Political risks on PFI deals may be overstated, but 3i looks to be the best bet, says Max King.
“Those who cannot remember the past are doomed to repeat it,” said writer George Santayana. The headlong rush by politicians, media and public opinion to condemn PFI deals and all related cooperation between the public and private sectors promises to take us back to the bad old days of public-sector procurement and under-investment.
A year ago, everything was running smoothly for the infrastructure funds. There were no operational problems or threats; shares that carried an attractive and steadily rising dividend in a seemingly never-ending era of low interest rates, were trading at healthy premiums to net asset value (NAV), and firms were regularly issuing new shares to finance value-enhancing acquisitions.
Now, though, it looks very different. Rising interest rates and bond yields have undermined the attractiveness of the yields, the Labour party has promised to nationalise PFI projects and the collapse of Carillion has reminded investors that the subcontracting of maintenance does not eliminate all of the risk. The share prices of infrastructure funds have gone from significant premiums to NAV to discounts.
This could present a compelling opportunity for investors. As David Stevenson points out in this week’s cover story, shares in HICL represent better value than they did – they yield 5.4% for the year ending 31 March 2018 with a 5% dividend increase promised in 2019. With provisions of £59m for its exposure to Carillion, the company claims to have taken a “prudent view” of the likely outcome.
As for the political risk, Christopher Brown of JP Morgan Cazenove puts it succinctly: “We have estimated that the cost of nationalising all PFI projects would be around £174bn. Labour has the challenge of explaining to the electorate why incurring debt of such large quantities for ideological reasons would be so much better than the alternative of spending it directly on the NHS and schools.” Moreover, as bond yields rise, the cost of financing the additional debt is increasing.
Still, some caution may be justified. The National Audit Office’s recent assessment of PFI was “luke-warm at best and damning at worst”, as Kieran Drake of Winterflood Securities, puts it. This supports a broad public perception that PFI has been a poor deal for taxpayers. At the same time, though, the Carillion fiasco is making PFI providers realise that, with fixed price contracts and slim margins, they have been taking on too much risk.
All of the funds have implicitly accepted the declining attractiveness of UK PFI by diversifying their portfolios. In September 2015, PFI accounted for 99% of HICL’s assets and the UK for 89%; now those figures are down to 74% and 80%. Assets purchased in the last 30 months include the HS1 fast rail link and Affinity, which supplies 1.5 million customers in the home counties with water.
INPP has invested in National Grid’s gas distribution network, while JLIF has invested in the Barcelona Metro and service stations in Connecticut. BBGI, which has UK exposure of just 42% of its portfolio, has increased investment in Canada. These three funds have lower exposure to Carillion, more assets overseas and less exposure to UK PFI than HICL, although investors should keep in mind that some of the other assets (non-PFI assets in the UK and assets overseas) have at least as high operational, political and regulatory risk as PFI projects.
3i Infrastructure (LSE: 3IN) looks a better bet. Only 7% of its portfolio is in UK PFI and exposure to Carillion is less than 1%, but its share price has suffered along with the others. At 197p, it trades at a 3% discount to Brown’s 205p estimate of current NAV. This has been boosted by two recent sales that together added 26p to NAV: Anglian Water and Elenia, the Finish electricity distributor.
3IN is expected to return 20% of net assets to shareholders, but this will still leave 20% of remaining net assets in cash for future investment. The 4% dividend yield, growing faster than inflation, is less than its rivals, but its capital performance is far superior, while its low exposure to the controversies of PFI should make it immune from UK politics.