SMALL CAP IDEA: NextEnergy Solar Fund offers high yield at a discount

NextEnergy Solar Fund’s half year numbers underline a familiar puzzle for renewable infrastructure investors: A portfolio that appears to be doing what it said it would do is trading at a steep discount.

At the recent interims for the six months to 30 September, net asset value (NAV) per share fell 6.6 per cent to 88.8p, giving a fund NAV of £510.9 million. The share price, however, sits far lower.

 Broker Cavendish in a recent note said that ‘at the current 54p share price, the discount to NAV is 39 per cent’ and calls this ‘inconsistent with the resilient operational performance of the portfolio’.

For income hungry private investors, a double-digit discount combined with a double digit yield is at least worth a closer look.

What does the fund actually own?

NextEnergy Solar Fund (NESF) is a London listed investment company that owns solar farms and one battery energy storage system, known as a BESS. At the half year it held 100 operating solar assets and one BESS asset, with total installed capacity of 939 megawatts and a remaining weighted average asset life of 24.3 years.

The portfolio is mainly UK focused, but there are assets in Italy, Spain and Portugal. Total generation in the period was 7.6 per cent ahead of budget, helped by solar irradiation 13 per cent above expectations. This outperformance produced an extra £2.5 million of cash.

NextEnergy Solar Fund (NESF) is a London listed investment company that owns solar farms and one battery energy storage system,

So, the physical assets are doing more than expected. The pressure on NAV has come from somewhere else.

Why has NAV fallen?

NAV is the per share value of the underlying assets, after debt, based on discounted cash flow models. For NESF, those models are highly sensitive to assumptions about future electricity prices.

Cavendish attributes the bulk of the NAV decline to ‘a decrease in short term UK power price forecasts’, which feeds directly into expected revenues. Third party consultants supply those price curves. The fund uses the average of their central forecasts.

In this period, one consultant produced a particularly low near-term forecast, which dragged the average down and knocked £25.1 million, or 4.4p per share, off the NAV. A further 0.9p per share reduction came from lower revenue forecasts for the battery asset.

Offsetting these headwinds were positive items. The passage of time in the valuation model, often called ‘time value’, added 4.5p per share. Project out performance contributed 0.7p. A renegotiation of fees with asset manager WiseEnergy delivered a 1.3p uplift.

In other words, what has changed is the modelled value of future cash flows rather than the assets’ ability to generate electricity today.

Revenue visibility and how the fund gets paid

About half of NESF’s revenue comes from inflation linked, government backed subsidy schemes. The other half is earned through power purchase agreements, or PPAs, with utilities and corporate offtakers.

Subsidies include Renewable Obligation Certificates and Feed in Tariffs, which pay the generator an indexed top up for the electricity produced.

PPAs are contracts that fix the price at which NESF sells power, usually for one to three years. The company runs a ‘rolling 36 month’ PPA programme that aims to lock in prices above adviser forecasts to increase cash flow visibility.

For income investors this contractual structure matters because it underpins the dividend.

Dividend cover looks robust

NESF has been a consistent dividend payer since listing in 2014. The fund is estimated to have declared cumulative dividends of £419 million, equivalent to 80.5p per share.

In the first half of the current financial year the fund declared dividends of 4.21p per share, the same as the prior year period. Dividend cash cover, which is the amount of operating cash flow relative to cash dividends, was 1.7 times, up from 1.5 times a year earlier.

The board has ‘approved a sustained dividend target’ of 8.43p for the current year, and Cavendish says this is ‘forecast to be covered in a range of 1.1 to 1.3 times by earnings post debt amortisation, and providing a prospective 15.6 per cent yield, one of the highest in the UK market’.

That prospective yield figure is based on the current share price cited in the note. It is unusually high for an infrastructure fund whose revenues are heavily contracted and partially subsidy backed. Investors will want to weigh that income attraction against balance sheet and policy risks.

Gearing and the capital recycling programme

NESF is not a low geared vehicle. Including £198.5 million of preference shares, total debt at the half year was £517.5 million. With gross asset value ‘just over £1.0bn’, analysts calculate period end gearing to gross asset…