John Laing Group — Project investment delivers growth

JLG originates, invests in and manages portfolios of infrastructure projects. The business operates in selected geographical markets – Asia-Pacific, North America and Europe – and is focused on the transport, environmental and social sectors. At 30 June 2018, the value of the investment portfolio of 41 projects, and JLG’s 2.4% holding in JLEN was valued at £1,259.7m. The assets are split between projects under construction, primary (c 50.5%), and operational projects, secondary (c 49.5%). JLG has separately listed two funds on the London Stock Exchange: John Laing Environmental Assets (JLEN in 2014) and John Laing Infrastructure Fund (JLIF in 2010). JLG retains c 2.4% of JLEN.

After the recent strong performance, the shares are trading at a small premium (c 2%) to the H118 NAV per share of 307p, (average 2015–18 of -4%; maximum +12%, minimum -18%). The valuation is broadly in line with our revised FY18e forecast NAV per share of 318p (Exhibit 3). However, despite its recent strong run JLG stands at a discount to peer group averages (c 8% premium). At a 8% premium to the last disclosed NAV per share of 307p JLG would be worth c 332p/share. Given the relative rating, proven track record of growth and the prospect of continuing increases in the NAV per share and DPS, we believe JLG continues to offer potentially attractive returns to investors.

We set out our assumptions for the movement in the basic components of the portfolio value in Exhibit 1. We also show our revised assumptions for growth in NAV per share and DPS. Following the recent strong H118 results, we have increased our forecast for NAV per share growth (Exhibit 3). The increase, in large part, reflects an assumption of a greater FV movement.

JLG’s business remains sensitive to changes in discount and foreign exchange rates.

The continuity of strategy and senior management has enabled JLG to successfully exploit the opportunities in the international market for infrastructure investment. In H118 the net asset value rose 9.3% and the DPS increased 2.9%. In the previous three years to the end of 2017, the company achieved a CAGR in NAV per share, including dividends, of 15.5%.

JLG is an originator, active investor in and manager of infrastructure projects. The business is organised into three key areas; primary, secondary and asset management. The primary business focuses on sourcing, originating and bidding for greenfield sites. Capital is recycled by selling assets once they are operational. The secondary business concentrates on ownership of renewable energy and PPP projects. JLG invests globally and the portfolio is well diversified by asset type. The asset management business actively manages JLG’s own investment portfolio as well as providing services to two external funds, JLIF and JLEN.

JLG’s strategy is to create value for shareholders (as shown by NAV per share and DPS growth) as a result of its origination, investment and management of international infrastructure assets. In targeting primary investment, JLG identifies jurisdictions that possess stable political and regulatory environments, demonstrate a commitment to privately financed infrastructure and allow JLG to work with trusted partners. In addition, projects must be based on realistic targets and offer a strong secondary market for assets. Portfolio value enhancement can be achieved through a variety of techniques, including reduction of asset replacement costs, management costs and purchasing costs. JLG has also targeted fee income from managing external assets (for JLIF and JLEN); we believe this will continue as an element of its strategy, albeit with the possibility of the loss of revenue from JLIF in light of the current recommended offer.

Phil Nolan, chairman of JLG since 2010, stepped down after the AGM in May and has been replaced by Will Samuel, who originally joined the board as chairman designate in December 2017. Will is also chairman of Tilney Group and was previously chairman of TSB, Howdens Joinery and Ecclesiastical Insurance Group. In May Andrea Abt also joined the board as a non-executive director. In contrast, there have been no changes to the executive membership of the board of directors over the last year. Olivier Brousse remains chief executive officer (since 2014) and Patrick O’D Bourke continues as group finance director (since 2011). In addition to Will Samuel, five other non-executive directors (following the appointment of Andrea Abt) sit on the board of the company.

With a strong presence in its key markets, a long track record of successful investment, a strong investment pipeline and a balance sheet reinforced by the proceeds of a recent rights issue, we believe JLG is well placed to continue its strategy of growth and returns for shareholders.

JLG’s H118 results demonstrated the continuing growth of the business post the March rights issue.

The all-important NAV rose from 281p (306p restated for the rights issue) to 307p, an increase of 9.3%. The NAV per share exceeded our forecast for FY18 of 303p. The principal components of the movement in the NAV can be seen in Exhibit 2. The significant FV movement (£193.9m) was helped by the disposal of JLG’s remaining 15% of the InterCity Express Programme (IEP Phase 1) in May. The project was sold for £232m, above book value, and JLG has disclosed that the net benefit from value enhancements and other changes, of £86.3m, was primarily due to the gain on the disposal of IEP Phase 1. JLG also benefited from a change in operational discount rates, which totalled £43.2m of the £193.9m. Overall, the weighted average discount rate fell to 8.7% from 8.8% as at 31 December 2017. As always, the unwinding of discounting (£47.8m) and reductions in construction premiums (£23.2m), embedded value within the portfolio, contributed significantly to the FV movement. The IAS 19 pension gain, which we had not included in our forecasts, added 6p/share to NAV growth.

The other important benchmark, DPS, increased 2.9%, to 1.80p per share (from the rebased 1.75p per share). In total, JLG has achieved a CAGR in NAV per share, including dividends, of 15.5% in the three years to the end of December 2017.

Following the results, we have revised our forecasts for FY18 and beyond. The details are set out in the financial section of this report, but the principal changes are shown in the table below.

Exhibits 4 to 7 show the investment portfolio split. In particular, we would point to the relatively smaller portion of the portfolio now invested in the UK. In addition, it is worth noting the five largest investments now comprise c 41.3% of the portfolio (FY17 39.3%).

Of the 10 largest investments, only three are located in the UK: IEP Phase 2, Cramlington Biomass and Manchester Waste Thermal Power Station. JLG has published book value ranges for each of its five largest primary and secondary investments, shown in Exhibit 8.

In March 2018, JLG launched a one for three rights issue at 177p (issuing 122.32m shares) to raise £210m net of cost. A relatively heavy share issue, the price was deeply discounted (c 26.8% to the theoretical ex-rights price).

The rationale for the issue was to enable JLG to increase the scale of its operations and to take advantage of the higher proportion of attractive investment opportunities that were now available to it, as its relationship with partners and other developers strengthened. Although JLG raised capital at the time of its IPO in 2015, the scale of the opportunities, particularly in the US, has exceeded expectations.

JLG’s corporate philosophy has been to adhere to a self-funding model, whereby new investment commitments are financed through operational cash flow and investment realisations. At the time of its rights issue, JLG reiterated its belief in the self-funding model but in recent years (Exhibit 9) investment commitments have generally far outstripped realisations. However, H118 results highlighted the volatility of this trend with realisations of £241.5m, in large part due to the disposal IEP Phase 1 (£232m), far outstripping new investment commitments of £39.2m. It is conceivable that a parity of commitments and realisations can be achieved, although we view this as more likely to be in the long term given the current strength of global infrastructure markets.

JLG’s business model is based on its investment origination and asset management capabilities. Initial value is created through establishing greenfield infrastructure projects, while additional value is derived from enhancing each project’s cash flow via efficiency improvements and cost optimisation and also from de-risking the projects. Between 31 December 2014 and 31 December 2017, JLG made 28 new investments and disposed of 21 projects. Effective implementation of the model is based on the integration of the project origination and asset management business, JLG’s independent status allowing it to forge wide-ranging alliances with other market participants and the group’s intellectual capital based on its extensive network acquired through deals in different geographies and sectors over a long timeframe. JLG’s expertise and market presence has allowed it to build a strong track record of growth and an extensive investment pipeline. Given JLG’s experience of different geographies and asset types and the existence of long-term relationships with other investors and contacts, we believe it is a business model that it would be difficult for competitors to replicate.

For JLG the key measurement of how successful it has been in developing its business model and implementing its strategy is growth in the DPS and NAV per share. In the period 2015–17 JLG has achieved a CAGR of 15.5% in NAV per share (including DPS). Exhibit 10 shows that JLG has posted impressive growth in several key benchmarks.

The evolution of the portfolio is the key determinant of NAV per share. While new investment and realisations play an important role in determining the portfolio value, the NAV is also significantly influenced by FV adjustments (see Exhibit 1).

It is worth reiterating that an important part of the overall FV movement relates to the embedded value and is generated by the twice-yearly updating of a project’s DCF. The two principal constituents of embedded growth (reduction of construction risk and the unwinding of the discount rate) contribute significantly to the overall FV movement (on average more than 60% of total FV movement in the last four years). In addition to FV movements, JLG generates cash flow from the cash yield on the secondary portfolio and fee income generated by JLCM for the provision of asset management services. In the next section we examine the role of JLCM.

Although JLG itself only returned to the market in 2015, in the five years prior to its own flotation it listed two separate funds on the market, JLIF in 2010 and JLEN in 2014. JLG no longer has any holding in JLIF but it retains a small number of shares in JLEN (£9.7m c 2.4% as at 30 June 2018). However, JLG does provide investment management services (through John Laing Capital Management) to the two funds and retains a first-offer arrangement for certain types of asset disposal with JLIF and JLEN.

In the case of investment management services JLG generates a management fee based on a percentage of external assets under management (£1,649m at December 2017; £1,808.1m at H118). In 2017 JLG generated revenue, from external assets under management, of £16.7m, equivalent to 1.01% of year-end funds under management. In H118, investment management revenue totalled £9.4m, primarily from JLIF and JLEN, but also including some director fees.

In addition to the provision of investment management services, JLG has first-offer agreements with JLIF and JLEN, covering certain types of asset disposals, including rail, road and accommodation. However it is important to stress that the first-offer agreements with JLIF and JLEN do not require JLG to sell to the two funds. In 2014–17, approximately 70% of assets (by sale proceeds) were acquired by JLIF and JLEN. According to JLG, between 31 December 2014 and 31 December 2017, it made 21 divestments of entire or part interests in its investment portfolio, predominantly of investments from within its secondary investment portfolio. Exhibit 11 below shows the percentage of assets sold to either JLIF or JLEN. Significantly, the two largest disposals in 2017 and 2018, including the recent IEP Phase 1, were made to third parties. However, with JLG’s declining UK investment base and JLIF’s UK focus, the proportion sold to JLIF and JLEN might be expected to decline. We do not expect JLG’s ability to divest assets to be significantly affected by the potential loss of a first-offer agreement with JLIF.

In light of JLIF’s recent recommendation to shareholders to accept the offer from Dalmore Capital and Equitix Investment Management, which is expected to become effective this autumn, we set out the basis of JLG’s relationships with JLIF and JLEN and the terms of the agreements. The investment management agreement can be terminated by either party, with a one-year notice period. JLIF can also terminate in six months, with the payment of an additional six months of fees. The first-offer agreement relating to non-rails assets can also be terminated by either party, giving one year’s notice, or if the JLIF investment advisory agreement has already been terminated, with a 45-day notice period. The first-offer agreement related to rail assets can only be terminated in the event of a material breach of the agreement or in the event of insolvency.

If the proposed offer for JLIF proceeds as expected, there is a possibility that both the investment advisory agreements and the first-offer agreement will be terminated. The immediate revenue impact would be the loss of the investment management fee relating to JLIF. Given the asset split between JLIF and JLEN (broadly 75/25%), we would estimate the revenue lost to be in the region of £14.3m (75% of £19m) on annual basis, equivalent to c 3p/share. However, we would also expect some reduction in costs resulting from any changes. The impact of the absence of a first-offer agreement with JLIF is harder to evaluate. Given the boards of JLIF and JLEN are free to choose whether to make an offer for any particular asset, there is no reason to suppose they have systematically overbid for assets and the premiums paid have not been out of line with that achieved by JLG’s sales to third parties.

Despite the uncertainty surrounding JLIF, JLG’s share price has recovered lost ground in recent months after a period of weakness in the second half of 2017 and the beginning of 2018 related to adverse newsflow in the UK. As we highlighted in a previous report, in September 2017 the Labour Party indicated that if it were to form the next government it would ‘abandon PFI as a tool for future infrastructure investment’ and ‘bring in-house existing PFI projects’. JLG has not quantified, publicly at least, the impact of any changes to the PFI but we have calculated previously the impact would likely to be less than 5p per share. We believe that given the reduced percentage of the portfolio invested in the UK (30.6% 30 June 2018, versus 33.9% 31 December 2017) and the small proportion of the pipeline (less than 5% of the PPP pipeline) focused on the UK, this will not act as a significant impediment to future growth at JLG.

We have written previously (JLG: positive outlook for growth) about the positive trends in the global market for infrastructure and renewable energy. We believe the key drivers of population growth, urbanisation and tightening environmental standards remain in place. Historic underinvestment in infrastructure assets over the last 10 years (since the financial crash) has only increased the pressure for investment. In addition, we believe the falling costs of wind and solar generation will lead to renewable energy taking an increasingly large share of investment in new generation capacity. JLG remains positive on the general outlook and the pipeline of potential investment opportunities now stands at £2,300m (75 projects) (+c 7% versus FY17 £2,150m). In particular, JLG sees significant opportunities in the US and parts of Europe, although the outlook for the UK appears less favourable (the UK now accounts for less than 5% of the PPP investment pipeline).

Of the total pipeline, JLG regards c £500m as short- to medium-term opportunities, split c £325m PPP (12 opportunities) and £186m renewable energy (six opportunities). Of the 12 PPP projects, 10 are located in North America and two in Europe (one in the UK). The six renewable energy projects are split: Europe four, Asia Pacific one and North America one.

According to JLG, the market for secondary assets remains strong and the yield shift between primary and secondary assets remains attractive.

Phil Nolan, chairman since 2010, stepped down at the AGM in May and has been replaced by Will Samuel, who originally joined the board as chairman designate in December 2017. Mr Samuel is also chairman of Tilney Group and was previously chairman of TSB, Howdens Joinery and Ecclesiastical Insurance Group. Andrea Abt, who brings experience of a variety of senior functional roles, also joined as a non-executive director following the AGM. However, there were no changes to the executive membership of the board of directors over the last year. Olivier Brousse remains chief executive officer (since 2014) and Patrick O’D Bourke continues as group finance director (since 2011). There were also no changes to the ranks of the non-executive directors during the year. In addition to Will Samuel, five other non-executive directors (following the appointment of Andrea Abt) sit on the board of the company.

The investment portfolio remains the chief store of value within JLG and in the following section we examine some of the principal determinants of value.

NAV per share remains the principal benchmark for evaluating JLG’s share price. As we have already seen, JLG has achieved significant growth in its NAV per share in recent years and we expect continued growth in the forecast period. Despite the steady increase in NAV, the shares have fluctuated between a discount to a small premium to NAV per share (Exhibit 15).

After the recent strong performance, the shares are trading at a small premium (c 2%) to H118 NAV per share of 307p, (average 2015–18 of -4%; maximum +12%, minimum -18%). The valuation is broadly in line with our revised FY18e forecast NAV per share of 318p.

Exhibit 16 highlights that JLG, despite its recent strong run, stands at a discount to peer group averages (c 2% premium versus sector average premium of 8%). At a 8% premium to the last disclosed NAV per share of 307p, JLG would be worth c 332p/share. Despite the recent strong performance of the shares, given the relative rating, proven track record of growth and the prospect of continuing increases in the NAV per share and DPS, we believe JLG offers potentially attractive returns for investors.

Below we set out the principal assumptions that underpin our forecasts.