You could argue that investing in infrastructure is boring. Long-term contracts, predictable cash flows, must-have assets, availability rather than demand-linked revenues, inflation-linked income and counterparties with strong credit ratings ought to make for ‘sleep at night’ investments.
For many years, the ratings on listed infrastructure funds reflected these characteristics. That all changed in 2022 as interest rates started to rise. Money was diverted into cash deposits and bonds. Selling pressure allowed discounts to open up, that left some investors disillusioned, which compounded the problem.
Today, even though rates are coming back down again, every London-listed infrastructure fund is trading on a discount. However, the security of income from these funds was not really in doubt. Trusts kept hiking dividends and now they all trade on attractive dividend yields.
While all of these funds look too cheap to my eyes, one rating appears particularly anomalous – that of GCP Infrastructure, a £700m market cap investment company. Managed by Phil Kent and Max Gilbert, supported by an experienced team at Gravis, the company invests across a range of different infrastructure sectors, although its focus has shifted more towards renewable energy infrastructure over the last few years, which gives it strong environmental, social and governance (ESG) credentials.
The main difference between GCP Infrastructure and the bulk of its peers is that it structures its investments as loans. That means they are protected by a ‘cushion’ of equity that takes the first hit if anything goes wrong. However, that margin of safety is not reflected in its rating.
Barring Digital 9 Infrastructure (which took a number of wrong turns and is now in wind up mode), GCP Infrastructure’s shares trade on the widest discount (currently almost 30%) and the highest yield (9.2%) within its infrastructure subsector.
My belief is that the company was particularly badly affected by selling pressure related to the cost disclosure problems that have plagued the investment company sector but, fortunately, are now being addressed.
In an effort to remedy its discount, the board of GCP Infrastructure launched a capital recycling programme in 2023. The ambition was to release £150m (roughly 15% of the portfolio) to rebalance sector exposures, apply funds towards a material reduction in the revolving credit facility and support the return of at least £50m in capital to shareholders before the end of 2024.
GCP Infrastructure’s first disposal, raising £31m, was of its interest in loan notes secured against a 52.9MW Scottish wind farm. The price was a 6.4% premium to asset value and the money was used to reduce the outstanding balance on its revolving credit facility. By the end of September 2024, that balance was down to £57m (from £154m as at end December 2022 and £104m as at 30 September 2023).
However, the company has dropped a heavy hint that something more substantial is in the works. On 24 October 2024, it announced its net asset value as at end September 2024. The figure (105.22p per share) came in a little lower than the value at end June.
Normally, GCP Infrastructure would provide a detailed breakdown of the underlying movements that contributed to this, but this time it declined to do so. The statement said the company is in active due diligence and negotiations on disposals of material components of its investment portfolio and does not wish to risk such processes through publication of further detail on the constituent movements in the NAV.
It sounds to me as though we could be on the verge of a disposal large enough to restart its buyback programme. Currently, this has not been reflected in the share price, which feels like an opportunity too good to pass up.
There is more to GCP Infrastructure than the short-term discount narrowing opportunity and the chance to lock in an attractive yield. The manager sees the potential to use the capital recycling programme as a way of improving the quality of GCP Infrastructure’s portfolio, reducing the portfolio’s sensitivity to factors such as volatile power prices and removing exposure to supported living accommodation (thereby reducing the duration of the portfolio).
At the end of June 2024, supported living accounted for around 12% of the portfolio, around a quarter was exposed to private finance initiatives, public-private partnerships and similar assets, and the balance to a broad spread of renewables assets. These range from onshore wind and solar, through to geothermal (it financed a well that is being used to heat the Eden project in Cornwall) and electric vehicle charging.
In addition to the disposal activity related to the capital recycling programme, there is a natural pattern of loan maturities and reinvestment. The advent of higher interest rates is allowing the managers to improve the portfolio’s risk-adjusted returns. Once the disposal programme is complete, I would expect that the improved quality of the portfolio will be easier to appreciate. That should support a more permanent narrowing of the discount.
James Carthew is head of investment companies at QuotedData. Thew views expressed above should not be taken as investment advice.