Sequoia Economic Infrastructure Income Fund Limited (SEQI.L) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Sequoia Economic Infrastructure Income Fund Interim Results Investor Presentation. [Operator Instructions] The company may not be in a position to answer every question received during the meeting itself, however, the company can review all questions submitted today and we'll publish those responses where it's appropriate to do so. Before we begin, we'd like to submit the following poll, and I'm sure the company will be most grateful for your participation. I'd now like to hand over to the management team for your presentation.

Good morning, everyone. Welcome to the first half fiscal year '25 interim call on SEQI. 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 Dimond, Head of Client Capital. If we turn right to the introduction, SEQI's portfolio has had a good 6-month period. And our resilient portfolio has generated substantial cash during the period with NAV climbing from 93.77p at year-end fiscal '24 to 95.03p for the period ending 30 September '24. Dividends paid have been 3.4375p per share, and this is consistent with our full year dividend target of 6.78p (sic) [ 6.875p ] per share and is cash covered at 1.06x. We've been able to maintain credit quality of the portfolio without a reduction in targeted yields. 58.5% 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 nonperforming 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. The current and expected stable or gradually declining interest rate environment is also supportive of SEQI. We have 3.5p per share of expected pull-to-par upside. We have a strong pipeline of investment opportunities, with a highly selective investment policy. It's approximately GBP 500 million 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. We've had a significant share buyback program where during this 6-month period, the fund has bought back 49.3 million shares. That's in the last 6 months, and SEQI 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 64.65, up from 62.77 for year-end fiscal year '24.

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 we 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. The U.K. remains relatively large by historical standards, about 29% of the portfolio, but the U.S. 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. 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. 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. 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 93.77p to 95.03p 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 81.1p to 80.2p. 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 cover, the cash cover on the dividend has remained constant at 1.06x, which is consistent with the long-run guidance historically given of 1.05x to 1.1x. And the portfolio ESG score has improved quite materially actually from 62.77 to 64.65. Turning on to the next slide. We have a NAV bridge on Page 5. You can see opening NAV at 93.77p. As I mentioned, by far, the main 2 drivers of NAV performance are interest income at 5.4p (sic) [ 5.39p ] per share over the period, offset partly by dividends of 3.44p. So you'll see that interest income, this is an accounting definition, not cash definition, very well covered dividends. Offsetting that a bit further, if 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.

Great. Thank you, Steve. Turning to SEQI's long-term performance against its benchmark since IPO. On this chart here, you'll see 3 lines. The blue line is SEQI's share price total return performance. The black line is SEQI'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. 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. You'll see clearly, there's been a large gap between the SEQI 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 SIMCo. 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. Notwithstanding the discount, the SEQI NAV total return has outperformed the underlying high-yield bond benchmark broadly by between 3.5% and 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 our 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. This is the 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 had treated over 0.5 million patients. 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. We are part of a club of lenders and the total loan is EUR 29.5 million. 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.

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 U.K. What happened over the course of 2021, as you'll recall, is that gas prices increased at an unprecedented pace and a large number of the smaller energy supply companies in the U.K. had difficulty maintaining their hedging arrangements, right? They just started to absorb more and more capital and companies like Bulb and they didn't have enough capital to maintain a full hedging book over the winter months. And so Bulb went into special administration, which meant we couldn't enforce our security over the assets of Bulb and its parent company, Simple Energy, went into just normal administration. So it's now been about 3 years since all that has happened. We've been working very hard, both with Interpath who are the administrators at Simple and Teneo, the Special Administrators appointed 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 will recover 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. 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 GBP 25 million, which has been fully received in cash. We went through a restructuring of Simple Energy and the IT systems and department 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 ENSEK, which is a subsidiary of Centrica. 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 a simple level, that gives, as I said, actually a very positive full or nearly full recovery on the transaction over the last 3 years.

Thank you, Steve. If we go to the closing remarks, which are on Page 9. SEQI, 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 selective investments. Our revolving credit facility has been renewed. It's GBP 300 million 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. 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 1.06x, unchanged from fiscal year-end '24, which was also at 1.06x. 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. 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 '24. 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 IA to receive 10% of our fees and shares and SIMCo has accumulated a lot of shares over the years. So we feel investors' pain on the share price. Lastly, we feel there is a good opportunity right now given how SEQI 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&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. There's also attractive yields on reinvestment right now. And as we mentioned earlier, the yields in our pipeline currently at about 10% and that includes a strong thematic pipeline of about $500 million 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. 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, for attending our first half fiscal year '25 results call.

That's great. Randy, Steve, Matt, thank you very much indeed for updating investors. I will just bring up your cameras if I may. [Operator Instructions] take a few minutes to review the questions submitted already. I'd just like to remind you that a recording of this presentation along with a copy of the slides and the published Q&A will be accessible via your Investor Meet Company dashboard. Randy, as you can see, you've had a number of questions submitted by investors throughout today's presentation and a couple received beforehand. So thank you to everybody for engagement. If I may, Randy, just hand back to you to read out those questions, and I'll pick up from you at the end.

Yes. Well, thank you very much for that. Yes, so let's get right into the Q&A. First question is on dividend cover. I'm happy to take this one. The actual dividend is what is the -- the actual question rather is, what is the estimated dividend cover now that the share buyback is in full swing? And the answer to that is that we don't publish forecasted or expected dividend cover numbers. As we said in the results presentation, the dividend cover for the period ending September 30, the most recent period, was 1.06x, and that's unchanged from the dividend cover of 1.06x at the end of the last fiscal year in March of '24. The second question, Steve will take this one. It's on investment strategy. And the question is, how do you see your investment strategy evolving over the next 5 years? And are there new sectors or regions you plan to focus on?

That one. So I think the first thing to say is that broadly, the investment strategy, of course, is not going to change, right? The focus will remain on private debt backed by infrastructure assets. We'll maintain a high level of diversification. I think that's very important for risk management purposes. And by diversification, I mean not just having a wide range of loans and not having unduly large loans, but also spread by jurisdiction, sector, subsector, some of the key risks, key counterparties. In other words, properly genuinely diversified. Having said that, I think one of the key things about our portfolio is that the capital is very agile. It's our first column on this slide and the closing remarks that's on the screen. And what that means is the maturities of our loans typically are relatively short, 4 or 5 years is typical, which means we're getting back 20% to 25% of our capital through loan repayments each year. And that's a good thing because it means that we can then redeploy the money into different sectors and take advantage of market conditions. So the question is then if we crystal ball gaze, where do we think we'll be redeploying money? I think there are some sectors that have been really strong and remain very strong. So digitalization, I think, is a key sector for us. So that would include things like mobile phone towers, data centers, fiber-to-the-home, subsea data cables. They've all been very well-performing assets for us. I think that's likely to remain quite large. I think conventional power will also remain very significant. I think where we look to increase exposure is probably in some of the transport-related sectors where the portfolio is quite underweight. And I think geographically, as we mentioned in the interims, we're just beginning to look for the first time at Portugal and Italy. We think there's some very interesting opportunities in both those jurisdictions. They will obviously have the effect of increasing portfolio diversification, which, as I said, is a very important risk management tool. And so although we haven't done investments in those countries yet, I expect that we perhaps will be looking at things very seriously in the near term.

Thank you, Steve. If we go to the next question, it is on the pipeline. I'd be happy to take this one. And the question is, could you provide more detail on the GBP 500 million equivalent pipeline, particularly in new jurisdictions like Italy and Portugal and the expected time line for converting these opportunities to investments? So a few numbers on the pipeline. It is right now about GBP 500 million equivalent. So it's across different currencies. But when you convert everything to sterling, it's about GBP 500 million. That consists of about 12 to 13 different lending opportunities or what we call 12 to 13 names. The range of yields on that pipeline is about 9% to 11%. And for those of you familiar with credit ratings, the expected credit rating and we don't know yet because we haven't finished all of our credit work, but the expected credit rating would be in the single B to the BB category, and that's, of course, where we invest now. And they're across currencies in dollars, sterling and euros. In terms of Italy and Portugal, really, the point of us recently making these eligible jurisdictions is -- was to expand the opportunity set of lending opportunities. When we originally did SEQI way back in 2015, some of you might remember a bit of stress that was in the market at the time called the sovereign debt crisis. That's well over now. So we feel from a credit perspective, these countries are certainly investment worthy. But the main point of adding those is that we just want to broaden the set of lending opportunities available to us. The next question is on portfolio diversity, and Steve will take this one. And the question is, with a significant percentage of the portfolio in defensive sectors, how are you balancing sector diversification with targeting high-yield opportunities?

Yes. It's a really interesting question. I think to put it into context, all infrastructure really is relatively defensive. If you compare an infrastructure asset to, say, a consumer goods company or a business in the leisure sector or anything with discretionary spending, you'll typically find infrastructure outperforms during recessions, right? That's one of its defining characteristics that infrastructure is often providing essential services. So what we're talking about here really is degrees of defensiveness. And in particular, we're looking at things like transactions with long-term contractual income or regulatory income or cash flows with exceptionally low volatility. And we think that's an important part of the strategy because particularly at the moment, when we look at the global economy, clearly, there are risks present. I don't want to exaggerate them, but we're seeing, obviously, economic weakness in Germany. There's risks around perhaps tariffs and inflation perhaps beginning to become more of a concern in the U.S., perhaps looking forward. So you want to have those nice transactions with this, like I say, defensive income, very predictable cash flows. And that forms more than half the portfolio. It can be the case that you're not going to get such high yields on those deals, but we don't actually feel a need just to chase yield for the sake of it. We're trying to build a balanced portfolio that hits a good yield. As Randy said, the current portfolio yield is about 10% and the range of opportunities we're looking at is 9% to 11%. So it's a good yield on the assets, but it's actually about managing risk, having that spread of assets and relatively safe assets, I think, stands us really well for the sort of long-term future of the [ firm ].

Great. Thank you, Steve. While you have the floor, there's another question here on managing currency risk. And the question is how do you manage currency risk for investments outside the U.K.? And what was the impact of FX movements on the portfolio during the last period?

Yes. So we've fully hedged the NAV into sterling. So in other words, if we have a dollar-denominated asset, for example, we will do a currency hedge where we'll effectively sell those dollars and buy sterling. And we'll do that through FX forwards or currency swaps, which pretty much fundamentally the same thing when all said and done. There's a little nuance [indiscernible] in that the way assets get valued is different to the way derivatives get valued. So you can find over the life of investment that these P&L effects caused by these different valuation methodologies. Now they cancel out. But you do see that in some periods, there's a small gain and other periods, there's a small loss. So actually, in the last 6 months, there was a small gain, about 0.3 -- sorry, a small loss, about 0.3%. In the previous period, there was a small gain of the same order of magnitude. So you do get a little bit of noise as it were, but the fundamental point is that we're fully hedged against FX rate movements.

Great. Thank you, Steve. The next question will pivot over to Matt. And the question is about who we market to, and I'll read out the full question. Having been a retail shareholder for 4 years, this is the first presentation I have seen on this or other similar channels. Who you're marketing to? And who do you see as your core shareholders?

Thanks, Randy. Well, firstly, we don't see any particular subgroup as core or we really welcome all types of investors. And indeed, we've got a very broad range of investors from the most traditional wealth managers and private client brokers that are very active in investment companies. We have pension funds, other asset managers, multi-managers, insurance companies and a growing number of retail investors as well. So we absolutely welcome all, particularly as infra credit is coming of age as a broader class for allocation. It's increasingly becoming some front of mind and understood by the market. And we welcome all of this interest. In terms of platforms, this -- we're delighted to be on this platform for the first time, Investor Meet Company. And I dare say we'll be a regular participant in this and equivalents as well. We've also, in 2024, initiated a program with Kepler that provides kind of more 2-way access to the retail market through their publications and events that they stage as well. So it's a journey, but we're really looking forward to greater engagement on the retail side.

Great. Thank you for that, Matt. Here's a question on the Trump administration. Perhaps Steve can do this one. He just did a podcast on this topic, and I would encourage everybody to find that on our website and listen to it. The question is, what will the Trump President -- what impact will the Trump presidency have on SEQI, especially with regard to investments in the renewables sector?

Yes. Thanks, Randall. And I like I said, there's a podcast that did literally last week on seqi.fund under the Media tab, which goes into this question in more detail. But I think the short answer is we've spent a lot of time looking through Trump's policies. We've been speaking to our advisers and economists and political commentators and try to figure out what the likely sort of pass some of the scenarios out looking forward. And our best sense is that some parts of the infrastructure market in the U.S. will probably benefit from Trump's policies. So things like conventional power, LNG, midstream energy assets, we've got exposure to all of those are likely to benefit. But other sectors and renewable energy is one may suffer. Before I dive into that in a bit more detail, I wanted just to give just 2 seconds on a bigger point, which is I think what often matters more than direct consequences are indirect consequences. So if you look across actually all of Trump's policies, not just in the infrastructure space, but more broadly. They are designed to be pro-growth, which clearly would be a benefit to investors in the U.S., but may have an effect of increasing inflation, right? So things like tariffs, tax cuts funded through borrowing [indiscernible] inflation, which might result in higher costs for some businesses and potentially higher interest rates. So the macro picture, I think, is probably as important as the policy picture. Going back to renewable energy, I think the answer is quite nuanced in some ways. We don't think we'll see a complete repeal of all the regulatory and tax support that goes into the renewable sector. So the so-called IRA, the Inflation Reduction Act, which brought in a lot of these measures, we think is likely to remain in place or large parts of it in place. We think some parts of renewable market will suffer more than others. And in particular, we think things like rooftop solar might be exposed, things like utility scale solar, much less so. And I think what we're seeing in the U.S., therefore, is a lot of activity to try to protect projects that are underway. These obviously are where people as lenders will be involved from the possible consequences of regulatory or legal changes. So basic idea is we'll see projects breaking ground, equipment being bought probably on a slightly accelerated time scale to lock in some of these tax benefits sooner rather than later. And for people like us who are involved in financing projects, which are already underway, therefore, we think the impact will be quite limited. I think longer term, you may see less activity in the renewable space, which is probably a concern for equity investors, but won't really affect us directly.

Great. Thank you, Steve. We've got a question here about the buybacks and investments. So I'll be happy to take this one. The question is, given the -- it's a good question. Given the trade-off between buybacks and deploying capital into new investments, what is the long-term strategy for balancing these 2 priorities? And this is a really good question. And the key word in that question is balance. And what I would say is that the Board of the fund has said that they would be minded to do buybacks when the discount becomes unreasonably large. And as far as investment opportunities, as long as we continue to see what we consider to be optimal risk return investment opportunities, then we would expect to continue to invest. I mean the fund has a lot of upside potential to grow given the size of the investment opportunity. And just to put a few numbers around that last point, there's been about just north of $1 trillion worth of private infrastructure equity that's been raised. And when a sponsor, which is the term for an infrastructure equity investor, either expands a project or buys another project, they usually get -- almost always, they get debt financing. So that circa $1 trillion of infrastructure equity that's been raised is going to require about $2 trillion to $3 trillion of debt -- of infrastructure debt. And that's at a time when banks are pulling back because the regulators, really, if you go way back to 2008, 2009, have increased the amount of regulatory capital that banks need to set aside to make loans into infrastructure. So it's a huge opportunity, and we don't see any drawing up of optimal investment opportunities for us to invest in going forward. I'm happy to take the next question as well. And it's about alignment of interest. And the question is, please comment on the alignment between SIM, that's Sequoia Investment Management and investor interests. So happy to do that. And we're really aligned with investors. And I say that because, first of all, SIM, the investment adviser, owns shares. The company owns shares, quite a few shares. We also received 10% of our SEQI fee in shares. And then thirdly, the directors of SIM also own shares. So there's a lot of share ownership. And as we said in the results presentation, because of the share ownership, we're right on the same side of the fence as our investors. And we -- even though we've had wonderful performance that's been reflected in the NAV, we're very conscious that it hasn't been reflected in the stock price yet, and we're doing everything that we can do to correct that. That really takes us to the end of the questions. So we'll wrap it up here, and I just want to thank everybody for joining us this morning. We very much are delighted to do presentations like this, like the investor meet presentation, and we look forward to presentations like this in the future as well.

Thank you very much.

That's great. Randy, Steve, Matt, thank you once again for updating investors this morning. Can I please ask investors not to close this session as we'll now automatically redirect you for the opportunity for you to provide your feedback in order that management can better understand your views and expectations. This will only take a few moments to complete, but I'm sure it will be greatly valued by the company. On behalf of the management team of Sequoia Economic Infrastructure Income Fund, I'd like to thank you for attending today's presentation, and wish you all a good rest [ of the day ].