The chasm that has built up between the market value of infrastructure funds and the assets in which they invest is problematic for expansion plans. Equity markets are no longer the easy source of growth capital that they have been.
In that context, Greencoat UK Wind is in a more assured position. It has scale on its side, owning and operating 46 wind farms throughout Britain. Those assets are capable of generating 1.6 gigawatts of power, enough to power 1.8 million homes. It also has capitalised on soaring wholesale energy prices. Projects include the Maerdy wind farm in south Wales and a 19 per cent stake in Hornsea One in the North Sea.
It sets the FTSE 250 investment trust on course to generate more than £200 million in excess cash this year. That’s over and above the cost of the dividend, leaving Greencoat with the spare change to either reduce debt or spend on acquiring new assets. It is also an indication of how well the generous dividend, which increases each year in line with the higher retail prices index measure of inflation, is secured.
In the first six months of the year, Greencoat generated £204 million in net cash, more than twice covering the £95.5 million cost of the dividend, which equated to 4.38p a share. Analysts have forecast a payment of 8.77p, leaving the shares offering a potential dividend yield of 6 per cent at the present share price. Factor in those meaty cash payments and the total return generated for investors over the past decade is 194 per cent, 13 per cent over the past year.
Wholesale power prices have fallen since the start of this year, but still remain elevated by recent norms. For Greencoat, which is set to generate about half its cash from selling power into the wholesale market, that will have an impact.
The company has done some conservative modelling. A dividend rising in line with RPI would remain covered even in a severe and unlikely scenario where power prices fall to £10 per megawatt-hour, a dramatic decline from the £104.06/MWh average achieved in the first six months of the year and still less than a quarter of the level in the years immediately before the pandemic. That’s based on a forecast of RPI staying at a high 7 per cent next year, before falling to 3.5 per cent in 2025.
Nevertheless, Greencoat’s shares trade at a 12 per cent discount to its net asset value. That precludes it from repeating the sort of ambitious fundraising it has undertaken in recent years, most recently tapping markets for close to £400 million in November 2021. This does limit the scale of the trust’s expansion — for now.
True, the impact of inflation is not wholly negative — there is a link in the cashflows that its assets generate. Where does that come from? Renewables obligation certificates, a type of green government subsidy that makes up one of the fund’s key revenue streams. The other source is selling in the wholesale energy market. But the mitigation against rising interest rates is not one-for-one. Increasing inflation added 8.1p a share to the NAV in the first six months of the year, but lifting the discount rate wiped off 11.4p a share.
Much of the £499 million cash on Greencoat’s books will be used to buy a 13.7 per cent stake in the London Array offshore wind farm, with about £150 million of the £640 million new term loan facilities put towards acquiring the South Kyle onshore wind farm in Scotland. Net debt stands at 34 per cent of gross asset value, against a prudent internal ceiling of 40 per cent. The company will look to sell assets to free more cash for acquisitions.
Greencoat raised its discount rate again to 11 per cent at the end of June, as rates rose once more. That should leave it in good stead to close the prohibitive valuation gap.
ADVICE Buy
WHY The shares trade at a discount to NAV and offer a generous dividend yield
Law Debenture
The stock selectors at Law Debenture can’t claim credit for the FTSE 250 investment trust edging ahead of its benchmark over the past 18 months. Without the benefit derived from locking in debt at cheaper rates, its net asset value rose by only 2.2 per cent in the latest six months, just behind a 2.6 per cent increase in the FTSE Actuaries All-Share Index.
Direct Line, the troubled motor insurer, was the biggest turkey, an investment that James Henderson, the manager, describes as a “mistake” but not one that he plans to offload. Instead, he is betting on a change in management and rising premiums to spur recovery.
There was also AFC Energy, the lossmaking renewable fuel cell company and a victim of the sell-off as monetary policy has tightened. Law Debenture has been adding risk at a time when broader markets have been averse, a trade it hopes will pay off when interest rates stabilise. Until then, more pain could be in store.
Yet investment weakness points to one of the big differentiators in the Law Debenture approach. Its professional services business, whose activities include providing trustee services to pension schemes and acting as an intermediary between corporate bond issuers and holders, makes up some of the shortfall in returns. The fair value of the business rose by 4.4 per cent over the first half of the year, although that was a lower rate year-on-year. The attraction of a steadier stream of income is reflected in the trust being one of the few whose shares still trade at a premium to net asset value.
The professional services business also frees up the trust to invest in stocks that don’t pay dividends at all. Over the past decade it has funded 34 per cent of the dividend bill. That payment has been maintained or increased for 44 years and has grown at a compound annual rate of 8 per cent over the past decade. The dividend looks secure enough, but then again, there are trusts with an even more consistent record of increasing cash returns whose shares trade at a marked discount to NAV, like Alliance Trust. If they close the value gap, there is a chance their capital returns could outperform.
ADVICE Hold
WHY The shares offer a decent dividend yield that looks secure
