Virtues of diversification

Ecofin Global Utilities and Infrastructure Trust (EGL) has generated strong returns during the last 12 months, despite broader macro-economic challenges which include persistent inflation, rising geopolitical concerns, and issues around renewable energy policy in the US. Over the 12 months to 30 November, the portfolio delivered a NAV total return of 20.5% and a share price total return of 22.1%. EGL’s manager thinks that this highlights the value of its diversified approach with exposure across multiple sectors and geographies allowing it to capitalise on the drivers fuelling the energy transition and global infrastructure cycle.

It adds that the structural increase in the earnings of the utilities and infrastructure sectors in which EGL invests, driven in particular by the acceleration in total electricity demand growth, provides an attractive opportunity for investors. The manager comments that this is made even more compelling by the underlying valuation of the portfolio, which trades at a significant discount to current benchmark multiples.

Developed markets utilities and other economic infrastructure exposure

EGL seeks to provide a high, secure dividend yield and to realise long‐term growth, while taking care to preserve shareholders’ capital. It invests principally in the equity of utility and infrastructure companies in Europe, North America, and other developed OECD countries.

Source: Morningstar, Marten & Co

Market backdrop

In our last note, published back in June, we discussed EGL’s manager’s view that a combination of strong earnings momentum, high visibility, and attractive valuations across EGL’s portfolio provided an excellent opportunity for investors. The manager says that this has only become more compelling in recent months as markets confront a challenging combination of tepid economic growth expectations, stubborn inflation, and elevated geopolitical concerns, all while valuations at the index level have continued to climb.

US inflation was 2.8% in October, the highest reading in over six months.

Although the sharp fall in inflation has been widely seen as a positive, with the view that this could allow interest rates to begin to normalise, it appears that the final leg towards central banks’ 2% inflation targets has been more of a struggle than had previously been anticipated, notably in the US. In recent months, inflation has continued to come in above expectations, with the latest data showing a year-on-year growth rate in the Fed’s preferred measure of inflation (personal consumption expenditures) of 2.8%, the highest reading in over six months.

The picture appears to have been muddied further by the outcome of the US election, following the Republican sweep of the Presidency, House, and Senate. There has been considerable commentary that anticipated policy changes – including trade, immigration, and tax – are expected to be inflationary, which appears to have been the main driver behind treasury yields moving upwards.

On a relative basis, US equity index multiples are now the highest since data began over a century ago

This apparent combination of stubborn inflation and nominally restrictive financial conditions seems to sit at odds with equity markets which have continued to climb. On a relative basis, US equity index multiples are now the highest since data began over a century ago, and now make up over 70% of the global benchmark – for comparison, this was around 30% in the 1980s.

In Europe, inflation appears to be less of a concern, however in conjunction with anaemic growth (which has also been a factor in the UK), the picture is looks somewhat far from rosy, with heightened political uncertainty in both Germany and France another concern.

Modern utilities

Due to the resilience and visibility of their earnings across economic cycles, EGL’s manager continues to beat the drum for the modern utility and infrastructure companies that EGL holds. It believes they could provide an excellent hedge for current market conditions, highlighting that these companies defensive characteristics were evident during the peak of the post pandemic inflation surge, as earnings growth remained positive thanks to the sector’s effective pricing power (as operators of essential infrastructure) and exposure to government subsidies, hedging strategies, inflation linkages, and long-term fixed-price contracts.

As we discussed in our previous note (which you can read here), EGL’s manager argues that these companies can no longer be considered simple defensive plays due to their evolving business mixes (i.e. much less conventional generation and commodity price exposure) and modern revenue contracts derived from clean energy production and distribution. As Figure 1 highlights, many utility companies now look capable of providing earnings and dividend growth comfortably ahead of broader market averages.

Figure 1: S&P 500 Utilities EPS growth

Source: Bloomberg

An example of this is the performance of EGL portfolio companies Vistra and Constellation. The two US utilities are in the top 10 best performers in the S&P500 so far this year, having been beneficiaries of the downstream effects of the AI boom (they are both capable of providing decarbonised baseload energy to fuel the increasing power demands of energy-hungry data centres). The managers note that this power demand is expected to increase by a factor of five from today’s level in the US, to around 107TWh by 2027.

Power used for AI is expected to increase by a factor of five from today’s level in the US, to around 107TWh by 2027.

Illustrating the potential upside of these changing demand dynamics was the recent announcement that Microsoft has agreed to purchase the entire output of Constellation’s 835MW nuclear plant at Three Mile Island, which will come back online in 2028. Constellation estimates that this capital investment shifts its earnings per share growth rate to c. 13% p.a. for 2024-2030, versus 10% p.a. previously.

The scale of these moves – and the strong performance of US utilities generally – has helped drive EGL’s NAV higher over the last few months, and whilst the opportunity provided by data centre growth and AI could be significant, as we discuss in the asset allocation section, this is just one component of the broader energy transition and infrastructure development cycle providing long-term, which EGL’s manager expect to provide structural growth for EGL.

However, despite these fundamental changes, EGL’s manager comments that the sector has been neglected by generalist investors, leading relative valuations to fall below levels seen during the worst of the GFC. Whilst there has been a positive inflection off these lows, valuations remain deeply depressed it adds. This could give investors the opportunity to buy resilient, secular growth themes at a marked discount to current benchmark multiples.

Figure 2: US utilities P/E ratio relative to US equity P/E ratio

Source: Morningstar, Marten & Co

Portfolio – Asset allocation

EGL focuses on assets its manager believes have high barriers to entry, effective pricing power, sustainable growth and predictable cash flows.

One of the key factors driving the managers’ investment decisions is the belief that the market still views the utilities sector as mostly homogenous, failing to recognise what it sees as the deep structural changes that have occurred over the past decade. The manager says that it has been able to capitalise on these dislocations, with the portfolio trading on a significant discount to equivalent market benchmarks.

EGL’s manager says that the growth capabilities of many of these companies have advanced well past the plus or minus GDP characterisations with which they have often been associated. It cites the performance of Vistra and Constellation as evidence of this but adds that this transformation goes well past changes to the energy market. For example, it highlights both the construction and transportation company Vinci, which it says continues to drive impressive returns from its toll roads and airport concession investments, and the environmental services company Veolia, particularly around the structural growth in water services and related technologies such as desalination and mobile water treatment. Both companies have been recently had their weights increased within the portfolio and are now top 10 holdings (discussed on page 8). The manager comments that both these European assets trade at significant discounts to their American peers.

Portfolio developments

As Figures 5 and 6 show, there have been some changes to EGL’s geographic allocations over the course of the year, with a notable reduction in North American exposure due to profit taking after a very strong period of performance for US utility holdings, which is offset by an increase in Europe. The UK has also seen a modest decrease. As is usually the case with EGL, these changes reflect stock choices and reflects the manager’s effort to capitalise on what it describes as increasingly favourable valuations in European infrastructure and utilities companies, which trade at around a 50% discount to their US peers.

Top 10 holdings

Since we last published, European energy distribution network operator E.ON and French transportation and infrastructure company Vinci have moved into the top 10, replacing utilities, American Electric Power and RWE.

Figure 9: Top 10 holdings as 31 October 2024

Source: Ecofin Global Utilities and Infrastructure Trust, Marten & Co

E.ON

EGL’s manager cites E.ON as being a good example of the favourable valuations on offer in the European market. The German integrated utility trades on a forward P/E of just 10.9x, around a 20% discount to its European peers, and almost 40% to those based in the US. The company is one of EGL’s more defensive positions, both from a valuation standpoint and in terms of its large, regulated asset base, which can provide highly stable and visible earnings.

Figure 10: E.ON (EUR)

Source: Bloomberg

The company has undergone significant restructuring over the last few years, selling off much of its generation assets to focus on becoming a pure play network operator. It continues to make considerable investments in grid infrastructure development, recently announcing a 27% increase to its five-year investment target which now sits at €42bn. With the IEA’s most recent World Energy Outlook predicting that global network infrastructure will need to be doubled, EGL’s manager says that there is a massive opportunity for operators such as E.ON that have the scale to capitalise on the level of development required. The company has delivered solid improvements in its profit outlook in recent years as its asset base expands and is expected to deliver annual EBITDA growth in the high single digits through to 2028.

Whilst fundamentally a defensive play, E.ON offers significant upside, particularly following the recent weakness in its shares as a result of German political uncertainty, which the managers have taken as an opportunity to add exposure. It trades on one of the most attractive valuations in the sector, with the manager noting that it appears to have slipped off other investors’ radar since the sale of its generation assets. In addition, the company offers an attractive dividend yield of 4.7%.

Vinci

Figure 11: Vinci (EUR)

Source: Bloomberg

Vinci is a French-based developer and operator of global transport infrastructure concessions such as motorways and airports (including Gatwick and Edinburgh in the UK), energy infrastructure and construction around the world. The company is active in nearly 120 countries and has been in EGL’s portfolio for several years with the position being steadily increased, most recently in October, as the managers were looking to add exposure to what it sees as high-quality European infrastructure names.

EGL’s manager says that, thanks to its diverse asset base, Vinci has been able to deliver reliable, annualised free cashflow growth of almost 12% over the last decade, which has allowed it to consistently pay a dividend of around 4%. It adds that, despite this, Vinci trades on a forward earnings multiple of 13, which it thinks is too cheap. Although this would appear to reflect concerns around the impact of newly announced French taxes, and the expiry of some of its existing road tolls over the next decade, EGL’s manager says that, on balance, its track record of stability and exposure to multiple secular growth markets comfortably offset these.

The manager adds that the company also provides an excellent hedge for business cycle risk going forward, with the bulk of its revenue attached to crucial infrastructure, while a more volatile inflation outlook would also be a positive given its ability to directly pass on rising costs to the consumer, making it a strong diversifier within EGL’s portfolio.

Additional developments

The managers have been active in recent months, reducing gearing in the lead up to the US elections, and adjusting allocations to reflect relative performances across the company’s universe. This included profit taking among US utilities which were strong performers for the first nine months of this year (including NextEra Energy, AEP, Constellation, Vistra, Edison).

In addition, new positions in Belgian power grid operator Elia and US environmental service provider, Waste Management were added.

Elia Group

Figure 12: Elia Group (EUR)

Source: Bloomberg

Elia is one of the largest power grid operators in Europe. Its inclusion in EGL’s portfolio increases the trust’s exposure to regulated networks on the continent, with the aim of capitalising on the growing demand for grid infrastructure development. The company’s shares have been deeply depressed in recent years, falling almost 50% from their peak reached in 2022, with the regulated energy sector suffering from concerns around leverage, and the impact of regulatory adjustments.

However, Elia maintains one of the strongest asset base growth profiles amongst its peers according to EGL manager, who says that the company is well exposed to the structural growth opportunities driven by the EU’s climate targets, and the increase in total power demand which in Belgium is expected to double over the next 20 years.

It adds that power network infrastructure investments have increased dramatically in recent years, with capex expenditure plans suggesting spending in western Europe could rise to around $120bn in 2025 and $166bn in 2026, from just $60bn in 2024. It believes that this will Elia and other regulated utility providers the ability to expand their assets, with Elia seen to be particularly well positioned given their access to external capital to drive their capex plans. EGL’s manager says that this has already led to improvements in the company’s profit outlook, and there remains a long runway for growth in its view.

Waste Management

Figure 13: Waste Management (USD)

Source: Bloomberg

Waste Management is the largest garbage collection, transportation, processing, and disposal operator in the US. EGL’s manager says that the company provides the trust with exposure to above-trend US growth, while allowing it to diversify away from some of the pure play US utilities that have performed strongly this year.

The manager adds that the company provides monopoly-like exposure to a sector which is relatively uncorrelated to broader market cycles, noting that it provides highly predictable cash flows and, thanks to its scale and vertical integration, maintains considerable pricing power, insulating it from any re-inflation risks. A forward multiple of 27x earnings is a reflection of these dominant characteristics in the manager’s view. It comments that it is willing to pay up for high-quality assets when suitable.

The manager believes the company should benefit from multiple positive structural drivers, including the significant increase in infrastructure spending in the US (discussed in our previous note) and an accelerating focus on sustainability and recycling. Operational improvements from industrial automation, fleet upgrades, and healthy M&A potential could provide additional upside.

Performance

Figure 14: EGL’s NAV total return relative to benchmark indices, over five years to 30 November 2024

Source: Morningstar, Marten & Co

Figure 15: Cumulative total return performance over periods ending 30 November 2024

Source: Morningstar, Marten & Co. Note 1) EGL was launched on 26 September 2016. Note 2) Volatility is the annualised standard deviation of daily returns over five years.

Annual Results to 30 September 2024

On 17 December, Ecofin Global Utilities and Infrastructure Trust (EGL) announced its annual results for the year ended 30 September 2024. The company delivered an NAV total return of 25.9%. This was ahead of comparable infrastructure and utilities sector returns as well as that of the global MSCI all countries world index, despite a significant headwind from sterling strength. The company’s share price total return was 24.8%. Four quarterly dividends were paid during the period totalling 8.10p per share. Due to the board’s confidence, the quarterly dividend will be increased by 3.7% to 2.125p per share (8.5p per share per annum) which is applicable from February 2025.

Discussing the performance, chairman David Simpson noted:

“Performance was positive across the utility, environmental services and transportation infrastructure portfolio segments during the year, and especially strong in the US. Stock selection was beneficial. The portfolio was well positioned for the recovery in share valuations of utilities and the resurgence in interest in nuclear power. With heightened market volatility, our investment manager also found opportunities to manage position sizes profitably. A modest level of gearing boosted underlying returns.”

Trump effect

Having delivered strong returns over the first 10 months of the year, EGL’s portfolio took a modest towards the end of October as rising bond yields and the potential impacts of a Trump presidency and Republican sweep appeared to weigh on clean energy stocks and the traditionally more interest rate sensitive sectors of the market. As we have noted, clean energy benchmarks have dropped around 20% from the beginning of October as it appeared that markets were beginning to price in a Trump presidency. The peak to trough drawdown was less than half, at around 10% for EGL, which its manager says reflects the benefits of its broad infrastructure and utilities diversification.

YTD, EGL has delivered a NAV total return of 20.5% and a share price total return of 22.1% though to 30 November.

Despite the impact of the impending Trump presidency, year to date, the company has delivered a NAV total return of 20.5% and a share price total return of 22.1% though to 30 November. This has been achieved despite the portfolio having significantly less in the US which now accounts for almost 70% of global equity indices.

The recent weakness across the clean energy sector and EGL’s relative underweight to oil and gas infrastructure, which has a significant weight in the S&P Global Infrastructure Index, has meant the company now trails marginally behind the global utilities and infrastructure benchmarks over the year to 30 November. Despite this modest underperformance, EGL has still comfortably outperformed these indices over the long term, as highlighted in Figure 15.

EGL’s manager believes that the structural upside for power producers in both the US and abroad is still significant, while investments spread across the infrastructure and utilities sectors provide significant growth potential, especially considering the relative valuations of the EGL portfolio.

Premium/(discount)

Over the 12-month period ended 30 November 2024, EGL’s shares have traded between an 18.8% and an 8.6% discount to NAV. The average over that period was a 13.2% discount. As of publishing, EGL was trading at an 16.01% discount.

Figure 16: EGL premium/(discount) over five years to 30 November 2024

Source: Morningstar, Marten & Co

The current 11.7% discount, which is significantly above its longer-term averages, may provide an attractive entry point for EGL. Its manager highlights that this could be even more attractive once the relative valuation of the portfolio compared to benchmark averages (highlighted on page 5).

EGL traded on a premium as recently as the beginning of 2023 and whilst some repricing was perhaps justified due to the structural increase in interest rates which followed, its manager thinks that selling was indiscriminate across the listed infrastructure and utilities sector – and in EGL in particular – went well beyond the mechanical impact of higher rates. It adds that, since then, the discount has struggled to recover despite the trust continuing to deliver strong returns – as evidenced by its recent annual results. However, it says that this has also created opportunities, that could lay the foundation for EGL to continue its long track record of outperformance.

Share buybacks

As highlighted in Figure 16, having issued shares when they were trading at a small premium, the company has been steadily repurchasing shares since it began trading at a substantial discount. Over the last 12 months to 30 November 2024, it has repurchased almost 7m shares.

Figure 17: EGL share buybacks and issuance

Source: Marten & Co

Gearing

EGL’s manager has traditionally been very targeted with the use of the company’s gearing. This was increased over 2023 when utility valuations were depressed, reduced in the period before the US election, and had risen again to 14.8% as of 30 November 2024, with the company identifying opportunities to add new names and increase the weightings of a number of key holdings.

Dividend

EGL is managed to strike a balance between capital growth and income, and whilst much of this note has focused on the portfolio’s growth potential, it remains a potentially reliable source of income for investors. EGL has tended to pay an uncovered dividend in recent years, supplementing its net revenue with modest amounts from its distributable reserves. These reserves remain substantial, amounting to £110m at the end of March 2024.

The quarterly dividend will be increased by 3.7% to 2.125p per share (8.5p per share per annum) which is applicable from February 2025.

Supporting the dividend is the growth of EGL’s investment income, with revenue return per share growing at a rate of almost 10% in recent years. For FY2024, the company paid a total dividend of 8.1 pence per share, an increase of around 5% on the previous year for a current yield of 4.69%.

Due to the board’s confidence, the quarterly dividend will be increased by 3.7% to 2.125p per share (8.5p per share per annum) which is applicable from February 2025.

Figure 18: EGL revenue income and dividend by financial year

Source: Ecofin Global Utilities and Infrastructure Trust

Fund Profile

Further information regarding EGL can be found on the manager’s website:

https://www.redwheel.com/uk/en/individual/ecofin-global-utilities-and-infrastructure-trust-plc/

Ecofin Global Utilities and Infrastructure Trust Plc is a UK investment trust listed on the main market of the London Stock Exchange (LSE). The trust invests globally in the equity and equity-related securities of companies operating in the utility and other economic infrastructure sectors. EGL is designed for investors who are looking for a high level of income, would like to see that income grow, and wish to preserve their capital and have the prospect of some capital growth as well.

On 1 October 2024, Redwheel completed the purchase of the assets of Ecofin Advisors, the investment manager of EGL. The Ecofin team has relocated to Redwheel’s offices, but there are otherwise no changes to the investment strategy, process or Ecofin brand. Also effective from 1 October, the investment management fee was reduced to 0.9% per annum of NAV on the first £200mn; 0.75% above £200m and up to £400m; and 0.6% thereafter.

Reflecting its capital preservation objective, EGL does not invest in start-ups, small businesses or illiquid securities, as these may involve significant technological or business risk. Instead, it invests primarily in businesses in developed markets, which have ‘defensive growth’ characteristics: a beta less than the market average; dividend yield greater than the market average; forward-looking EPS growth; and strong cash-flow generation.

It also operates with a strict definition of utilities and infrastructure as follows:

electric and gas utilities and renewable operators and developers – companies engaged in the generation, transmission and distribution of electricity, gas, liquid fuels and renewable energy;

transportation – companies that own and/or operate roads, railways, and airports; and

water and environment – companies operating in the water supply, wastewater, water treatment and environmental services industries.

EGL does not invest in telecommunications companies or companies that own or operate social infrastructure assets funded by the public sector (for example, schools, hospitals or prisons).

No formal benchmark

EGL does not have a formal benchmark and is not constructed with reference to any index.

EGL does not have a formal benchmark and its portfolio is not constructed with reference to an index. However, for the purposes of comparison, the MSCI World Utilities Index and the S&P Global Infrastructure Index are the global indices deemed the most appropriate by the manager. The company also supplies data for the MSCI World Index and the All-Share Index in its own literature for general interest. The MSCI World Utilities could be considered as the most relevant – although it should be noted that this index has a strong bias towards US companies and excludes transportation services and some environmental services that EGL invests in.

Previous publications

Figure 19: QuotedData’s previously published notes on EGL

Source: Marten & Co

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