Challenger Infrastructure Fund

Listed infrastructure owner Challenger Infrastructure Fund reported decent results from its two investments. UK utility provider Inexus (82.5% owned by CIF) saw underlying earnings before interest, tax, depreciation and amortisation (EBITDA) rise 1% to £23.3m for the half ended 31 December 2011. Over the same period, petrochemical storage owner LBC Tank Terminals (66.2% owned by CIF) experienced a 15% increase in EBITDA to US$51.4m, boosted by significant improvement in its French operations and growth from LBC USA.

The group will soon pay securityholders a 5-cent interim distribution (already trading ex distribution). But, as previously advised, view this as a return of your capital rather than a return on capital—distributions aren’t backed by cash flow at this stage. As a result, net cash at the fund level fell from $180.6m to $154.4m during the half, and will fall to $138.6m, or 44 cents per security, on payment of the interim distribution.

2012 is a crucial year for the group. Inexus’s significant debts of £445m (the explanation for our conservative ‘low valuation’ of zero for this investment—see Challenger Infrastructure’s flaming buy on 30 Jun 11 (Buy - $0.94)) fall due this August. If Inexus can roll its debts on reasonable terms, our ‘low valuation’ for Challenger Infrastructure will receive an immediate boost. If it is unable to roll its debts and defaults, our ‘high valuation’ will need substantially shearing.

The strategic review outlined on 29 Aug 11 (Buy – $0.95) is, in part, a response to this coming debt maturity. The board recently asked its advisors to ‘explore market interest for individual assets or the fund’ (as a whole). With the stock trading at a steep discount to underlying net asset value, any deal could add significant and immediate value for securityholders. And, if lenders happen to baulk lending to Inexus, it’ll make acute sense for that asset to be sold quickly, even at a fire sale price, to an owner with deeper pockets. Part offence and part defence, the strategic review makes sense.

Although there are genuine risks to the upside case, a quick resolution to the substantial difference between share price and underlying value could be in the offing. The stock is up 6% since 20 Oct 11 (Long Term Buy – $1.09) and we’re maintaining our current recommendation. LONG TERM BUY.

Note: The model Income and Growth portfolios own Challenger Infrastructure Fund securities.