Although I liked the structure and the overall asset Under the allocation policy (e.g. bias towards infrastructure companies that benefit from long-term tailwinds) of the UTF, there were two areas of concern, which actually stemmed from the same nuance, namely higher interest rates.
Heading into the fourth quarter of 2023, it still looked like interest rates would adopt a “higher for longer” scenario. There was no significant discussion around multiple rate cuts already in 2024. So this obviously implied a high risk for UTF to protect its net asset value, while still managing to accommodate the dividend of around 8, 5%.
The first area of concern was the fact that the UTF had (and still has) recourse to external debt, which explains 30% of the total asset base. A significant portion of these revenues were tied up at fixed interest rates below the market level. In the case of refinancing at higher or more market-aligned interest rates, the UTF would face serious obstacles in terms of its ability to cover the dividend.
The second issue related to UTF’s underlying companies which inherently have fairly debt-saturated balance sheets, where higher rates would ultimately dampen their ability to distribute high-yielding dividends (which are a major source of cash flow). UTF treasury).
Now, if we look at the chart above (from the publication date of my article), we can see that UTF was down noticeably until November, when more positive news regarding rate policy d interest has arisen.
The fact that at one point UTF fell 15% in just about 30 days, and then once the positive news came in, it rose again, confirms that UTF is heavily exposed to rate risk. ‘interest.
With the above in mind and the assumption of a normalization of the interest rate environment, let’s examine UTF’s prospects of maintaining its attractive dividend and generating acceptable returns as we approach 2024 .
There are also two aspects I want to highlight in the context of relatively favorable interest rate projections.
The first is related to the structure of the external leverage profile of the UTF. As we can see in the table below, the lion’s share of these borrowings are based on fixed interest rates, which helps reduce the overall funding cost of the UTF.
Currently, UTF’s weighted average funding cost is 2.5%, which is well below the prevailing market funding rate. The relevant financing rate would be closer to the variable rate component, i.e. 6.2%.
Now that we know quite clearly that rates have peaked and that in 2024 there will be a convergence towards accommodative levels, the leverage profile of UTF looks more acceptable.
The most important aspect here is the weighted average duration of fixed rate financing. For now, it is about 2.8 years, which allows us to assume with more certainty that the UTF will manage to avoid rolling over a fixed rate debt with a very expensive debt that would jeopardize the sustainability of its dividend.
The second is related to the composition of UTF’s assets.
This pie chart clearly shows how concentrated UTF is in infrastructure activities. Additionally, we can also notice that approximately 18% of total AUM is invested in fixed income securities (e.g. corporate bonds and preferred stocks).
The benefit here is very simple: the duration factor gives a significant boost to UTF holdings.
In other words, since infrastructure companies tend to hold relatively large debts, mainly due to the stability and predictability of cash flows, any positive rate of change dynamics in the cost of financing confers a material benefit to free cash flow. This, in turn, allows for higher valuations and safer dividend coverage ratios.
Furthermore, we also need to understand the fact that most of these infrastructure companies have taken long-term borrowings to maximize the match of asset and liability profiles. The longer the duration of the debt instrument, the greater the impact of any change in SOFR.
Finally, since my article was published, UTF has fallen into discount territory relative to its current NAV.
The dominant discount of around 4.5% provides an added benefit to long-term investors, who are looking to buy and hold UTF with the aim of receiving its high-yielding dividend.
The improvement in the interest rate environment (i.e. clarity on the maximum level) and the general consensus on lower interest rates from 2024 have eased some of the pressure from UTF’s prospects of sustainably maintaining its 8.5% dividend. Considering that the weighted average duration of fixed rate financing is approximately 2.8 years, UTF has sufficient time before having to roll over fixed rate borrowings. This means that even if SOFR declines at a less accelerated rate than currently expected, UTF will still fare well from a funding cost perspective.
As a result, and given the exposure to strong infrastructure companies and high-yielding dividends, I would rate UTF a Buy.