Directors' valuation of the Investments portfolio

The Directors’ valuation reduced by £93 million to £1,151 million (2017: £1,244 million), primarily due to £187 million being realised from divestments in the year (2017: £105 million). The number of projects in the portfolio increased from 71 to 74. This reflected continued success in targeted sectors with five new projects included in the Directors’ valuation for the first time.

The Group invested £58 million (2017: £35 million) in new and existing projects. Cash yield from distributions amounted to £89 million (2017: £53 million) as the portfolio continued to generate cash flow to the Group net of investment.

The business continued its strategy of maximising value through recycling equity from operationally proven projects, whilst preserving interests in strategic projects that offer opportunities to the wider Group.

In February 2018, the Group received £104 million from 12.5% partial sales in Connect Plus, the company which operates the M25 orbital motorway, on completion of a 7.5% sale agreed in December 2017 and a further 5% sale agreed subsequently in February 2018.

In the second half of the year, the Group sold its interests in Fife Hospital and the Nesbit Palisades multifamily housing project, and completed partial sell-downs of its interests in the University of Edinburgh student accommodation project and phase one of the student accommodation project at the University of Texas, Dallas. In total, £187 million of proceeds were received in 2018.

Unwind of discount at £96 million (2017: £97 million) is a function of moving the valuation date forward by a year with the result that future cash flows are discounted by one year less. Operational performance movements resulted in an £18 million increase in the value of the portfolio
(2017: £33 million), consisting mainly of an exchange rate gain of £36 million on the US portfolio offset by a number of changes in cash flow forecasts, discount rates and economic assumptions, including in respect of two UK investment assets which were written down in the year.

The methodology used for the Directors’ valuation is unchanged, producing a valuation that 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 assumptions. 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 periods, the Directors’ valuation may differ significantly from the accounting book value of investments shown in the financial statements, which are produced in accordance with International Financial Reporting Standards rather than using a discounted cash flow approach.

Demand for high-quality infrastructure assets in the secondary market continues to exceed supply and the Group will continue to sell investment assets timed to maximise value to shareholders.

The Investments portfolio is now more heavily weighted to North America (UK 43%, North America 57%). Within the UK, roads is still the largest sector despite the partial sales of the Connect Plus M25 investment, whilst in North America US military housing represents the majority of the portfolio. The Investments portfolio includes £1 billion of projects that have completed the construction phase and are operational.

Movement in Directors’ valuation

_{4 2017 valuation includes £62 million relating to the 7.5% partial disposal of the Connect Plus M25 asset, as the disposal proceeds had not been received at year end. The proceeds were received on 23 February 2018.}

UK portfolio

In the year, £34 million was invested across four projects in the portfolio: Aberdeen Western Peripheral Route; Irish Primary Care; Welland Bio Power; and the regeneration development at East Wick and Sweetwater.

In February 2018, there were partial sales of 12.5% of the Connect Plus M25 asset, comprising the completion of a 7.5% sale agreed in December 2017 and a further 5% sale agreed subsequently in February 2018, which generated proceeds of £104 million. In September, the Group completed the sale of its entire 50% interest in Fife Hospital for a cash consideration of £43 million. In December, the Group sold an 80% interest in its investment in the University of Edinburgh student accommodation project which generated proceeds of £24 million.

In aggregate operational performance movements resulted in a £21 million reduction in value arising from the net effect of revised cash flow forecasts and discount rates for certain projects, including in respect two investment assets which were written down in the year.

Discount rates applied to the UK portfolio range between 7% and 11.5% depending on project risk and maturity. The implied weighted average discount rate for the UK portfolio is 8.5% (2017: 8.5%). A 1% change in discount rate would change the value of the UK portfolio by approximately £49 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 increase 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.

Portfolio valuation December 2018
Value by sector

Portfolio valuation December 2018
Value by phase

Portfolio valuation December 2018
Value by income type ​

^{4 2017 valuation includes £62 million relating to the 7.5% partial disposal of the Connect Plus M25 asset, as the disposal proceeds had not been received at year end. The proceeds were received on 23 February 2018.}

North American portfolio

In 2018, the business won five projects: four investments in private rental housing portfolios at Birmingham (Alabama), Zephyrhills (Florida), Ridgeland (Mississippi) and Memphis (Tennessee); and a PPP project to construct and operate the Automated People Mover at Los Angeles Airport in California.

Investment of £24 million was made during the year in two existing and four new projects: a PPP data centre in Canada; a student accommodation project at Purdue University; and the stakes acquired in the four private rental housing portfolios.

In December, the Group completed the sale of its investment in the Nesbit Palisades multifamily housing project in Alpharetta, Georgia generating cash proceeds of £3 million. In addition, there was a partial sale of the Group’s investment in phase one of the University of Texas, Dallas student accommodation project which generated proceeds of £13 million.

Operational performance movements resulted in a £39 million increase in the value of the portfolio, consisting mainly of an increase of £36 million due to exchange rate movements, together with some revised cash flow forecasts and discount rate assumptions for certain projects.

Discount rates applied to the North American portfolio range between 7.5% and 10.5%. The implied weighted average discount rate is 8.2% (2017: 8.2%) and a 1% change in the discount would change the value of the North American portfolio by approximately £86 million.

Under the Tax Cuts and Jobs Act passed by the US Government in December 2017 there are provisions to restrict the tax deductibility of interest expense. The Group’s assessment of the provisions is that the restriction will not have a material effect on the Directors’ valuation.

For more information, see pages 27-29 of the 2018 Annual Report.