John Laing Group — From transition to implementation

FY20 was a year of two halves for JLG. H1 saw underlying net asset value (NAV)/share fall 10%, predominantly due to the impact of falling power price forecasts on renewable valuations (see our note Reset and refocus). However, performance improved substantially in H2. Underlying NAV/share grew 5% (15p/share), largely due to the sale of IEP East for a c £88m (18p) premium to book value (before costs), partially offset by a further £18m (4p) decline in renewable valuations and £40m (8p) of costs. Excluding the uplift from IEP East, the value of the public-private partnership (PPP) portfolio increased by £53m (11p) in H2.

Activity levels also picked up substantially in H2. JLG added four shortlisted positions in PPP (SE Metro – Waste to Energy, Frankston Hospital, Ontario Line and Potrero Bus Yard) and secured two further exclusive positions in ‘core-plus’ projects, one in the UK (accommodation) and one in Europe (fibre to the home). Offsetting this, one shortlisted PPP project was cancelled, one faces increased uncertainty and two were won by competing consortiums. Investments increased to £98m (up from just £5m in H1) and JLG disposed of its IEP East and its Australian wind farm portfolio (gross proceeds of up to £422m and £158m respectively). The increased activity resulted in a substantial mix shift in JLG’s portfolio over the year. Renewables fell from 34% of portfolio value in FY19 to just 17% at end FY20 (Exhibit 3). European assets (excluding the residual IEP East stake) are now just 11% (previously 34%) and primary assets are just 22% (51% previously).

The arrival of Ben Loomes (CEO) in May was another significant development in FY20. His new ‘Grow, optimise, enhance’ strategy was laid out in a capital markets day in November and is discussed in detail in our recent Outlook note. It targets sustainable returns of 9–12% in the medium term, predominantly driven by 1) a decision to exit a declining PPP market in the UK and Europe, 2) re-investing cost savings to establish a core-plus strategy to accelerate growth and 3) further enhancing both operational and balance sheet efficiency using third-party capital. JLG has already begun to execute this strategy. The sharp reduction in both renewable and European PPP exposure during FY20 plus enlarging its stakes in the I-77 and Clarence Correctional Centre projects (in the United States and Australia respectively) are consistent with this new approach.

The focus for JLG in FY21 is executing this new strategy. It has made several key hires in recent months including Rob Memmott (CFO), Christopher Reeves (ESG director), and Angenika Kunne (investment director – Core-Plus) and other senior hires are described as ‘well-progressed’.

A key priority is increasing the level of investment. JLG had already committed to invest £63m in FY21 entering the year. On top of this it is guiding to at least £100m in new commitments, implying a further £68m on top of £32m already committed to Pacifico 2 (Colombia). The aggregate value of the three preferred and short-listed PPP opportunities expected to reach financial close during FY21 (North-East Link, ViA15 and SR-400) is £106m. Adding £83m from the two core-plus projects, the total aggregate equity position of the pipeline is £189m. To meet its target effectively JLG has to close at least 36% (£68m/£189m) of its disclosed pipeline. We forecast £163m of investments in FY21 (Exhibit 4). The challenge for JLG will be increasing the pace of investment while maintaining discipline.

Further realisations are also expected. The agreed sales of IEP East (second tranche) and Australian wind farm assets should result in proceeds of £356m in FY21. In addition, JLG describes the current level of interest in its secondary assets as high. It has received a number of unsolicited approaches, some of which it is currently progressing. Our (arguably conservative) total realisations forecast of £400m, implies an additional £37m of disposals in FY21. We would expect progress on its commitment to exit its remaining renewable portfolio (£268m) by end FY22 during FY21.

JLG believes the encouraging rebound in activity levels that began in H220 presages a ‘structurally favourable market for infrastructure’. Countries are seeking to stimulate their economies through investment in infrastructure. The most obvious (and largest) example is Biden’s ‘Build Back Better’ programme in the US ($2tn over four years), but all of JLG’s key markets have laid out substantial infrastructure programmes in the last year (Exhibit 5).

The initial focus of JLG’s core-plus strategy is likely to be digital, particularly fibre-to-the-home (FTTH) infrastructure. In our recent Outlook note Grow, optimise and enhance, we assessed this opportunity in detail. Governments increasingly recognise the strategic imperative of 1Gbit/s connectivity and existing projects show customer adoption rates (and hence returns) are consistent and predictable (Exhibit 6). However, the company also highlighted that activity in energy transition, particularly around EV charging infrastructure, is picking up.

JLG has a strong balance sheet to execute on this opportunity. The £466m in available financial resources at the end of FY20 does not include the remaining £356m in net proceeds from the sale of IEP East and the Australian wind farm portfolio. In time JLG expects to attract third-party capital to both further accelerate its execution here and leverage its existing cost base.

The scope for valuation uplifts from both the discount rate unwinding and reductions in risk premia are likely to be less in FY21 than in previous years due to a smaller primary portfolio. Offsetting that, to some extent, a smaller, rebased renewable portfolio is likely to be less of a drag. We forecast a 4% underlying increase in NAV/share (excluding FX, pension and dividend payments) driven primarily by the PPP and projects portfolio (Exhibit 7). An FY21 dividend forecast of 11.4p is underpinned by the £356m in net proceeds from already agreed realisations.

However, foreign exchange rates have moved against JLG in FY21 so far. FX was a major driver of both H1 and H2 performance in FY20 (see Exhibits 1 and 2) and, with the full disposal of IEP East, an even larger share of assets will now be outside the UK. According to JLG at end FY20 a 1% move in the pound sterling has an impact of £11m on the portfolio valuation. Rebasing to current exchange rates reduces our underlying FY21 NAV/share forecast 7p and leads us to forecast reported FY21 NAV/share of 306p (vs 312p previously). The new CFO (Rob Memmott) is examining a hedging strategy that would reduce the exposure of the portfolio to FX and also tackle the volatility caused by shifts in the valuation of the pension fund.

We introduce an FY22 NAV forecast of 317p, based on 7.6% underlying (ie constant currency, pre-dividend) growth driven by greater investment activity and less renewable exposure. Our forecast is in line with JLG’s guidance of a ‘step-up in growth in 2022 towards our medium-term returns target range.’

At 316p, JLG’s shares 1.03x our rebased FY21e NAV/share forecast, a rating that stands at a discount to both its historical (1.07x) and peer group average (1.16x) ratings. FY20 realisations underpin an FY21 yield of 3.6%. Adverse FX moves may obscure NAV/share progress in FY21, but the company appears to be executing at pace in an infrastructure market that looks set to deliver sustained structural growth. JLG’s greenfield business model gives investors a unique way to gain exposure to these growth trends.