Directors' valuation of the Investments portfolio

During the first six months of the year, the Directors’ valuation increased to £1,235 million (2016: £1,220 million). The size of the portfolio was maintained at 69 projects, with the increase in valuation due to the unwind of the discount partially offset by negative exchange rate movements. The Group continued to make investments, with £24 million (2016: £45 million) invested in new and existing projects. Cash yield from distributions amounted to £26 million (2016: £43 million). 

The methodology used for the Directors’ valuation is unchanged, producing a valuation that more closely reflects market value and which, therefore, changes with movements in the market. Cash flows for each project are forecast based on historical and present performance, future risks and macroeconomic forecasts and which factor-in current market attitudes. These cash flows are then discounted using different discount rates based on the risk and maturity of individual projects and reflecting secondary market transaction experience. As in previous years, the Directors’ valuation may differ significantly from the accounting book value of investments shown in the accounts, which are produced in accordance with International Financial Reporting Standards rather than using a discounted cash flow approach.

Demand for high-quality infrastructure investments in the secondary market remains strong and the Group will continue to sell investment assets timed to maximise value to shareholders. Investor appetite for yield in the ongoing, low interest rate environment continues unabated and pricing in the secondary market is, therefore, expected to remain strong for the foreseeable future.

Movement in Directors’ valuation

UK portfolio

In the first half of 2017, £3 million of equity investment was made in projects across the portfolio. Operational performance movements resulted in a £5 million reduction in value, which reflected updated forecast assumptions across a number of projects, the most significant of which related to a change in the timing of lifecycle cost savings.

Discount rates applied to the UK portfolio range between 7% and 14%, depending on project risk and maturity. The implied weighted average discount rate for the UK portfolio remains constant at 8.3% (2016: 8.3%). A 1% change in discount rate would change the value of the UK portfolio by approximately £79 million.

Consistent with other infrastructure funds, Balfour Beatty’s experience is that there is limited correlation between the discount rates used to value PPP (and similar infrastructure investments) and long-term interest rates. In the event that interest rates increased in response to rising inflation, the impact of any increase in discount rates would be mitigated by the positive correlation between the value of the UK portfolio and changes in inflation.

The UK Government has announced that the previously-published draft legislation in response to the OECD’s recommendations on the tax deductibility of interest expense will be reintroduced into Parliament later this year and take retrospective effect from 1 April 2017. The proposals continue to preserve the concept of the public benefit exemption put forward by the OECD and also include other helpful measures to protect public infrastructure projects such as PPPs. The draft legislation is complex and remains subject to change. The Group’s assessment, which is subject to further review as the legislation is finalised, remains that the impact on the Directors’ valuation will not be material. Balfour Beatty continues to engage with the UK Government and Tax Authorities to clarify and evaluate the impact of the draft legislation.

North America portfolio

Investment of £21 million was made in the period on three existing projects: two hospitals in Canada and the student accommodation project at the University of Texas, in addition to the stake acquired in a private rental housing portfolio in Atlanta. Carmendy Square, Florida, was sold in the period, generating a net £2 million in proceeds.

Operational performance movements resulted in a £25 million decrease in the value of the portfolio, nearly all of which was due to the strengthening of sterling against the US dollar.

Discount rates applied to the North America portfolio range between 7.5% and 10%. The implied weighted average discount rate is 8.0% (2016: 8.2%). The fall in weighted average discount is due to a number of investments moving from the construction phase into the operations phase. A 1% change in the discount rate would change the value of the North American portfolio by approximately £71 million.