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Chunky dividend cover is the key to UKW’s resilient proposition…
Greencoat UK Wind Plc
Investec view: The NAV at 31 December 2023 was 164.1p/share, a reduction of 3p/share (1.8%) over the full year. Key drivers included an increase in discount rates (-11.4p/share), depreciation (-5.1p/share) and lower power prices (-12.0p/share), offset by inflation (+5.7p/share), accretive investments (7.5p/share) and other movements (+3.3p/share) including the recognition of REGOs. Generation of 4,743GWh was materially below budget (-13%) owing to low wind resource (-7%) during the period. Despite this, cash generation remained strong, and the dividend was covered 2.1x. The company has maintained a disciplined approach to capital allocation and was able to invest £821m into Dalquhandy, London Array, South Kyle and Kype Muir Extension wind farms, increasing net generating capacity by 397MW. UKW had committed to acquire South Kyle and Kype Muir in 2020 and recognised significant uplifts upon completion, primarily as a result of the improved power price environment compared to when the acquisitions were agreed. The company also increased its 2023 dividend to 10.0pshare (original target was 8.76p/share) with a final quarter dividend of 3.43p/share. The target dividend for 2024 is also 10p/share, an increase of 14.2% above the original base for 2023, and significantly above December’s RPI of 5.2%. UKW also announced a £100m buyback programme in Q4 2023 although we note that it has only used c.£20m to date; given the material discount to NAV at which the shares currently trade, we would hope to see the intensity of the buyback increase so that the NAV accretion can be banked for ongoing shareholders. UKW has maintained an RPI linked dividend since launch and the current dividend of 10.0p/share equates to a yield of 7.4% at the share price. The levered portfolio discount rate is 11% and we estimate that, at the current share price, this implies a steady state return of c.12%. Whilst forward power prices have reduced materially over recent months, forecast cash generation and dividend cover remains strong. UKW expects to generate surplus cashflow in excess of £1bn over the next five years, which provides the Board and Manager with flexibility and options in respect of capital allocation and the ability to reinvest into new assets, increase share buybacks and/or pay down debt. We reiterate our Buy recommendation.
Greencoat UK Wind - 10% total NAV return projected for 2024 NextEnergy Solar Fund - De-leveraging remains key Universal Music Group - Streaming continues to drive growth
Greencoat UK Wind Plc NextEnergy Solar Fund Ltd
We see recovery potential for the sector, but appreciate near-term challenges and explore the potential NAV impacts and balance sheet resilience should revenues remain subdued, alongside dividend distribution capabilities.
UKW GRID HEIT GSF
Greencoat UK Wind - NAV decline 1% in Q4 23 but UKW remains well positioned Impact Healthcare REIT - Steady income growth and record tenant cover
Increased clarity on underlying assumptions highlights UKW’s resilient proposition…
Investec view: The company announced its interim results for the period to 30 June 2023. The NAV at end-June was 165.8p/share, which represents a fall of 0.8% over the six-month period (NAV at 31 March was 166.3p/share). The key drivers of the NAV over the period included a 100bps increase in the portfolio discount rate (the levered discount rate is now c.11%), which reduced the NAV by 11.4p/share, a reduction in short-term power prices (-6.8p/share) offset by higher actual and forecast inflation (+8.1p/share). The company also revalued its committed investment in South Kyle. UKW will acquire the asset on 31 August 2023; however, the commitment was made in Q1 2020. The revaluation of South Kyle and the Kype Muir extension resulted in an increase in value of £132.5m (5.7p/share) above the investment consideration. Net cash generation (+8.8p/share) exceeded the dividends paid during the six months (-4.1p/share). Portfolio generation for the period was 2,088GWh, which was 18% below budget owing to low wind. Earlier this week, UKW announced the acquisition of London Array offshore wind farm for consideration of £444m, a significant acquisition for UKW given its size. The company agreed £640m of new term loans (weighted average cost of c.7%) in order to finance the acquisition and to repay existing term loans (£150m) and drawn amounts on its RCF (£200m). The term debt which was prepaid had a weighted average cost of c.2.0%. The company remains conservatively geared; pro forma leverage, factoring in the acquisitions of South Kyle, Kype Muir and London Array will increase to c.36% of GAV, including drawings of c.£270m on the RCF. That said, given the current macro-economic backdrop, and with equity markets currently closed, and with the company trading on a not insignificant discount to NAV, we believe that shareholders would welcome a clearer articulation of the company’s capital allocation policy going forward, particularly given that UKW should generate c.£200m p.a. of excess cashflow over the coming years. UKW has maintained an RPI-linked dividend since launch, and the current dividend of 8.76p/share represents a yield of 6.0%. The forward power price curve has reduced materially over the last few months, although it still remains elevated compared to historic levels. UKW continues to benefit in this environment and to generate significant cashflow. The dividend was covered 2.1x by operational cashflow in H1, despite low wind resource (-18%) during the period. This strong cashflow more than underpins the RPI-linked dividend and also allows excess cashflow to be reinvested into new assets and/or pay down debt. We reiterate our Buy recommendation. Capital allocation:
Crude falls on Fed minutes
UKW JSE STAR
UKW’s strong performance isn’t necessarily reflected in the share price…
Investec view: This morning, Greencoat UK Wind (UKW) announced a NAV of 167.1p/share as at 31 December 2022. This reflects an increase of 12.1p/share in the fourth quarter (+7.8%) and 33.6p/share (+25.1%) over the year. The increase in Q4 was driven by an update to its power price assumptions, which added c.20p/share, offset by the impact of the Electricity Generator Levy (EGL), which reduced NAV by 8p/share. Overall, 2022 generation was 5% below budget reflecting lower wind resource in H2; however, given the elevated power price environment, the 2022 dividend was covered 3.2x by operational cashflow. UKW has maintained an RPI-linked dividend since launch in 2013. It announced a dividend target of 8.76p/share for 2023 (current yield of 5.7%), which represents an increase of 13.4% versus 2022, in line with December RPI. Whilst the forward power price curve has reduced materially over recent months, it remains elevated against historic levels, albeit with significant volatility. The EGL has removed a significant amount of the upside above £75/MWh; however, UKW is the largest beneficiary in the listed renewables sub-sector from the elevated power price environment given its limited PPA fixes. The company continues to generate significant cashflow and this more than underpins its RPI-linked dividend and also allows excess cashflow to be reinvested into pipeline assets. We reiterate our Buy recommendation. Power prices: The forward curve for short-term power prices used in the 31 December valuation has reduced from the levels seen in Q3 (see page 2), and is at a similar level to that used in the Q2 NAV. UKW had not included the higher Q3 forward curve in its Q3 NAV as at 30 September 2022, given the elevated level and heightened volatility. The short-term power price assumptions now baked into the valuation are an average of £120/MWh for both 2023 and 2024. The company has retained a discount of c.30% to the forward curve. The previous valuation included a c.50% discount, with implied prices of £120/MWh for 2023 and £90/MWh for 2024. The discount applied has reduced given the greater clarity on the regulatory environment following the EGL. Balance sheet: UKW has aggregate group debt of £1.78bn (31% of GAV) comprising £900m of term debt, £680m share of Hornsea 1 debt and £200m of drawings on its RCF (£600m capacity). The company is committed to acquire Kype Muir (c.£50m, although c.£40m has been funded to date) and South Kyle (£320m). The company has £160m of cash on its balance sheet, and this, alongside excess forecast cashflow in H1, will be used to finance these commitments.
Greencoat UK Wind - 31% YoY NAV TR as power price assumptions revisedJLEN Environmental Assets - c.1% decline to NAV at Q3 updateUS Solar Fund - Mount Signal 2 sale option exercisedBlackstone Loan Financing and Marble Point Loan Financing - December NAV updatesPrimary Health Properties - Axis Technical Services acquisition
UKW JLEN USF BGLF PHP
Investec view: The NAV at 30 June 2022 was 153.6p/share, which represents an increase of 20.1p/share over H1 (+4.3p/share, +2.9% in Q2). A key driver of the increase in NAV was the uplift in the portfolio valuation, which added 10p/share. Increases in forecast power prices added 13p/share, and an increase in inflation assumptions (at Q1) added 6p/share. Excess cashflow added a further 10p/share. These moves were offset by depreciation and other assumption changes (-6p/share) and, notably, UKW disclosed an increase in its portfolio discount rate, which reduced the valuation by 3p/share. Net cash generated by the portfolio was extremely strong and covered the dividend 3.8x (without any debt amortisation). UKW portfolio discount rate increased by 50bps to 7.7%, reflecting both a greater proportion of merchant cashflows (which attract a higher discount rate vs. fixed cashflows) and an increase in the underlying benchmark rate. We understand that the split between the two drivers was roughly even. The Renewables Infrastructure Group (TRIG) also announced an NAV today as at 30 June 2022. It outlined that no change had been made to benchmark discount rates applied in the valuation, with demand for assets in the renewables sector remaining resilient. Both funds have recently transacted in the same asset, so UKWs move appears pre-emptive rather than a reflection of actual market pricing. Whether transactional pricing eventually moves remains to be seen, but the link between discount rates and risk-free benchmarks is anything but exact, as we have seen across over a decade of near-zero interest rates. We believe that this is a strong set of results and that the company is well-placed to benefit in the current macroeconomic environment, principally from higher inflation and elevated power prices, which are both likely to persist for longer than perhaps initially expected. As a result, the company is generating significant cashflow, and this more than underpins its RPI-linked dividend, and allows excess cashflow to be reinvested into pipeline assets. The shares are currently trading around NAV, which we believe is an attractive entry point, and given strong fundamentals, we upgrade to Buy. Gearing: At 30 June 2022, the company had £900m of fixed rate, term debt, which equates to c.20% of GAV. The £250m balance on the RCF at the beginning of the period was refinanced with £200m AXA term debt and £50m from excess cashflow during the period. The company has access to a £600m RCF that is currently undrawn. It also has cash balances of c.£236m, which in addition to the RCF and excess cashflow generated, will be used to fund the company’s committed pipeline of c.£771m.
Greencoat UK Wind Plc Renewables Infrastructure Group Limited GBP Red.Shs
UKW is in a strong position to capture the benefit of current high energy prices
Investec view: UKW announced a strong year-end NAV of 133.5p/share which represents an increase of 4.5p/share (3.5%) over the quarter. The increase in NAV reflects strong cash generation and increased forward power prices, although there has been no material change to long-term forecasts. In late November 2021, UKW raised £450m through a heavily oversubscribed and up-sized equity raise at an issue price of 132.0p/share. Whilst we now estimate that this capital raise might have added c.0.3p/share to the 31 December 2021 NAV, we understand that some investors already had reservations about the pricing of this raise given that the strength in NAV was at least partially expected as a result of strong prevailing power prices. This NAV may confirm their concerns. In a busy Q4, Greencoat Capital was acquired by Schroders. In our view, the company should benefit from the larger institutional platform afforded by Schroders and, we hope, could act as a catalyst for greater transparency and improved disclosure. In the short-term, the company continues to be a beneficiary of its exposure to higher power prices, supporting the growth in the dividend. Dividend increase in line with RPI: UKW announced a dividend target of 7.72p/share for FY22, which represents an increase of 7.5% compared to FY21 (7.18p/share). The company has maintained its commitment to increase its dividend in line with RPI. The 2021 full year dividend was covered 1.9x, which reflects both low generation (20% below budget) and high power prices which were significantly above budget. Acquisitions Earlier this month, UKW announced the commissioning and resultant acquisitions of Windy Rig (43.2MW) and Glen Kyllachy (48.5MW) wind farms. The acquisitions were first announced in Q4 2019. Both assets are subsidy-free and take the number of subsidy-free assets to three out of 43. Gearing: UKW entered into an agreement with AXA to provide an 8-year £200m facility, which will be used to repay the RCF. At 31 December, UKW had aggregate group debt of £950m. Total gearing is c.23% of GAV. Acquisition of Greencoat Capital: In December, it was announced that Schroders had agreed to acquire a 75% shareholding in Greencoat Capital for an enterprise value of £358m. The deal includes a potential earn out, payable three years after completion, which is subject to stretch revenue targets, the continued employment of senior management and is capped at £120m. There are a series of options, exercisable by Schroders or the Greencoat management shareholders in place for Schroders to acquire the remaining 25% shareholding over time at a price based on a fair market valuation at the time of the option exercise.
Investec view: The Renewables Infrastructure Group (TRIG) has published a solid set of results. The NAV at 30 June was 114.3p/share, down 0.9% over the six-month period primarily due to the change in UK corporation tax which reduced the NAV by 3.2p/share. A provision applied to older assets with FiTs in France and FX movements further reduced NAV. These effects were largely offset by a 20bps reduction in discount rates and an increase in power price forecasts in the near term. The NAV total return in H1 was positive at 2.0%. We believe TRIG’s NAV valuation looks conservative versus a number of peers and an evolving macro backdrop, particularly with regard to its corporation tax, inflation and power price assumptions. TRIG has applied the increase in UK corporation tax from 2023 for the full duration of the projects’ economic lives which we believe is the correct approach. We note, however, that both UKW (Hold) and ORIT (Sell) have applied the change for a handful of years rather than over the full duration of the cashflows. Whilst we struggle to understand why some peers would assume that future tax regimes are any different in the future from those currently outlined, we understand that if TRIG had taken a similar approach, the NAV would be c.2p/share higher (or conversely, the NAVs of peers, and recent NAV performance would be meaningfully lower). TRIG’s valuation assumes UK RPI of 2.75% p.a. to 2030, and 2.0% thereafter. Most peers have increased their assumption to 3.0% to 2030 with UKW assuming an even higher rate of 3.3% to 2030, and 2.3% thereafter. We estimate that if TRIG had assumed UK inflation of 3% to 2030 and 2.25% thereafter (an increase of 25bps p.a.), the NAV would be c.1.5p/share higher. However, if the shift is not parallel due to a shorter time spike, i.e. in the period to 2030, then the effect on the NAV is potentially greater. Assuming UK inflation of 3.3% to 2030 and 2.3% thereafter, we estimate that TRIG’s NAV would be c.2.8p/share higher. With expectations for inflation increasing, TRIG’s NAV should be a beneficiary of actual inflation outperforming the assumption and/or future changes to the inflation assumption. We note that TRIG has already entered into inflation swaps to hedge some of its RPI and CPI exposure. Power prices are also recovering strongly and long-term forecasts may now have baked in all of the downside of renewables build-out and be future beneficiaries of the growth in demand for electricity as we transition towards a net zero economy. If UK power prices were 5-10% higher along the curve, we estimate this would add c.2.4-4.8p/share to TRIG’s NAV.
UKW ORIT TRIG
Greencoat UK Wind (UKW) was the first renewable energy infrastructure trust to launch, and its subsequent growth has led to significant benefits for investors. The tiered fee structure and economies of scale have led to the OCF reducing significantly over time. At the same time, the trust can now consider much larger sized investments, which in themselves offer economies of scale and therefore potentially higher returns than might otherwise be the case. Finally, its scale enables a dedicated management team to optimise the assets and enhance performance. This shows up in the NAV performance of UKW, which continues to perform strongly relative to peers and the UK equity market. UKW remains the only renewable energy infrastructure fund to explicitly state that its aim is to grow dividends in line with inflation. The UK Government’s ten-point plan for a Green Industrial Revolution to achieve carbon neutrality by 2050 requires a significant ramp up of offshore wind generation to 40GW, which would represent a quadrupling of current capacity. Offshore wind farms are typically significantly larger than onshore, and UKW’s increased scale will allow it to invest in this asset class. Notwithstanding a competitive market, UKW has a significant pipeline of assets that it has committed to buy which should give reassurance on the immediate future in terms of capital deployment. UKW’s target dividend for the current year is 7.18p, meaning the shares offer a prospective dividend yield of 5.4% on the current share price, which we think compares well with income sources elsewhere.
Greencoat UK Wind (UKW)’s managers continue to build a formidable portfolio of wind farms in the UK. Whilst the market for wind farms in the UK is currently competitive, the team have been able to raise and deploy significant amounts of capital during the last financial year – all at rates of return that we think should enable the trust to meet its total return objective of 8-9% net of fees. Increased size brings efficiencies in many ways. As we discuss in Charges, the OCF is now sub 1% per annum. Size also allows operational efficiencies, but perhaps most importantly allows the trust to buy much larger assets. UKW’s increased scale allows it to invest in the burgeoning market for offshore wind farms more effectively, which currently represents 30% of the portfolio. UKW has twin aims of delivering a high, RPI-linked income return for shareholders whilst maintaining capital value in real terms. 2020 has shown the strength and resilience of UKW’s relatively simple model, with the trust generating a covered dividend and continuing to state its ambition to grow the dividend in line with inflation. At the current price, we estimate that the prospective yield is 5.5%. Excluding income, the NAV has grown from launch at 98p to 120.4p, growth of 22.9% which compares with RPI growth of 18.8%. UKW has historically traded at a significant premium to the peer group average. UKW now trades on a premium to NAV of 7.4%, below the five-year average for the trust and relative to the weighted average for the peer group of c. 10%.
In December we highlighted that ESG was the surprise ‘thematic winner’ of 2020. Perhaps not in performance terms (can anything beat the FAANGs?), but almost overnight it has become a standard part of fund presentations. Asset flows into ESG funds also back up our contention, with huge growth in assets seen by ESG-related funds during 2020. However, as we discussed in December, within the equity trust universe there are relatively few equity trusts that offer ‘pure’ exposure to the theme. And of those that do, many stand at chunky premia. The new US presidency is focussing on climate change as one of its four key pillars. Larry Fink, CEO of BlackRock, published his ‘Dear CEO’ letter in January, which for the second year in a row ‘majored on’ (as they say on that side of the pond) climate change – we touch on elements of his letter below. Suffice to say, the CEO of the world’s biggest asset manager thinks that aside from posing a big risk to traditional portfolios, “the climate transition presents a historic investment opportunity”. It would appear that increasingly everyone else thinks so too. We examine the potential and pitfalls of being greenwashed, and look for the best opportunities to avoid it.
UKW IHR NESF USFP TRIG
Kepler’s investment trust ratings seek to identify the top-performing closed-ended funds in the growth, income & growth and alternative income categories. Previously presented only on our retail site, today we can unveil for both professional and retail readers the winners of the ratings for 2021. Our ratings are designed to capture attractive and persistent performance characteristics and to reward long-term success. Like all quantitative systems they are backward-looking, but we have attempted to reward those trusts which have done well in the context of their own goals and benchmarks, and which have done so for a sustained period. As the selection system is entirely quantitative, it allows us to set aside all personal biases and views – and all commercial relationships – and look at the universe in a purely objective way.
UKW HICL TRIG SWEF BRGE THRG BRWM
Greencoat UK Wind (UKW) has seen continued acquisitions and capital raises throughout 2020, despite the pandemic. The trust remains the largest listed renewable energy infrastructure fund, with gross assets of £3.3bn once the latest acqusition completes. It provides a pure investment exposure to UK wind farms, with the twin aims of delivering a high, RPI-linked income return for shareholders whilst maintaining capital value in real terms. UKW is achieving its managers’ ambitions in becoming ‘utility scale’, which benefits shareholders in a number of ways (see Portfolio section). The overall costs of running the trust have continued to reduce, and scale also allows the managers to negotiate operational cost savings and implement other asset management initiatives. Lastly, the trust has the scale to purchase institutionally sized assets. This is increasingly important in what is now a popular market and asset class, and bodes well for the future. At the current price, the dividend yield is 5.3%. As we discuss in the Dividend section, one of the distinguishing features of UKW relative to peers is that it aims to link the dividend with inflation, as measured by RPI. UKW is on track to pay the 2020 target dividend of 7.1p, representing compounded growth of 18.3% in total since listing and ahead of inflation. UKW has historically traded at a significant premium to the peer group average. This was the case until relatively recently, with the share price not having recovered its poise yet, following the £400m equity issuance completed at the end of September. UKW now trades on a premium to NAV of 10.3%, relative to the weighted average for the peer group of 13.1%.
Background: UKW has agreed to acquire South Kyle Wind Farm for a consideration of £320m, which is due upon completion, currently scheduled for Q1 2023 once the wind farm commences commercial operations. South Kyle is a subsidy free project. Investec view: This represents a material acquisition by UKW and increases its subsidy-free commitments to c£513m (28% of current NAV). This is at a time when spot power prices have fallen to unprecedented levels and power price forecasts have been materially reduced. Assuming no further investments, and all subsidy-free projects are funded, unsubsidised assets will comprise c17% of the portfolio, and this will materially increase the risk profile of the company. In its recent results, the manager stated that it expects that ‘the majority of future investments will continue to be made from UK wind farms accredited under the ROC regime’ and we would expect this to be the case going forward, in order to balance the risk profile of the underlying revenues of the company. UKW also needs to balance the funding of its commitments, which at £513m, are now greater than the available capacity under its acquisition facility. The RCF has a capacity of £300m and is largely undrawn. UKW currently trades on a material premium (16%), however we believe an equity raise in the short term to be unlikely given the significant effect of cash drag and the lead time before investment in these projects and therefore the company is reliant on this premium being sustained and being able to raise equity at a later date. Power price sensitivity: Revenues are currently split so that approximately 56% of cashflows are fixed whilst 44% are derived from the sale of merchant power. On a fully diluted basis, which assumes the commitments to unsubsidised projects are funded, UKW buys nothing else between now and Q1 2023, and it does not fix any merchant cashflows, the split would change to 45% fixed/55% merchant. The most recent sensitivity produced by UKW (31/12/19) shows that a +/-10% parallel shift in the forecast curve would cause a +/-7.4% change in NAV. However, this sensitivity does not include commitments (UKW had made c£193m commitments at 31/12/19). Given that UKW assumes power price exposure from its commitments when the agreements are signed, we believe that these should be included within the sensitivity. On this basis, the sensitivity would increase to a c9% move for a 10% shift in the forecast curve. Continued overleaf
March is traditionally considered ‘ISA season’, when UK investors focus on their annual ISA allowance and are encouraged to ‘use it or lose it’. As we highlighted in our article last year, investment trusts within ISAs are an excellent way to benefit from the power of compounding over the long term, without worrying about the tax consequences of whether you are receiving capital gains or dividend income. Our analysis last year showed that the top ten compounding trusts – since Personal Equity Plans or PEPs (the precursor to ISAs) were first introduced – come from a very wide range of asset classes. We determined that the distinguishing factors between them were manager skill and the unique ability, afforded by the structure, for investment trust managers to truly invest with a longer-term horizon than the open-ended competition.
UKW JCH JGGI AEI CTY
Greencoat UK Wind (UKW) provides a pure investment exposure to UK wind farms, with the twin aims of delivering a high, RPI-linked income return for shareholders whilst maintaining capital value in real terms. These aims have been fully met so far. As we discuss in the Dividend section, the dividend forecast for next year is 7.1p, representing a compound annual growth of 18.3% since listing. NAV progression has also remained ahead of inflation, with growth of 22.1% against RPI over the same period of 17.4%. In share-price terms, shareholders have enjoyed a total return of 115.1% since launch to 31 December 2019. During 2019, the trust’s earnings were below budget thanks to wholesale power prices remaining below average last year and thanks also to lower power generation from the wind-farm portfolio. Even so, UKW’s dividend was well covered at 1.4x. The manager’s long-term expectation is 1.7x. UKW continues to grow, and now has gross assets of £2.44bn invested in 35 wind farms. Despite a competitive market, the manager has deployed around £800m of capital (invested and committed) over 2019, and is now becoming ‘utility scale’. UKW now provides around 1% of UK electricity generated. As we note in the Discount section, the publication of a bearish note on long-term electricity prices by Bloomberg New Energy Finance has caused a healthy reduction in the premiums across the sector, not to mention the recent market falls. UKW trades at a premium to the peer-group average, perhaps because of the higher investment returns so far delivered, the higher discount rate, and also because of its well-covered dividend.
Investec view: Greencoat UK Wind (UKW) declared a NAV of 121.4p/share, which represents a decrease of 1.7p/share over the year. Key drivers included a change to the modelled corporation tax rate (-2p), a reduction in power price forecasts (-5p) and a reduction in discount rates which added 4p. However, it is worth noting that the NAV has increased ahead of RPI since launch. The company declared an aggregate dividend of 6.94p/share, which was covered 1.4x by operational cash flow. We note that cover was lower than in previous years (historically 1.5-1.8x, although it did fall to 1.4x in 2016), and this was predominantly due to lower wind speeds and generation, in addition to lower UK power prices. UKW’s debt has a bullet repayment structure and therefore dividend cover of 1.4x does not take into account any amortisation of its debt, unlike its peers. UKW provides investors with exposure to a diversified portfolio of wind assets in the UK. We like the simple capital structure and note that it has the lowest gearing in the peer group. That said, we believe the company needs to do more surrounding its disclosure on power price forecasts. The company trades on a material premium, although this is supported by what we believe to be conservative discount rates. A dividend yield of 4.9% remains attractive, particularly in the current interest rate environment and we remain comfortable with our Buy recommendation. Power price forecasts: Given the recent bearish forecasts by BNEF, we believe that this reporting period provided a chance for the peer group to provide more colour on the forecasts used in portfolio valuation. Unfortunately, UKW has not taken this opportunity. UKW simply states that base case real power prices increase from £45/MWh (2020) to £48/MWh (2050). The shape of the curve is not provided. Given the importance of the forecast curves to valuations, we believe that disclosure needs to improve, with greater focus on what adjustments are made to curves, cannibalisation assumptions and capture price assumptions. (See our recent note here.) Increase in dividend target: During the year, UKW declared a dividend of 6.94p/share, in line with its stated target. This was covered 1.4x by operational cash flow. For 2020, the company is targeting a dividend of 7.1p/share, which represents an increase of 2.3%, in line with RPI. Continued overleaf
Inflation has been relatively tame for the past two decades, yet history suggests it would be unwise to reject the possibility of a damaging period of higher inflation out of hand. Central banks’ post-crisis quantitative easing policies have not led to the high inflation expected by some, but periods of high inflation in the past have been due to very different causes. When looking at the historical record, we see clear signs that the threat of inflation cannot be written off, and so taking out an insurance policy might be wise. Below we consider the potential sources of an inflationary shock to the global economy, and some assets and trusts that offer protection.
UKW RICA BRWM CTPTF
Bonds have traditionally been a core part of private client portfolios. Harry Markowitz is generally credited with developing and popularising the modern approach to investment diversification, as part of his doctoral thesis in 1952. Markowitz’s 60/40 equity/bond portfolio quickly became a staple of retail investor portfolios, and for many years equity and bond portfolios built around this basic concept have been highly successful for investors. The attractions were clear: aside from the solid income that bonds offer investors as a portfolio component portfolio, they also provided something of a hedge to equity exposure.
UKW TRIG HICL SONG
Greencoat UK Wind (UKW) provides a pure investment exposure to UK wind farms, with the aim of delivering a high, RPI linked, income return for shareholders whilst maintaining capital value in real terms. We have recently launched an Environmental, Social & Governance (ESG) analysis section as part of our standard fund profiles. From an ESG perspective, UKW clearly ticks the “environment” box in that investing in UKW provides the long-term capital which enables an increase in renewable energy provision in the UK, and the shift to a lower carbon economy. The managers estimate UKW prevents over 1m tonnes of CO2 per annum from being emitted with thermal generation being the alternative. We calculate that this is equivalent to 0.8kg per share. Setting this into context, a flight from London to Milan emits 181kg of CO2 (Source: Atmosfair). A £10k investment in UKW is equivalent to 5.6 tonnes of CO2 “prevented” per year. In other respects, Greencoat as manager is clearly a keen proponent of ESG, and aware of its responsibilities therein. Greencoat were signatories to the UN-supported Principles for Responsible Investment (PRI) in 2016 and provides a lot of detail of how it incorporates ESG issues in its decision-making process and asset management. Wind is a resource that the UK has plenty of. In 2018 it was a significant contributor to the UK’s electricity supply – meeting 17% of the country’s total demand (renewables as a whole contributed 30%). As such, it is likely to remain one of the central planks of the UK’s strategy to achieve a lower carbon economy. Greencoat UK Wind (UKW) currently owns a portfolio of 35 wind farms around the UK, which together generate enough electricity to power 940,000 homes and is the largest renewable infrastructure fund listed on the LSE with net assets of £1.9bn. UKW remains amongst the best performing of the renewable infrastructure funds since it launched in 2013. Since launch, the company has delivered strong total returns comprising the 6p dividend, which has risen with RPI, and capital growth of 23.9%. In share price terms, shareholders have enjoyed a total return of 96.8% in just over six years. Despite the considerably lower volatility that the company exhibits, on a NAV total return basis UKW has outperformed the FTSE All Share Index total return since launch by over 30 percentage points. UKW’s main objective is to pay a high dividend to shareholders that is linked to inflation (RPI) and to preserve capital after taking inflation into account. The trust has a target for 2019 of 6.94p per share, representing a 2.66% increase over the prior year, and in line with RPI for December 2018. This year so far, UKW has paid two dividends totalling 3.47p which is in line with the target. Since launch (and based on the dividend target for 2019) the dividend has risen by 2.95% p.a., which compares to the retail prices index of 2.6% p.a. over the same period. At the current share price, the prospective yield is 5.0%. Around 50% of the company’s cashflows are directly index-linked, with the remainder being exposed to electricity prices. As such, electricity prices, which are assumed to have a correlation to inflation, affect UKW’s ability to grow the NAV by RPI in the long term. Given the high dividend cover of 1.7x on average, the company expects to be able to continue to grow the dividend by RPI on an annual basis over the long term. UKW has been growing strongly, and during 2019 so far has invested in excess of £600m funded from equity issuance and re-investing surplus cashflows supplemented by debt facilities. Net assets are now £1.9bn. Shareholders benefit from this growth in the form of a declining OCF, which has been coming down rapidly and through operational economies of scale within the business. As at the end of 2018, the OCF was 1.13%, a reduction from the 1.24% level at the end of 2017, and 1.46% at the time of initially listing. The published forecast OCF from the managers for 2019 was 1.08% at the beginning of the year. Many of the listed 'alternative income' funds continue to trade at significant premiums – and UKW is no exception on a current premium to NAV of 13%.
Greencoat UK Wind – Results of fundraising | Oakley Capital – Investment in Inspired
Greencoat UK Wind Plc Oakley Capital Investments Ltd Registered
Greencoat UK Wind – Share issuance programme and initial fundraising | UK Commercial Property – Q1 2019 NAV and dividend
Greencoat UK Wind Plc UK Commercial Property Reit Limited
Greencoat UK Wind’s (UKW) aim is to provide investors with an annual dividend that increases in line with RPI inflation (target of 6.94p for 2019, a yield of 5.1%) while preserving the real value of the NAV in the long term through reinvestment of excess cashflow and the use of portfolio gearing. So far it has delivered on all of its promises since launch in 2013. UKW is now the largest listed renewable infrastructure fund, with net assets of in excess of £1.7bn (after the recent placing). Investment activity this year has continued apace, with £452m invested so far in 2019. This will bring the total portfolio to c. £2.3bn in size by the end of March. The managers expect to be able to benefit from scale, both in operational terms, but also in terms of acquisitions and financing. The OCF last year fell to 1.13% (from 2017’s 1.24% and 1.46% at listing) and is forecast to be 1.08% after the recent placing. The portfolio will shortly constitute investments (in whole or in part) in 34 operating UK wind farms around the country. These assets represent a net generating capacity of 950MW, enough to power c.900,000 homes. As such, the portfolio has geographic diversification around the UK, not to mention diversification by turbine manufacturer and by units – the company will own (or has interests in) a total of 715 turbines by the end of March. UKW buys only operating wind farms in the UK. UKW has unequivocally been a strong performer since it launched. The NAV total return (i.e. with dividends reinvested) since launch has been 8.3% pa. Despite the considerably lower volatility that the company exhibits, on a NAV total return basis UKW has outperformed both the FTSE All Share Index total return since launch, and peers in the listed renewable infrastructure sector. Around 50% of the company’s cashflows are directly index-linked, with the remainder being exposed to electricity prices. As such, electricity prices, which are assumed to have a correlation to inflation, affect UKW’s ability to grow NAV by RPI in the long term. Given the high dividend cover of 1.7x on average, the company expects to grow the dividend by RPI on an annual basis over the long term. Currently the trust has £400m of longer-term fixed rate borrowing, with a weighted average cost of 3.08% and remaining term of 5.6 years. The trust has an additional £394m of shorter-term gearing drawn down, equivalent to 34% of gross assets. Together the average interest cost is 2.76%. Over the medium term, the team expects total gearing to be between 20% and 30% of total assets. Many of the listed 'alternative income' funds continue to trade at significant premiums – and Greencoat is no exception on a current premium to NAV of 13%.
Greencoat UK Wind – Finals to 31 December 2018 | Tetragon – Finals to 31 December 2018 | RM Secured Direct Lending – Proposed fundraising | Electra Private Equity – Dividend declaration
UKW TFG RMII ETIVF
UKW – Greencoat UK Wind – Accelerated close of placing | RDL – Ranger Direct Lending – Portfolio, management and valuation
Greencoat UK Wind Plc Ranger Direct Lending Fund
Greencoat UK Wind – Acquisition and fundraising | Greencoat Renewables – Q4 2018 NAV and dividend | AEW UK Long Lease – Q4 2018 NAV and dividend
Greencoat UK Wind Plc Greencoat Renewables Plc
Greencoat UK Wind - Q4 2018 NAV and dividend
Greencoat UK Wind - First subsidy-free investment | HarbourVest Global Private Equity / NB Private Equity Partners - 3% NAV total return for HVPE and -1.1% for NBPE in November
Greencoat UK Wind – Acquisition
Greencoat UK Wind – Acquisition | Assura – Acquisition update | Triple Point Social Housing – Acquisition update
UKW AGR SOHO
The company’s aim is to provide investors with an annual dividend that increases in line with RPI inflation (equivalent to 6.76p for 2017, a yield of 5.6%) while preserving the real value of the NAV in the long term through reinvestment of excess cashflow and the use of portfolio gearing. The company has now achieved critical mass, having recently announced a further investment of £163m into its 30th wind farm, bringing total assets to £1.6bn. As the company grows, the managers expect operational and further purchasing efficiencies. The board have guided that the OCF will fall this year to 1.15% (from last year’s 1.24% and 1.46% at listing). UKW buys only operating wind farms in the UK, and have expected lives of 25 years at the time they are built. The company recently announced for the first time the portfolio discount rate of 7.7%, which also represents the currently expected total return on the assets in the portfolio. Appropriately geared, this enables the company to pay a high level of dividends as well as (in an average year) to reinvest around a third of cashflows in new assets to maintain the NAV in real terms. The dividend is the ultimate measure of whether the managers and board have or have not been successful. To date, the company has delivered on all its promises, and in contrast to peers, the managers recently reaffirmed their confidence in being able to pay a dividend that matches inflation (dividend cover averages 1.7x). At the current share price, UKW’s prospective yield is 5.6%. Aside from valuation and operational risks, political risks are the main external risk to be aware of. Barring any major changes to the political landscape or long-term power prices, the company aims to be able to reinvest surplus cashflows to maintain the NAV in real terms. Relative to most funds, the key drivers - and risks - to the NAV are uncorrelated to equity markets, which means UKW might be considered to have portfolio diversification properties.
UKW does an excellent job of making its financial results entirely unremarkable. On track for the dividend and dividend cover, a slightly dull NAV (109.8p) as Q2 power prices disappointed (but still up on the half) and discount rates were unchanged. The only sign of excitement is that the team would like to buy more assets.
Taking advantage of their approach, UKW’s manager used the fund’s FY results to declare the year has been ‘poor’ (below budget wind and power prices) and that their dividend would only be 1.4x covered by cash earnings; a level many renewables funds would be delighted with.
Expanding on our recent NESF comment, we extend the analysis to the wider renewable sector and find that the pre and post-brexit power price increases are positive for the sector and should deliver NAV upticks in the coming months. FSFL and TRIG are due to publish their 30 June NAV’s in the next couple of weeks. We expect Brexit and the movement in power prices since March to enhance NAVs by, possibly, 4-6p over a number of periods probably starting in September with the initial response being in the 2-4p range in addition to the core return that the funds generate when faced with a stable power curve. The implication is that the current valuation premiums (1.5-9.9pps) to the historic NAVs are overstated on a forward basis. While much of the focus will be on the funds’ NAVs, the true value is the cash flow boost and the positive implications for servicing both the dividends growth and debt (interest and amortisation) costs. For fund specific thoughts, see later in the comment. Exactly when the NAV upticks occur is a little vague and a function of each vehicle’s power curve and hedging strategy. We highlight that in contrast to NESF, UKW’s June NAV and curve was non-responsive to the 10% increase in ICE’s UK’s power price futures curve between March and end May. Since then the curve as risen a further 10%, suggesting a little catch up may be in order. We highlight that it has been unofficially confirmed that the two leading forecasters Q2 updates contradicted each other (a small up and a small down) i.e. the power curve story and NAV impact on the Q2 NAVs will be confused/contradictory. Given that the action (to date) is in the first 1/5th of the fund’s power price curve (and valuation models) any read across from each fund’s sensitivity analysis (which applies to the whole curve) needs to be made cautiously. A review of the funds’ published power price sensitivities (see below) highlights a wide range (c4p-8.5p per share) of NAV response to a 10% change in power prices. Our caution on the size and timing of the NAV enhancement reflects a combination of the opacity of the power price modelling process (i.e. we don’t really understand it) and a generalised belief that the forecasters will be reluctant to fully incorporation any uptick until it has proved ‘sustainable’ (and UK long-term growth prospects haven’t been meaningfully diminished); the forecasts declined 7-8 times over the two-ish years before the turn.
UKW NESF FSFL BSIF TRIG JLEN
That UKW’s Q1 NAV was down isn’t a surprise; its decline had been signaled by management. The uncertainty was the quantum. UKW’s Q1 NAV presages bad news for all the renewables funds with levered solar expected to suffer most (assuming effective discount rates remain unchanged) due to their limited winter generating capability.
Gas prices are low and consistent with £30/MWh power 25% below c£40/MWp incorporated into the December power curves. Reflecting this we expect the March power curves to be lower which will put pressure on the UK renewables fund’s Q1 NAVs (published in March). UKW highlights that the winter storms* have significantly boosted power generation to the benefit of 2016’s income account. UKW guides their Q1 normalised return expectation at 3pps and hazard that this may be boosted by 2pps (over H1) due to the weather.
If the oil price was to rebound to say $70 (+40%), it would have a direct and material impact on the market price of electricity, the price forecasts and by implication the NAVs of the listed renewables funds. In addition to the usual comments about operations, UKWs management (in response to questions) made observations about how power prices and the forecasts are established. The price of electricity is set by the marginal producer (gas) which is linked (with a delta of c0.5), via long term supply agreements, to the price of oil with a 6 month lag. In addition, the forecasts use the forward curve out about three years before departing on their own tracks.
UKW’s total power generation of 565GWh was slightly (3%) under budget in 2014 (wind speeds were down 2%) but well within the 10% standard deviation. This compares with 8% over budget in 2013. The portfolio saw a strong increase in cash generation to £32m (2013: £22m) following the acquisition of six new farms. A fall in the DCF valuation of the portfolio was offset by cash received; the NAV rose 2.5p to 102.4p and generated a total return of 8.7% in the 12m to 31 December 2014.
Secondary issues picked up the slack for a dearth of IPOs in Q4 2014*, with broad based contributions made by renewable (particularly solar), debt, property and infrastructure funds. Only one of the four launches announced was successful; River & Mercantile managed to raise £51m, just over half of the £100m target to invest in UK Micro-cap stocks (Miton Group are considering a similar launch for Gervais Williams). We are still waiting for news on the other three; Axiom European Financial Debt, Avenue Capital Credit Opportunities and Ben Goldsmith’s BGT Capital.
UKW BSIF NESF INPP GCP ESP FSFL UKCM SREI TFIF CVCG PSSL DPA GVP RMMC
UKW trades at a 4% premium, yields 6% and is ambitious to issue more equity. The fund had a good initial 9 month period, generating returns at the top end of the range (windy weather), meeting its initial dividend target, making new acquisitions and has raised additional capital taking its TNAV to £350m. The trust’s OCR is running at 1.46%pa. Wind should be a clean, simple and transparent asset generating an index linked return from an established technology whose key risks (issues with the turbine) are effectively insured by manufacturers (Siemans et al) with low fixed costs and limited leverage. Political risk is the asset class’ major risk, as investors have discovered in Spain. This was our first exposure to wind. UKW’s disclosure strategy is minimalistic and bluntly boils down to trust us (echoing private equity’s pre-Lehman communication strategy ). Our initial thoughts are interested, but unconvinced (largely due to the disclosure strategy). We shall continue to explore and review.
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