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Optimism remains despite challenging year for GCP

GCP Infrastructure Investments (GCP) announced its annual report for the year ended 30 September 2023. Total NAV return for the year was 3.7% while total shareholder returns fell 25.2%. The discount sat at around 40% at the last close while the weighted average dividend was 7.9%. The company also saw a considerable fall in profits which decreased to £30.9 million from £140.3m the year prior due to a combination of factors including lower electricity prices and generation and revaluations in respect of discount rate adjustments.

The company highlighted the challenging conditions throughout the year, including the ongoing war in Ukraine, and the UK’s mini-budget in September 2022. However, the board believes the discount at which the company’s shares have traded to the stated NAV is not reflective of the strength in the company’s underlying investment portfolio, with the effective yield considerably higher than the discount rate on investments determined by the independent valuation agent. Despite this, underlying portfolio performance remains strong.

Capital allocation policy

Following the termination of merger discussions with GCP Asset Backed Income and RM Infrastructure Income, the GCP Infrastructure board has reconfirmed its intended capital allocation policy for the forthcoming year:

  • prioritise the reduction of leverage whilst interest rates remain high, by using capital proceeds from disposals and refinances to repay the RCF;
  • improve the risk adjusted return of the existing portfolio by reducing equity risks as well as exposure to the social housing sector; and
  • buy back the company’s shares while they remain an attractive investment opportunity and/or otherwise return capital to shareholders.

At the year end, the average term of the portfolio was ten years. The company has historically been able to complete strategic refinances and disposals before the end of the term of the loan. [Though this was easier when rates were falling and borrowers were keen to refinance.] For the forthcoming financial year, the board and investment adviser intend to refocus on refinances and disposals. Subject to market conditions and the ability to agree acceptable terms, the board has set a conditional target of releasing £150m (about 15% of the portfolio) of funds in order to materially reduce the RCF and return at least £50m of capital to shareholders before the end of the calendar year 2024, whilst maintaining the dividend target.

The board believes that the capital allocation policy will emphasise the company’s position as a leading investor in infrastructure debt, with a strong focus on sustainable investments.

[Both the proposed merger partners had shorter duration portfolios than GCP and combining with either would have made this process easier. Nevertheless, this seems like a step in the right direction and hopefully will go some way to tackling the absurd discount (39.4% at last night’s close) that the fund’s shares trade on.]

Chairman’s comments

Commenting on the results and the outlook, chairman, Andrew Didham added:

“Bank of England base rates, which at the time of writing are 5.25%, have increased throughout the financial year in a bid to reduce inflation. Whilst year-on-year CPI peaked in October 2022 and has since fallen, it is still materially above the Bank of England’s target rate of 2.0%. Markets have predicted that interest rates will reduce in time, but are set to remain higher for longer than markets were pricing earlier in the year.

“Energy prices have fallen from the highs experienced in the previous financial year, but like interest rates, they are predicted to stay higher for longer than in this period last year. Furthermore, the UK has retained its commitment to decarbonise the electricity grid by 2035. Despite this commitment, and the need for new renewable electricity generation infrastructure to achieve it, there were no bids to build new offshore wind capacity under the most recent contracts-for-difference auction round run by the UK Government. The Committee for Climate Change has expressed concerns to Parliament about the pace of change required to meet the UK’s climate goals over the course of the 2030s. The failure to secure bids to build incremental offshore wind generating capacity is likely to make these targets even harder to achieve, which will likely lead to higher power prices for longer.

“A total of 41% of the portfolio benefits from some form of inflation protection, meaning that higher inflation is set to benefit the existing portfolio. In addition, renewable energy generators make up around two-thirds of the portfolio and are set to benefit from power prices being structurally higher than when the company originally invested. Thus, the current market and market outlook are positive for the company’s portfolio.

“Higher interest rates have caused a shift in credit markets and, as a result, opportunities to make new loans within the company’s risk appetite at rates of interest that reflect the steep change in rates across asset classes may emerge. Given the continuing need for new infrastructure to decarbonise the economy, the board is confident in the investment adviser’s ability to continue building a pipeline of attractive investments for the company. This gives the company the opportunity to reset the long‑term returns on its investments at a higher yield when it resumes investment activity.

“As noted above, the Board is focused on maximising value for shareholders by reducing leverage, disposing of assets where pricing is attractive to generate funds and optimise the portfolio, and buying back shares, given the attractive risk adjusted returns from doing so, before making any new investments.”

Optimism remains despite challenging year for GCP

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