beyond that it will continue to look for opportunities in the UK, Europe and US, Seekings said.
As a sign of its confidence, HICL issued new guidance for its dividends in 2019/20, saying it would aim to pay 8.25p per share. It reaffirmed its intention to pay quarterly dividends of 7.85p this year, rising to a target of 8.05p next year.
The shares firmed a penny to 157.6p, on a 5% yield and a 6% premium to their estimated NAV, according to Morningstar.
Iain Scouller of Stifel Funds said 'this is a good set of results, in our view, with the NAV just above our estimated range', adding he was pleased to see HICL address the 'key issues' of investors in its comments. He maintained his 'buy' recommendation, which he upgraded from 'hold' in June.
Matthew Hose of Jefferies described the results as 'solid' and said the company had 'reassured on a number of fronts'. He stuck with his 'hold' rating with a 158.2p price target.