Exorbitant energy prices have produced easy returns for producers for 18 months. In the case of Greencoat UK Wind, an owner and operator of wind farms throughout Britain, the investors’ cash that has flooded into the energy sector in that time has put the fund on course for entrance into the FTSE 100.
That’s if it is not due for a huge reversal in fortunes. Wholesale gas prices have been heading south since September, good news for consumers, less so for shareholders in energy suppliers such as Greencoat. The shares have followed suit and a rare discount has opened up against the value of the fund’s assets of just over 5 per cent. Investors seeking income should take that valuation gap as a cue to take another look at the stock.
The FTSE 250 fund’s portfolio spans 45 onshore and offshore wind farms, capable of generating 1.6 gigawatts of power. That’s equivalent to 6 per cent of UK wind, or 1.5 per cent of the nation’s electricity generation. Projects include the Maerdy wind farm in south Wales and a 19 per cent stake in Hornsea One in the North Sea.
Soaring energy prices have pumped up the cash generated by the fund, which totalled almost £330 million over the first six months of last year, more than double the cash churned out by its wind farms in the same period in 2021. Generous dividends are the main attraction. Factor those in and the total return amounts to 163 per cent, vastly outstripping the 87 per cent return generated by the FTSE All-Share index over that time frame.
Within the world of investment trusts, the promise of inflation-proof dividends often comes with the caveat that the policy does not apply amid the extraordinary double-digit rates clocked up in recent months. Not so for Greencoat. The trust is targeting a dividend of 8.76p a share for this year, a 13.4 per cent increase on that paid out in respect of last year and in line with December’s retail prices inflation measure. If it delivers on that target, the shares would offer a potential yield of 4.8 per cent at the present price.
Where does that inflation link come from? Renewables obligations certificates, a type of green government subsidy, which make up one of the fund’s key revenue streams. The other source is selling into the wholesale energy market. About two thirds of cash generated by the wind farms came from selling energy into this market, which is forecast to fall to just over 50 per cent by 2024. This is a more volatile source of revenue than government contracts, but it has the potential to deliver higher returns. Greencoat’s exposure to wholesale markets is higher than some peers, but then it also applies a greater discount rate to the future cashflows it expects to generate from its wind farms, of about 10 per cent.
Just how sustainable are the expansions in the value of the fund’s assets and in the dividend, now energy prices have started to ease? Higher interest rates also risk eroding the net asset value. Greencoat’s sharpest riposte? In June the fund applied a 50 per cent discount to forward energy prices, partly to account for volatile prices, as well as the windfall tax. That has stood the fund in good stead so far.
The NAV rose by 12.1p to 167p over the final three months of last year, despite the pullback in wholesale gas price forecasts, with the 8p hit from the generators’ levy also proving less dramatic than anticipated. For this year, the fund’s managers have assumed prices at roughly the same level they were just before the Ukraine war. Cash covered last year’s dividends more than three times over, which should inspire confidence that the trust can repeat a high payout.
ADVICE Buy
WHY The shares offer a generous dividend that is linked to inflation
Associated British Foods
Shaky profit margins have been the biggest turn-off for investors eyeing Associated British Foods, the owner of Primark, the low-cost, fast-fashion retailer. Higher raw materials, labour and freight costs have been inescapable, but putting up prices is unpalatable for a brand whose chief selling point is its cheapness.
However, figures for the peak Christmas trading period hint that it may be getting easier for the market to guess where profits will be over the next two years. Sales were better than expected, up 16 per cent at constant currency rates, with like-for-like sales at Primark up 11 per cent over the 17-week period.
A failure to recover higher costs means that adjusted operating profits are expected to fall over the 12 months to the end of September, which analysts have interpreted as £1.26 billion, from the £1.4 billion recorded last year. But that’s well flagged and the risk of disappointing against that forecast looks muted. Stock for the next three months is already in the warehouse and freight rates have come down.
Primark customers are spending less per shop, with the average basket size down roughly 2 per cent, yet there are more of them, indicated by sales that were markedly higher than the rate of inflation for apparel items, according to figures from the British Retail Consortium.
As for inventory levels, they were about 51 per cent higher at the end of September than the 2021 level, against a 22 per cent rise in revenue over the same period. That partly reflects a replenishment of stock diminished by snarled-up supply chains that have since unfurled. A jump in selling off goods at a discount remains one of the key risks for retailers this year, even the cut-price Primark.
Shares in ABF, a FTSE 100 group, deserve to be more cheaply valued than they were two or three years ago, but, at 14 times forward earnings, is a marked discount to a long-running average multiple of 20 justified? If the company can demonstrate that it can continue to outpace bearish sales expectations over its second quarter of trading, it might seem harder to explain.
ADVICE Hold
WHY The risk around inflation and consumer spending is accounted for in a cheaper valuation
