Higher maintenance costs at UK public-private partnerships have weighed on HICL Infrastructure (HICL ) and contributed to a small drop in net asset value (NAV) at the £3.2bn alternative income fund.

Half-year results this week showed HICL’s NAV per share dropped 1.1% to 156.5p in the six months to 30 September. This came after fund manager InfraRed Capital Partners had to spend more on the upkeep of 36 PPP projects that make up nearly a third of the portfolio and which are due to be returned to the public sector in the coming years as the fund’s contracts expire.

InfraRed said it prioritised high standards of facility condition and that ‘lifecycle spending’ became increasingly important to ensure a smooth handback to public ownership. It blamed above inflation increases in replacing items such as boilers and carpets for nudging up its discount valuation rate from 8% to 8.1%, which in turn depressed the NAV.

The interims revealed that HICL had been in a dispute with the counterparty at Manchester-based Tameside Hospital and sold its £6m equity interest in the project for £1.

‘All of this does highlight the increased risk of disputes as PPP projects near handback to the public sector and it would have had much bigger consequences had it been a larger asset,’ JPMorgan Cazenove’s Christopher Brown noted.

InfraRed said that Tameside was not representative of the broader portfolio, pointing out that higher historical inflation and growth assets had driven earnings higher.

Excluding profits on asset sales the company is making to recycle its capital, earnings covered the 8.25p dividend per share by 1.07 times – up from 1.05 times in March – and marked progress towards the 1.1 times target for 2026 when the dividend is expected to be 8.35p.

However, a cloud hangs over the dividend cover pending regulator Ofwat’s 2024 price review and its impact on Affinity Water, which is HICL’s largest holding at 8.3% of assets.

The water group, which serves parts of London, eastern and south-eastern England, submitted business plans to Ofwat in August that include planned dividends and business growth. A final determination is expected on 19 December.

InfraRed said Ofwat’s draft determination was consistent with its assessment that Affinity would be able to resume distributions to shareholders, although the yield would depend on how much borrowing Ofwat will allow.

‘HICL remains supportive of Affinity’s growth plans with a £50m equity investment anticipated over the next asset management plan period (AMP), contingent on a fair final determination, including the resumption of distributions at a reasonable level,’ it said.

The 6.7%-yielder has sold several assets over the last 18 months, generating £509m to repay borrowings on its £400m revolving credit facility and fund £17.6m in share buybacks as part of a £50m programme. That will leave total debt of 7% of net assets.

InfraRed fund manager Ed Hunt said he continued to look for attractive investment opportunities, which would be funded with the RCF and further asset disposals.

‘The risk and return proposition available to the company through buying back its shares will continue to be a key benchmark for future capital allocation decisions,’ he said, noting that new investments had to exceed a hurdle of a 9.7% return to go ahead.

HICL shares slipped to a 23% discount following the interim results on Wednesday as an increase in UK inflation in October knocked hopes of another interest rate cut by the end of the year.

Stifel analyst Iain Scouller there was a risk that discount rates would need to be increased across the whole core infrastructure sector if UK government bond yields rise to 5% in the weeks ahead, following the UK Budget and US election, which would hit NAVs.

However, based on the improving dividend cover, lower leverage and 6.7% dividend yield, he maintained a ‘buy’ recommendation with a fair valuation of 133p, a 15% discount to NAV.  ‘We think discounts will remain wide across the sector in the near term given the recent rises in gilt yields, but still think there is upside in the price from here,’ he said.

Jefferies analyst Matt Hose maintained a ‘hold’ recommendation, which he will review when Affinity’s outcome is received.