Coronavirus has touched everything, but a group of funds continue to look attractive for those seeking income from their investments.
Note: the following article was written in early March, when the six most established renewable energy funds were trading on substantial double-digit premiums. This seemed overly demanding, considering the challenges facing the sector as outlined in the article, most notably the downward pressures on UK power prices. We therefore suggested investors wait for better opportunities to take a stake.
Since then, the outlook for the power price has arguably deteriorated further due to the corona-induced reduction in corporate activity and the plunging oil price. If the UK government’s recent proposal to allow more onshore UK wind turbines increases supply from that quarter, it will further exacerbate the downward pressure. Meanwhile more of the funds are warning that they may not be able to keep increasing dividends in line with RPI, with two already having dropped that commitment.
However, by 23 March, shares in most of the funds had fallen around 30% from their peaks, leaving them on discounts of 10% or more. This made them look substantially more attractive. As formerly bearish Stifel analyst Iain Scouller said: “We will still need electricity, the sun will shine and wind will blow, and the funds should be relatively defensive in terms of dividends compared to equities, where I think we will see substantial cuts and suspensions of dividends.”
Alert investors quickly capitalised on the opportunity, so at the time of writing the funds are no longer quite such bargains. But when they are trading at or below NAV, and offering yields of 6% to 7%, they continue to look relatively attractive, particularly for income-seekers. (26 March 2020)
Renewables face a share-price shakeout
The six UK-oriented renewable energy funds with more than a three-year track record in this 13-strong sector have pulled in close to £6 billion in assets over their six- to seven-year lives, thanks to their attractive and modestly growing dividends. Their appeal is enhanced by their low correlation with bonds and equities, and by the growing enthusiasm for investments with strong environmental credentials.
As a result their shares all started 2020 on double-digit premiums, standing at close to or above 20% for Bluefield Solar Income (BSIF), the Renewables Infrastructure Group (TRIG) and Greencoat UK Wind (UKW).
Trust price falls
Since then there has been a shakeout, with all six trusts suffering share price falls before the Covid-19 sell-off began. Their appeal has arguably been somewhat enhanced by hopes that they will be relatively unaffected by the virus. However, brokers such as Colette Ord of Numis Securities and Iain Scouller of Stifel believe most remain demandingly priced despite the recent downturn.
The main problem unsettling investors has been the downward trajectory of UK power prices. By the start of 2020, UK power price forecasts had already fallen over 30% since the trusts were launched, with falling gas prices one of the main culprits. Worries were exacerbated when leading forecaster Bloomberg New Energy Finance warned of a steepening decline over the next 10 years, partly due to ever-growing generation at increasingly competitive prices by offshore wind and PV solar assets. This has been described as the sector ‘cannibalising’ its own profitability.
Power prices are of critical importance to renewable funds, as their revenue not only funds their dividends but also determines their net asset values, which are calculated on a discounted cash flow basis. On average, around 60% of the six funds’ revenue currently comes from various forms of inflation-linked subsidies and is therefore not immediately affected by weakening power prices, and quite a bit of the rest is sheltered by purchase price agreements (PPAs) covering the next six months to two years. But any unsubsidised balance is immediately at risk, and future PPAs look liable to be less rewarding than current ones.
Weak price forecasts
Other forecasters have so far been less apocalyptic than Bloomberg, and TRIG suggests that greater electricity demand for transport and heating should help prop up prices. But weakening power price forecasts have already contributed to falling NAVs for most of the funds.
NextEnergy Solar (NESF) and Foresight Solar (FSFL) have been worst hit, with their net asset values (NAVs) falling around 5% in the last quarter of 2019. This was blamed mainly on the reduction in forecasts for UK power prices, plus the energy watchdog Ofgem’s targeted charging review.
Foresight also suffered from a weather-related incident at one of its Australian assets, reminding investors that all the funds are vulnerable to changing weather patterns, while Next Energy marked its NAV down 0.7% due to the reduction in inflation forecasts. This reduces the value of the inflation linkage in its subsidies, so must also be a worry for other funds.
NESF also warned that its NAV will fall a further 0.8% or so if UK corporation tax is held at 19%, rather than cut to 17% as previously announced. The calculation seems surprisingly low, with Bluefield Solar Income, for instance, reckoning maintenance of corporation tax at the current rate will reduce its NAV by up to 2%. Both Next Energy and Foresight Solar tried to mitigate the fall in their NAVs, with NESF extending the projected life of its assets, while FSFL reduced the discount rate used to value them.
All the funds have deployed similar measures to enhance their NAVs over the years, but analysts have begun to question how much further they can go. All have also bolstered their NAVs by issuing new shares at sizeable premiums to NAV, but if their ratings fall they get less of a boost.
More importantly perhaps, the competitive market for UK energy assets, combined with the probability that such assets will enjoy fewer subsidies in the future, is making it harder for funds to keep adding to their generating capacity on terms that will not dilute their yields. In response, BSIF has made few acquisitions in recent years and TRIG is increasingly focusing its expansion on Europe.
Stifel’s Iain Scouller is particularly cautious about the established renewables trusts, and suggests investors only consider purchasing when they are issuing new shares at a below-market premium. Simon Elliott of Winterflood Securities agrees they are becoming more vulnerable to changes in power price as their exposure to unsubsidised revenue increases, and shares Scouller’s doubts about how much further NAVs can be propped up by lowering discount rates, but is more sanguine about asset life extensions.
“I can see no reason why wind and solar generation should not continue on many sites, with regularly upgraded equipment, for much longer than 30 years,” he says. John Laing Environmental Assets Group (JLEN) is Winterflood’s current sector favourite, on the grounds it has the lowest sensitivity to long-term power prices.
Colette Ord favours BSIF because of its managers’ resistance to buying assets which do not comply with their income-biased return targets, and its conservative valuation policies. It offers a high, comfortably covered yield and has frequently paid special dividends.
Ord is cautious about most of the more recent additions to the renewables sector, in particular Octopus Renewables Infrastructure Fund, which leapt to a double-digit premium before making any investments. She prefers Aquila European Renewables Income Fund, to which Numis are brokers.
Launched in mid-2019, AERI is targeting investments in wind, solar and hydro-powered renewable energy infrastructure in continental Europe and the Republic of Ireland, so it covers a much wider spectrum of energy markets and climates than most of its established counterparts. At the end of 2019 it was 72% invested with another 23% committed, predominantly in wind in northern Europe plus 15% in Portuguese hydro power. The majority of its current revenues is based on subsidies; the rest is underpinned by 10-year purchase price agreements, and it is targeting a dividend of 4 euro cents for 2020.
SDCL Energy Efficiency Income Trust (SEIT) also looks interesting. It focuses on operational energy efficiency assets, with no reliance on subsidies and only indirect exposure to power prices. It is targeting a dividend of 5p for the year to end March 2020, followed by 5.5p next year.
SEIT provides heat, power and light for commercial, industrial and public buildings using various forms of onsite energy generation, ranging from combined cooling/heating and power plants to rooftop solar panels. Lead manager Jonathan Maxwell says its installations work out cheaper, cleaner and more reliable than provision via the grid, and can cut energy waste by up to 30%.
The average length of SEIT’s contracts is only 11.5 years; however, at the end of the contract, counterparties have to pay SEIT to decommission the project, pay market value to retain the equipment, or extend the contract – as is frequently the case for similar contractors in the US. Contracts are typically on a fixed upward-only escalator or have some inflation linkage. As with the renewable generators, SEITs assets are valued on a discounted cash flow basis with negligible allowance for the residual value of any equipment installed, though this may be significant.
Launched in December 2018, the fund raised £226 million in several tranches. Around a third of its portfolio is in the US, a third in Spain, and the UK accounts for the final third if forward commitments as well as existing projects are taken into account. Maxwell says it focused overseas in 2019 as the UK was “pretty dead”, but that “since the election the phone has not stopped ringing”. On that basis another fundraising seems likely.
Pricey premiums dampen appeal
return (%) over:
|Trust||3 months||6 months||1 year||3 years||Current
Average premium (%)
|Aquila Euro Renewables Inc||-5||-11||n/a||n/a||3.6||n/a||1.4|
|Bluefield Solar Income Fund||1||6||15||51||21.5||17.5||5.9|
|Foresight Solar Fund||-3||-5||8||28||13.8||12.1||5.8|
|Gore Street Energy Storage||-2||6||7||n/a||2.6||0.8||8.3|
|Greencoat Renewables - Euro||2||-1||15||n/a||13.5||10.9||5.2|
|Greencoat UK Wind||-3||2||12||40||19.5||17.0||4.9|
|Gresham House Energy Storage||0||1||7||n/a||6.4||6.0||1.9|
|JLEN Environmental Assets||1||0||15||31||18.8||15.4||5.6|
|Next Energy Solar Fund||-4||-4||6||25||11.9||10.9||5.9|
|Octopus Renewables Infrastructure||7||n/a||n/a||n/a||8.8||n/a||0.0|
|Renewables Infrastructure Group||4||4||21||51||19.1||13.9||4.9|
|SDCL Energy Efficiency Income||3||3||13||n/a||15.0||9.6||3.2|
Source: Winterflood, as at 3 March 2020