Sequoia Economic Infrastructure H1 2025 Earnings Call Transcript

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December 5, 2024

There are 3 speakers on the call.

Operator

Good morning, everyone. Welcome to the First Half Fiscal Year twenty twenty five Interim's Call on SECI. This covers the period from 1 April 24 through 30 September 24. I'm Randall Sandstrom and also on the call with me this morning is Steve Cook, Head of Portfolio Management and Matt Diamond, Head of Client Capital. If we turn right to the introduction, SECI's portfolio has had a good 6 month period and our resilient portfolio has generated substantial cash during the period with NAV climbing from 93.77 at year end fiscal 2024 to 95.03 for the period ending 30 September 2024.

Operator

Dividends paid have been $3.4375 per share and this is consistent with our full year dividend target of $0.06.8 per share and is cash covered at 1.06 times. We've been able to maintain credit quality of the portfolio without a reduction in targeted yields. 58.5 percent of the portfolio is senior secured loans and we have low construction exposure at 8.1% of the portfolio. We're happy to report that we've made good progress on non performing loans during the period. We resolved 2 out of the 3 challenging positions with the sale of Clyde Street and the near full repayment of Bulb.

Operator

The current and expected stable or gradually declining interest rate environment is also supportive of SECI. We have 3.5p per share of expected holdapar upside. We have a strong pipeline of investment opportunities with a highly selective investment policy. It's approximately $500,000,000 in size and gross yields right now in the investment pipeline are about 10%. I think as everybody knows, we've had a proactive and balanced approach to capital allocation.

Operator

We've had a significant share buyback program where during this 6 month period, the Fund has bought back 49,300,000 shares. That's in the last 6 months, and SECI has been a leader in buybacks in the listed infrastructure and credit sector since July of 2022. We have the room to potentially and modestly increase fund leverage and take advantage of the attractive pipeline of investment opportunities that we have. We've also made, lastly, sustained ESG progress with the portfolio ESG score climbing to 64. 6 5, up from 62.77 for year end fiscal year 2024.

Speaker 1

Thank you, Randy. Turning on to the next slide, we're going to have a look at the portfolio in a bit more detail and then come on to talk about performance and some key metrics for the Fund. I think the first thing to say in terms of the overall portfolio is that it's remained approximately unchanged in terms of its main characteristics over the 6 month period. And this is consistent with our strategy that was set out in the annual accounts of maintaining credit quality, maintaining diversification and obviously targeting a 9% to 10% yield, which will enable us to comfortably cover the dividend and hopefully grow NAV as well. To give you a bit more detail on that, the portfolio key characteristics are set out on this slide.

Speaker 1

The U. K. Remains relatively large by historical standards, about 29% of the portfolio. But the U. S.

Speaker 1

Is, as it always has been, actually the largest single geographical area. The U. S. Entirely represents all of that. There's no exposure to Canada currently in the portfolio.

Speaker 1

We're currently about 60% senior secured debt, about 59%, which is unchanged over the 6 month period, about 60% fixed rate debt. And the idea there is to lock in interest rates if and when we start to see policy rates fall. And as Randy mentioned, about 8% of the portfolio relates to assets in the construction stage, which is up very, very fractionally on where it was at the end of the previous financial year, which was 7%. In terms of geographical sectors, the portfolio, as you can see, remains very highly diversified. Digitalization is our largest single sector.

Speaker 1

And within that, data centers and telecoms towers are the 2 largest areas. But actually, the portfolio is really well spread across a very wide range of different types of infrastructure and that clearly is a key way of managing risk within the portfolio. We spread our risks. We don't put all of our eggs into one basket. Turning on to the next slide on Page 4, we have here some more KPIs.

Speaker 1

As you can see, the portfolio yield to maturity is practically unchanged. It's 9.94% compared to 10.02% at the end of the previous financial year. The portfolio size is, again, very similar. We've seen a little bit of net asset growth, which we're obviously delighted by. It's gone from 93.77 to 95.03.

Speaker 1

And we'll look at a NAV attribution on that on the next page. The total return on the NAV over the 6 month period was 5.1%. That's not an annualized figure, obviously, with annualized 10.2%. We think that's a very solid performance. The ordinary share price, unfortunately, has ticked down a fraction from 81.1% to 80.2%.

Speaker 1

That gives a share price total return for the period of 2.9% once dividends are taken into account. Earnings per share are up clearly on the back of higher interest income. Dividends remain constant. Dividend covers, this cash cover on the dividend, has remained constant at 1.06x, which is consistent with the long run guidance that we've historically given of 1.05x to 1.1x. And the portfolio ESG score has improved quite materially actually from 62.77 to 64.65.

Speaker 1

Turning on to the next slide, we have a NAV bridge on Page 5. You can see opening NAV at 93.77. As I mentioned, by far, the main two drivers of NAV performance are interest income at 5.4p per share over the period, offset partly by dividends of 3.44p. So you'll see that interest income, this is an accounting definition or cash definition, very well covered dividends. Offsetting that a bit further is you have expenses of 0.8p, a number of small adjustments and actually a positive adjustment of 0.47p per share relating to accretion through the share buyback, which, as Randy mentioned, has been a very significant activity for the Fund over the period.

Speaker 2

Great. Thank you, Steve. Turning to SECI's long term performance against its benchmark since IPO. On this chart here, you'll see 3 lines. The blue line is SECI's share price total return performance.

Speaker 2

The black line is SECI's NAV total return performance. And the red line is our high yield bond benchmark. This is a global benchmark hedged into sterling to match our own hedging into our home currency. And first, one point to make is there isn't a clear direct benchmark for infrastructure high yield debt. The sector is coming of age and it's really growing as an institutional asset class for allocation.

Speaker 2

You'll see clearly there's been a large gap between the SECI NAV total return and the share price total return and that is what we refer to as the NAV discount. This is a factor that has been impacting not just us, but a lot of the peer group and the broader listed investment company market, particularly the alternatives. It's something that's very front of mind for the team here at CIMCO. We're looking to manage the discount continuously through our ongoing share buyback program, which has been in place since the middle of 2022. In conjunction with that, we continue to refresh the portfolio through highly selective investments at today's attractive yield levels.

Speaker 2

Notwithstanding the discount, the SECI NAV total return has outperformed the underlying high yield bond benchmark broadly by between 3.5% 4%. We're very sort of pleased with that continued level of outperformance reflecting not just the illiquidity premium that we can achieve through our strategy, but we believe are highly selective and focused approach to investments. In terms of when this discount we hope will narrow and disappear, we are relatively positive in terms of our outlook on this based on the scenario that rates have peaked and are generally expected to be reducing over the years ahead, maybe not as fast as they went up. But this is a very benign environment for our type of products of high yield credit as we can lock in some very good returns at these current rates. I mentioned that we are continuing to make highly selective investments and we've got a couple of case studies here.

Speaker 2

This is one that was completed in the middle of the year. It's called Project Crystal. This is a very high quality business in Germany providing critical medical services. Specifically, it's a leading provider of diagnostics and therapeutic services that includes MRI and radiotherapy. It operates across 29 centers in Germany, and it works with over 150 physicians, and they have treated over 500,000 patients.

Speaker 2

This industry is underpinned by a very stable regulatory environment. It has essential provides essential services and exhibits strong barriers to entry. Our equity partner in this is a very well established infrastructure equity player and they sit behind us in the capital stack. The business has grown well since its inception organically and also via acquisitions. Our loan has been provided in the form of a mix between term loan and CapEx facility.

Speaker 2

We are part of a club of lenders and the total loan is €29,500,000 It's a Holdco loan alongside other debt providers benefiting from senior security and other robust financial covenants. The loan will be utilized to refinance existing debt and provide capital for further growth, both potentially within Germany and elsewhere in neighboring countries. This example is a great illustration of a highly thematic infrastructure theme playing into health care and aging societies. I'd like to pass on to Steve to cover the next case study.

Speaker 1

Thanks, Matt. The next case study is actually one on the recovery on our loan to Bulb. So this is following the investment through the insolvency of Bulb. And just to refresh people's memories, Bulb was one of the largest challenger energy supply companies in the UK. What happened over the course of 2021, as you'll recall, is that gas prices increased at an unprecedented pace and the large number of the smaller energy supply companies in the UK had difficulty maintaining their hedging arrangements, right?

Speaker 1

They just started to absorb more and more capital. And companies like BOL found they didn't have enough capital to maintain a full hedging book over the winter months. And so Bold went into special administration, which meant we come to enforce our security over the assets of Bold. And its parent company, Simple Energy, went into just normal administration. So it's now been about 3 years since all that has happened.

Speaker 1

We've been working very hard both with Interpath, who are the administrators at Simple and Teneo, the special administrators, pointed to Bulb and a whole range of other participants in the market. And we've now got to a point where we expect to recover or have recovered the full amount of our loan. And we also have expectations that we'll recover some of all some or all of the interest that has accrued on the loan over the course of the administration. So it's been a very positive outcome. To achieve it, we had to be very proactive.

Speaker 1

So we've done a large number of things. We've been through a mediation process with the special administrators, which resulted in a cash settlement of £25,000,000 which has been fully received in cash. We went through a restructuring of Simple Energy and the IT systems and departments that Bulb had built up, which was widely considered to be best in class amongst the energy supply companies. And we spun that out into a company called Zoa, which together with management of the fund owned the equity in. Zoa has subsequently sold its business to NSEC, which is a subsidiary of Centrica.

Speaker 1

We still have some residual claims coming out of that. Some elements of the business weren't sold and we still have a claim over them. But actually overall, we received more than book value on that transaction at the point of sale, although we're not actually disclosing the precise terms of the sale. When you add together all of these, plus recoveries of cash at the simple level, that gives, as I said, actually a very positive full or nearly full recovery on the transaction over the last 3 years.

Operator

Thank you, Steve. If we go to the closing remarks, which are on Page 9, Secchi, we feel is well positioned to reap the rewards from our attractive diversified investments. And I wanted to cover 3 points on this page: agility, performance and opportunity. We feel the fund is very agile, and we've tried to have a thoughtful approach to capital allocation between buybacks and selected investments. Our revolving credit facility has been renewed.

Operator

It's $300,000,000 in size and that's with JPMorgan. We're diversified and we have a resilient portfolio. And by resilient, we mean defensive and it performs well during weaker markets. And this has been borne out by our low loss rates, which includes period the period of the sovereign debt crisis back when we started out, COVID and until recently very high rates of inflation. We also have fresh monthly NAVs, which are well established by external appraisals and our marks are done by PricewaterhouseCoopers.

Operator

We've also been locking in high portfolio yields through the use of swaps and we have just over 60% of the portfolio right now in fixed rate exposure. On performance, we feel that we have had good portfolio performance and this has included an attractive and consistently cash covered dividend, finishing the period with coverage of 1.06 times, unchanged from fiscal year end 2024, which was also at 1 point 0 six times. We've continued our long term outperformance versus the high yield benchmark that Matt talked about, outperforming that benchmark by an average of 3.7% over the Fund's life with half as much volatility as that benchmark. We also, as you know, have a very low average life of only 4 years, which helps to keep the portfolio fresh and thematic. And what this means is we get back about 25% of the portfolio every year to invest in currently attractive risk return opportunities and to fund the share buyback.

Operator

And a word on our loss rates. They've been low and they've now gotten even lower. Our loss rate per annum for the life of the fund is now on an average of 51 basis points per annum versus 58 basis points per annum at the end of fiscal year 2024. And then also I wanted to say underperformance, and I feel this is really important, that we realize that this performance has not been reflected in our stock price even though it has been reflected in our NAV. And this is why we have continued the share buyback program running for so long and it's also important to say that we continue as the IEA to receive 10% of our fees and shares and CIMCO has accumulated a lot of shares over the years.

Operator

So we feel investors' pain on the share price. Lastly, we feel there is a good opportunity right now given how SECI is positioned. There's a prospect, as we've mentioned, for lower interest rates, and we think that's good for portfolio valuation. We also think it will help drive more M and A, which will help drive more deal flow for our pipeline. Embedded in that is also the pull to par effect that we've talked about and we expect that to be 3.5p per share in upside.

Operator

There's also attractive yields on reinvestment right now. And as we mentioned earlier, the yields in our pipeline currently are at about 10%, and that includes a strong thematic pipeline of about $500,000,000 in size. And as Matt mentioned, as interest rates continue to drop and get lower, we feel that more and more borrowers will want to refinance to lock in those lower rates, which should help the growth in our pipeline. And then lastly, I just wanted to say that I feel our share price presents an opportunity. And I say that because in the last 6 months, if you look at our numbers, our NAV has performed really well.

Operator

It's grown in 4 of the last 6 months, but our stock price has gone sideways. And I feel that this does not reflect the intrinsic value of the Fund. Thank you, everybody. This finishes the presentation part of the results, and we'd be happy to turn it over to Q and A. Yes.

Operator

We're getting a few questions in. Thank you, everybody, for sending those in. The first question I'll be happy to answer is do we have any plans to increase the dividend in 2025? And on that, the dividend is something that's always reviewed by the Board, but there have been no announcements to change the dividend.

Speaker 1

Thanks, Randy. I think next question is asking about our use of interest rate swaps and in particular, how large are they and are they at the portfolio level or do we swap individual loans? And maybe to answer that, they're not incredibly material. They're typically 5% to 10% of NAV. So it's a relatively small proportion.

Speaker 1

And we don't do very long dated or high duration swaps. So we have a policy for the amount of interest rate sensitivity we want to take through derivatives. And we use them obviously just to target a particular fixed floating split on the portfolio. We hedge at the portfolio level, not against individual loans. And they give us a lot more control than just relying on the investment strategy.

Speaker 1

And the reason for that obviously is clearly you can target making fixed rate loans or floating rate loans, but you don't have the same level of control over which loans are going to repay. So fixing your sort of interest rate strategy or adopting an interest rate strategy just through the investments and the loan portfolio is slightly crude. Basically, interest rate swaps gives a lot more control, a lot more precision over that part of the strategy. I think the next question may be one for me as well, which is asking about the implications of the U. S.

Speaker 1

Election. We've actually just recorded a podcast on this very topic, which is on the Fund's website under media. So there's a 10 minute discussion on this topic, which I won't repeat now obviously. But I think the short conclusion is overall, we don't think there are huge risks presented by Trump's policies. Clearly, it's likely to be or they're likely to be, if anything, beneficial for things like conventional power, LNG, midstream, things that might benefit from some of his tax policies could be so economic growth could be positive.

Speaker 1

On the other hand, probably some negatives for things in the renewable sector, particularly rooftop solar, where we think there's enhanced levels of risk, potentially trade. So things like ports or container shipping might be affected by tariffs. And obviously, quite a lot of its policies are inflationary and that might lead to higher interest rates. So there's a lot of complex interdependent consequences that we talk about in the podcast. But the short conclusion is we feel that our portfolio is well positioned actually for what we expect Trump's agenda to be over the next couple of years.

Speaker 1

I can see a couple of questions here for Randy.

Operator

Yes. Absolutely. We've got a question in on our new sectors, geographies. Do investments in new jurisdictions, Italy and Portugal offer better returns than other areas? And it really depends.

Operator

The returns on infrastructure are more dependent on the sector, the subsector and the project itself than on the country or the jurisdiction. In all cases, we invest in investment grade and developed markets. So you're not going to see large differences in yields or spreads due to the country. The primary determinant of returns would be on the project, the degree of financial risk and the degree of business risk. Obviously, in those two countries, they're both subject to euro LIBOR, so we're not going to see any differences there.

Speaker 1

There's a few questions, which I'll probably lump together, if that's okay, relating to nonperforming loans. So I'll try to answer as many of these as I can do. So the first question is, how significant time commitment has been resolving and working through the non performing loans? I mean, look, the answer is it's a lot of work, but I think it's a really important part of a manager's role if you're in the debt space. So inevitably, if you work in credits, there will be underperforming and nonperforming parts of any loan portfolio.

Speaker 1

And you need to dedicate the resources and the right lot of expertise to working through them because actually it makes a tremendous difference. You know, having a sort of properly resourced senior experienced team directs directly leads to better financial outcomes. So it's we don't see it as being a distraction from the job. We think it's part of the job, actually in a very, very important part of the job. Next question on a sort of related theme is on Bulb, what is recognized in the valuation?

Speaker 1

And the answer is and what we say is we expect to get back of the current currently outstanding, our base case is we get back the principal and we're likely to get back some of the maybe even all of the accrued interest, right? So what we've done, as you'd expect, is we've taken the principal and accrued interest. We've haircut that for uncertainty and time value of money. So we applied an appropriate discount rate. What we haven't done obviously is look forward and say, look, if that takes 3 months, there'll be another 3 months accrued interest.

Speaker 1

So that would all be potential upside over and above the sort of discounting that's implied by the sort of discount factors on the loan. Obviously, it goes that same way, we're very pleased. And then a couple of questions on ACG Active Care Groups. This is not a distressed loan, but it's a restructuring where we've received some equity, I'm actually a majority equity position in the business. So we're currently carrying that at nil value, which obviously is the most prudent possible assumption.

Speaker 1

We're not obviously a private equity firm. Having said that, we're not inpatient capital. We're working with the company. We'll find an exit at the right time. But right now, it's about obviously building the business and looking for ways to maximize the value of our position there.

Speaker 1

So there's no specific update. But obviously, like I said, it's marked as cautiously as is possible given that it's marked at nil. So it's only upside from where we've got it marked at.

Operator

We've got a question here about our fixed floating balance. Are you still comfortable with that given the Trump result, potential inflation interest rate rises? Yes, we are comfortable, and we've never really moved that mix very much. We've tended to be sort of around fifty-fifty over the life of SECI, and we've moved that just a little bit given the peak that we've seen recently in interest rates. So I think that our current positioning is fine, and it can take into consideration a variety of scenarios on rates.

Speaker 1

There's a question here, which is, what is the average debt service cover ratio across the portfolio? And I'm going to answer that by saying it's not information that we disclose, but not because we feel it's remarkably sensitive, but actually because it's very dependent upon the sort of mix of assets in the portfolio. And by itself, it could be quite a misleading or confusing statistic. Now what do I mean by that? Well, just to sort of unpick the jargon, debt service coverage ratio is the ratio of a borrower's free cash flow, so cash flow available to service debt divided by debt service, so interest and mandatory debt repayments.

Speaker 1

So DSCR, debt service coverage ratio of 2 times means that for every pound of debt service, the borrower's got £2 of free cash flow. The reason why it's a confusing statistic is lenders will target very, very different types of DSCRs based upon the predictability and credit quality of a transaction. So give you an example, if you've got a deal and we've got one like this, which is a leasing transaction, right? So we financed the rolling stock on the Madrid Metro, where all the income comes from lease payments from the Madrid Passenger Transport Authority, you can finance that on a really low DSCR. If you've got something with much more operational risk, you have a really high DSCR.

Speaker 1

Taking the average of those two numbers, therefore, doesn't tell you much. It just tells you that you've got a wide range of things in the portfolio. So that's not a number that we think is useful to disclose, unfortunately.

Operator

Okay, everybody. That takes us to the end of Q and A. I know the further questions have come in. We'd like to thank everybody for attending our first half fiscal year twenty twenty five results call.

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Key Takeaways

  • NAV growth: NAV rose from 93.77 to 95.03, delivering a 5.1% 6-month total return (10.2% annualized), though the share price dipped slightly, resulting in a 2.9% share price total return including dividends.
  • Portfolio resilience: Maintained credit quality with 58.5% senior secured loans and low construction exposure of 8.1%, and resolved two of three non-performing loans through sale and near-full repayment.
  • Robust investment pipeline: Approximately $500 million of highly selective opportunities offering about 10% gross yields, with an expected 3.5 pence per share “pull to par” upside in a stable or declining rate environment.
  • Discount management: Repurchased 49.3 million shares over the period and continued buy-backs since July 2022 to narrow the NAV discount and support the share price.
  • ESG progress: Portfolio ESG score climbed to 64.65 from 62.77, reflecting sustained improvements in sustainability metrics.
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