UK interest rates and “risk-free” gilts at their peak?

09 Aug 2023 / Corporate research

Infrastructure stocks struggle

Executive summary

Infrastructure/Renewable Energy Funds

  • The share price performances of the nine Infrastructure Investment Companies (IICs) and of the 22 Renewable Energy Infrastructure Funds (REIFs) have been dire over the past year. Undoubtedly, the sharp rise in interest rates has presented the sector with serious challenges, especially since the yield on “risk-free” 10-year gilts has risen appreciably. Furthermore, the ongoing war in Ukraine and high inflation rates, from which many IICs and REIFs are partially ‒ if not wholly ‒ protected, continue to unsettle the sector.
  • Not only are rising interest rates seriously eroding investor sentiment, as the appeal of “risk-free” gilt-edged stocks is significantly raised, but they also directly affect NAVs. In recent months, several NAV reductions have taken place. Moreover, the average IIC is currently trading at a 22% discount (on an unweighted basis) to its NAV; the comparable discount (also on an unweighted basis) for the REIFs is 21%. Not surprisingly, there are now several share buyback schemes under way.
  • In recent months, spot energy prices have fallen markedly, after the massive surge, in early 2022, when the war in Ukraine began. However, this scenario has had less effect on long-term energy price projections, which are key to REIF valuations. Along with higher interest rates and the consequential impact on discount rates, the growth of many REIFs’ NAVs has stalled.
  • All constituents of the 31-strong IIC/REIF sector have seen their share prices fall over the past year – some very substantially. Three subsectors have been particularly badly affected: many smaller energy stocks; the two US-based renewable energy stocks (US Solar has now aborted its efforts to sell its business, due to the non-conducive market backdrop); and the telecoms stocks, most notably Digital 9 Infrastructure.
  • Prior to COVID-19, when both inflation and interest rates were low, real dividend growth was commonplace, while cuts in nominal growth were very rare. In recent years, though, few IICs/REIFs have been able to replicate this trend; although Greencoat UK Wind remains committed to its dividend growth, matching changes in RPI.
  • On the downside, leading IIC, HICL, has flagged a six-year flat dividend – until 2024/25 ‒ of 8.25p per share. Within the REIF sector, Ecofin US Renewables has announced a probable halving ‒ for 2Q’23 only ‒ of its quarterly dividend, which was previously $1.40 per share, following the impact of a tornado in Texas on nearby electricity transmission infrastructure. As for ThomasLloyd Energy Impact, its shares have remained suspended since 24 April 2023, following material accounting issues.
  • The average prospective dividend yield (on an unweighted basis) for the IICs is currently 6.7%; the comparable figure (also on an unweighted basis) for REIFs is 6.9%. These much higher yields reflect the sharp decline in recent months of the share prices of many sector constituents.
  • Discounting the suspended ThomasLloyd Energy Impact, only 3i Infrastructure, Bluefield Solar, Greencoat UK Wind and Sequoia Economic Infrastructure have been able to keep their percentage share price falls over the past year within single figures. By contrast, over the same period, Digital 9 Infrastructure’s shares are down by 45%, while both Ecofin and HydrogenOne Capital Growth have seen falls of ca.40%.
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