BlackRock Energy and Resources Income Trust (BERI) aims to provide high income through investment in the energy and resources sectors globally. From first principles, these sectors are traditionally good places from which to derive income: typically they exhibit strong free cash flow and, having largely de-geared since 2015, are in relatively strong financial shape.
As we discuss in the Dividend section, dividends everywhere are under question. The BERI managers are optimistic that their sectors are in a comparatively good position to ride out the COVID-19 induced economic slowdown. BERI’s board has reaffirmed its 4p dividend target (yielding 7% on a historic basis), supported by reserves or capital.
Over the past year there have been some small but significant changes to BERI. Energy transition stocks have been formally identified within the mandate. From 1 June 2020, BERI is working towards a neutral sector weight of 40%:30%:30% between mining, energy and energy transition stocks. As the pace and shape of energy transition evolves, the managers anticipate a higher weighting towards this sector over time.
Secondly, the board has emphasised to BlackRock that providing a covered dividend is of secondary importance to delivering strong total returns. Finally, Mark Hume – who has a specialism in energy stocks – has been promoted to co-manager.
A definitive shift towards the inclusion of energy transition stocks is already under way. This is likely to involve an increasing tilt towards structural growth, which may come at the expense of income in the short run. The board is focussing on total returns as an objective, and is looking to reserves to support the dividend as BERI makes its own transition.
BERI has historically struggled relative to the reference index. Perhaps this is why the board has decided to ‘free’ the managers from the trust’s high-income mandate, by not asking them to deliver a covered dividend in the future. In addition to reaffirming the dividend target, as we illustrate in the Dividend section, the board has indicated that it has substantial distributable reserves to support the dividend should it see fit.
In this context, with a historic dividend yield of 7%, BERI offers a yield considerably higher than most other areas of the market. Should the dividend level be maintained – or at least continue to offer a significant yield premium to the market – the discount of 15.3%, relative to other equity income funds that trade on much narrower discounts (and even premiums), looks anomalous.
Another potential catalyst for a re-rating could come from ESG investors. Although BERI is unlikely to fit within a negatively screened ESG mandate, the realigned portfolio does fit within a more real-world and constructive view of ESG investing. The managers clearly recognise the opportunity in energy transition companies, but they also remain engaged with those that will need to change their business models if the world is to successfully evolve to a low carbon economy.
The above notwithstanding, if the board were to start buying shares back, the discount could narrow relatively quickly. In this context, the current discount of 15.3% could represent an attractive entry point.
|Yield premium to market (historic yield of 7%), with dividend seemingly supported through capital payments||Specialist mandate means less diversified than generalist equity income funds / trusts|
|Discount of 15.3% looks anomalous, based on yield and changes made to mandate||Dividends paid from capital can erode trust's capital base, which is already on the small side|
|Less emphasis on providing a covered dividend, should help total returns improve going forward||Gearing can exacerbate downside|