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Ecofin Global Utilities and Infrastructure off to a good start

Ecofin Global Utilities and Infrastructure off to a good start – Ecofin Global Utilities and Infrastructure Trust has published annual results. The company’s shares were first listed on the London Stock Exchange on 26 September, 2016 and these results are for the financial year which ended on 30 September, 2017.  In that period, the net asset value per share increased by 7.2% on a total return basis (assuming the reinvestment of dividends) compared with a total return for the MSCI World Utilities Index of 5.8%, for the MSCI World Index of 14.9%, and for the All-Share Index of 11.8%. The price of an ordinary share rose by 20.9% on a total return basis in the financial period. Four quarterly dividends of 1.6p each, totalling 6.4p, were paid, providing a dividend yield of 4.8% on 132p, the price of the company’s ordinary shares as at 18 December, 2017.

Manager’s report

The manager gives a comprehensive report on the sector and the fund’s performance which we reproduce below:

A distinguishing characteristic of the utilities and infrastructure sectors over the course of the financial year was the marked differences in the performance of countries and regions, as shown in the chart on page 4 of the Annual Report and Accounts. The FTSE ASX Utilities Index declined by 9.0% over the year on a total return basis while the Euro Stoxx Utilities Index of Euro-zone utilities rose by 21.7% on a total return and Sterling basis. The U.S. S&P 500 Utilities Index rose by 4.4% on the same basis. 

Following the listing of the Company’s shares, the NAV per share fell as yields on U.S. government bonds rose in November and December; the NAV per share reached a low in mid-December. From then until the end of the financial year, the NAV per share recovered, ending up 14.5% from its December 2016 low. This was attributable to a number of factors including favourable trends in Europe and, most importantly, the Company’s asset allocation – which included a relatively high exposure to Continental Europe – and stock selection

Sector and portfolio developments 

After years of under-performance, Euro-zone equity markets were strong over the course of the year. Business activity increased and corporate earnings improved while the European Central Bank’s monetary policies continued to be very accommodative. Politically, fears that far-right or populist parties would come to power proved unfounded with the victory of centrist parties in the Dutch, French and German elections. These favourable trends coincided with an increase in electric power prices – the first in many years – which delivered a clear and unexpected boost to the Continental utilities sector. By the Company’s year-end, German and French forward power prices had risen by some 60% from the lows reached in the first half of 2016, driven largely by higher coal prices. In addition, the utilities sector in Europe saw a revival of take-over speculation and corporate activity; in September 2017, the Finnish utility Fortum made an unsolicited bid for Uniper, a publicly-traded affiliate of the German integrated utility E.ON. Six of the ten best performing holdings in the Company’s portfolio over the course of the financial year were Continental European regulated and integrated utilities: Italgas, Uniper, E.ON, Enel, Innogy and Terna. 

U.S. power prices also started to move higher during the year and the North American portfolio rose just over 7%, in line with its local sector index (in Dollars). The best contributors to the NAV’s advance were the renewables companies NextEra Energy Partners and Algonquin Power & Utilities, both amongst the Company’s ten largest holdings; InfraREIT, which owns transmission assets, also performed well. 

U.K. utilities, to varying degrees, suffered from uncertainties of a political and regulatory nature for much of the year and especially during the second half. The uncertain political context depressed valuations as did growing pressure from regulators to cut returns, both for water and electricity retailers. During the year to 30 September, the poorest performers in the portfolio were National Grid (-11.9%) and United Utilities (-11.1%); water stocks Pennon and Severn Trent also performed poorly in the second half of the year (both c. 7% lower). Shares in SSE, a larger holding in the portfolio, declined by 5.1% over the year.

Infrastructure exposure in the portfolio is quite diversified geographically. Direct energy infrastructure exposure – in gas pipelines – has been gained through holdings such as Williams Companies in the U.S.; water infrastructure is included in both the U.S. and pan-European portfolios; and the Company invests in airports and toll roads in Europe (Vinci, ENAV, Flughafen Zuerich) and in China (Beijing Airport). While not strictly regulated per se, these infrastructure businesses are centred on long-term contracts which include a high degree of utility-type inflation pass-throughs and quasi-regulated pricing formulas. 

There were no dramatic changes in strategic geographic allocations during the financial year. The portfolio began the year with a ‘transatlantic balance’, with approximately 45% of the portfolio invested in North America, 45% in Europe (including the U.K.) with the remainder invested in other OECD developed markets and emerging markets. As the year progressed, however, the portfolio became more heavily weighted towards Europe as the result of tactical allocations in response to market movements or regulatory and political developments and also as a result of superior performance. By year-end, approximately 53.5% of the portfolio was in pan-European equities, 37.6% in North American shares, 4.7% in other OECD markets and 4.2% in emerging markets. 

At the end of 2016, we increased our exposure to companies with quality long-duration business models and to renewable energy companies. Notwithstanding the strong fundamentals and dividend paying capacity of the Company’s U.S. holdings, over subsequent months our buying programme centred on European shares as the sell-off in the European utility sector had been even more pronounced than in the U.S. We concentrated buying activity in the worst affected European stocks, expecting the rapid and seemingly indiscriminate falls would reverse as the interest rate environment, in particular, stabilised. These companies included a host of regulated utilities, commodity-driven names and a number of infrastructure companies: EDF, Suez and Veolia in France, Enel, Italgas and Snam Rete Gas in Italy, EDP Renovaveis in Portugal, and Ferrovial in Spain. 

In Continental Europe a large proportion of the names in the Company’s portfolio are hybrid by nature, in the sense that they include both fully regulated businesses and more growth oriented segments. This is typical of the utilities and infrastructure universe in Europe. Engie, for example, invests in largely unregulated businesses and services but also controls France’s fully regulated gas transportation network. As a consequence, the share prices of these conglomerates tend to be less influenced by movements in long-term interest rates than many utility companies in the United Kingdom and the United States where business models are often more focused. 

Given President Trump’s proposed new policies which could have a significant impact on the economics of U.S. renewables and specifically on new projects, we reduced exposure to some renewable energy developers to focus on operators that earn their returns on an existing fleet of renewable energy assets, among which are the so-called ‘yieldcos’ in the U.S. At the time we reiterated our view that the key driver for long-term growth in renewables installations – not just in the U.S. but worldwide – is not regulation but economics, propelled by technological change and cost reductions. U.S. wind and solar generation, for example, are now cheaper than coal-fired power generation and competitive with gas. This has led to significant growth in bilateral contracting by large corporates replacing grid-procured electricity with self-procured renewable energy. 

We lightened U.K. equity exposure as the U.K. government threats to cap energy prices pressured the sector. Around the same time, we reduced exposure to French names ahead of the first round of elections and hedged, very briefly, a proportion of the Euro exposure. 

The rest of the portfolio, on average 9%, was committed to other OECD markets – in this case, Australia and New Zealand – and to emerging markets, specifically Hong Kong, the Philippines, Thailand and Brazil. The number of holdings in this segment increased from five at the Company’s inception to seven by the financial year-end with the additions of B Grimm Power in Thailand and Mercury in New Zealand. The percentage allocation increased from 6.4% at the beginning of the financial year to a high of 11% in May 2017 as a result of these additions and also good performance. By the summer, the weighting had retreated because we trimmed Mercury NZ and Transmissora Alianca in Brazil and tendered the Company’s EDC shares into a partial bid for cash for the majority of that company’s shares. 

Names which merit mention are NextEra Energy Partners and Algonquin Power & Utilities, which are both amongst the portfolio’s largest holdings, and B Grimm Power. NextEra Energy Partners (NEP) is a listed subsidiary of NextEra Energy Inc. which is a top quality integrated power company based in Florida and the fourth largest generator of electricity – and one of the largest operators of solar generating facilities – in the United States. NEP, a yieldco, was formed in 2014 and owns fully contracted wind power facilities. NEP’s cost of (debt and equity) capital is low, on an absolute and relative basis, enabling the company to fund projects, grow, and pay growing dividends to shareholders

Early this year, NEP decided to make a change in its ‘incentive distribution rights’ allocation, meaning that holders of NEP would receive 75% of incremental cash flow growth rather than 50% as previously, and this has been highly supportive for the value of NEP’s shares, as it limits its need for future equity raises. NEP has been one of the strongest contributors to the Company’s NAV progression since launch. 

Algonquin Power & Utilities’ performance has been less spectacular but steadily additive nonetheless, and the shares figure in the Company’s roster of top NAV contributors for the year. Algonquin’s business is described on page 8 of the Annual Report and Accounts. 

B Grimm Power, which was listed by IPO in July 2017, operates green-field power plants in Thailand and Vietnam. The company is growing quickly organically and by acquisition, and appeared undervalued relative to its international peers at the time of the IPO. The shares rose c. 40% between July’s IPO and the end of September 2017. 

The portfolio’s poor performers during the year were a shorter list and included EDP Renovaveis, which we exited on its lows last December in favour of other European names which subsequently performed, and Plains Group Holdings, one of the US’s largest crude oil transporters whose shares dropped some 20% after its limited partnership decided to cut distributions to unitholders in order to deleverage. Other laggards included Covanta, National Grid and SSE. 

Although exposure has been pared, we continue to believe that select U.S. midstream energy infrastructure companies are well positioned for higher earnings and accelerating dividend growth given the higher oil and gas production volumes and the significant new pipeline capacity underway to accommodate it. Although we are wary of this sector’s sensitivity to oil prices, some companies, like Williams Companies, are more insulated and the sector is conspicuously out of favour.”

EGL : Ecofin Global Utilities and Infrastructure off to a good start

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