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.
In our view 2020 shows the strength and resilience of UKW’s relatively simple model. A combination of the high and rising dividend, and the NAV growth has led to strong total returns since IPO and over the past five years. Indeed, UKW remains amongst the best performing of the renewable energy infrastructure funds since it launched in 2013.
At the same time, the NAV has been strong and uncorrelated with volatility in the equity market. The share price has had a beta and volatility of less than half of the FTSE All Share over five years (Source: Morningstar), and so we believe that over the long term UKW’s trading history illustrates that it is an attractive complement to equity portfolios.
Of late, dividend cover has been lower than the managers’ budgeted expectation of 1.6-1.7x. For the current year, it is early days yet. However, we understand that the team are optimistic that despite wind speeds being lower than usual in Q1 2021, higher wholesale energy prices mean that dividend cover should be in line with budget.
Notwithstanding a competitive market, UKW has a significant pipeline of assets that it has committed to buy which gives reassurance on the immediate future in terms of capital deployment. The current premium to NAV of 11% (Source: JPMorgan Cazenove) is in-line with the five-year average for the trust. In our view UKW justifies a premium rating to the peer group average, and so the current level could provide an attractive entry point for a trust offering a covered dividend linked to inflation, and an OCF projected to be below 1%.
|High dividend yield, well covered by cash
||Premium to NAV (although currently below peer group average)
|Continued commitment to RPI-linked dividend growth
||Gearing exacerbates underlying asset valuation movements
|Uncorrelated assets, and committed pipeline of investments
||Valuations based on long-term assumptions which may (or may not) prove optimistic
Greencoat UK Wind (UKW) was the first renewable energy infrastructure trust to launch on the London Stock Exchange, and its subsequent growth has led to significant benefits for investors. Firstly, the tiered fee structure and economies of scale have led to the OCF reducing significantly over time, with 0.98% being the expectation for 2021. Further to this, growth has enabled the trust to consider much larger sized investments, which in themselves offer economies of scale and therefore potentially higher returns than might otherwise be the case. Finally, having a large portfolio (currently valued at £3.4bn), enables the dedicated management team at Greencoat to optimise these assets to enhance performance. We examine each of these factors in the context of the portfolio below.
UKW’s portfolio has grown significantly, with £914m of capital invested during 2020, and a further £371m committed in 2020 for investment in 2021-2023. When we caught up with the managers recently, they noted that the investment market for wind farms is competitive currently, with institutional interest in assets strong but added to with new interest from corporates such as traditional energy companies. This, to us, makes the activity during 2020 seem prescient, as does the trust’s commitment to wind farms being constructed. In total, UKW has contracted to acquire five further wind farms totaling 398MW over the period 2021-2023, as each enters into operation for a total of £533m.
Of assets currently held, the portfolio constitutes investments in 38 operating wind farms, and one wind farm under construction. This represents a total capacity of 1.2GW. 70% of these assets (by value) are onshore, with 30% offshore. As we illustrate below, the portfolio is diversified geographically around the UK. UKW differentiates itself from many peers in that it focusses solely on wind farms in the UK, enabling the team to provide focus on managing the assets to optimise returns and pay a dividend linked with inflation as well as extract synergies (which we come to later). The managers are not restricted in their allocation across the UK, other than that offshore wind turbines are limited to a maximum of 40% of NAV. The weighted average age of the portfolio’s wind turbines is just over six years, which compares to typical subsidy regimes which have a life (from commissioning) of 20 years. As such, the portfolio has a long remaining runway of relatively secure income, which underpins the NAV (please see Performance section for the sensitivity of the NAV to different variable assumptions).
In UKW’s development, “scale begets scale”. This can be seen most clearly in the top ten investments which we reproduce in the table below. The effect of the trust having grown is illustrated by the most recent acquisition (Feb 2021) of the remaining 50% of the Braes of Doune wind farm in Stirlingshire, Scotland. The original 50% of the asset featured in the portfolio at IPO, but the size of the trust at the time prevented a larger investment. Having been a part owner of the asset since 2013 put the team in an excellent position to purchase the remaining stake. With the growth of the trust since IPO, this previously very large investment now only constitutes 3% of the portfolio.
Currently the largest asset in the portfolio is a 38% stake in the Humber Gateway wind farm, acquired at the end of 2020, which has capacity of 219MW and is located five miles off the Yorkshire coast. With all assets being acquired, UKW’s board has the final say of whether any asset is purchased. As such, there is a significant control in place to ensure that the managers are continuing to invest at rates of return that will enable the trust to meet its total return objective of 8-9% net of fees. The sizable investment in an offshore wind farm is perhaps indicative of things to come. 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 should allow it to invest in this asset class.
top ten investments
As we note above, increased size also allows the managers to make operational efficiencies. Greencoat has an experienced and large in-house asset management team, of which six engineers focus entirely on UKW’s wind farms. Their time is spent on three broad areas. Firstly, the team try to ensure that each wind farm is generating as much electricity as it can in the circumstances. The team perform detailed and specialist analysis on each asset, to maximise the overall wind farm return over individual turbine performance. Secondly, the team also focus on maximising the revenues from their assets, including developing ancillary revenue streams such as grid balancing participation with the National Grid. Thirdly, the team use the trust’s scale and buying power to negotiate lower operational costs such as pooling insurance and cutting costs for operation and maintenance (O&M) contracts. All of these initiatives are enabled by the sheer size of UKW, and enable Greencoat to offer what they view as a best in class service as manager.
Notwithstanding a competitive market, UKW has a significant pipeline of assets that it has committed to buy which gives reassurance on the immediate future in terms of capital deployment. As we discuss in performance, UKW aims to achieve its objective of maintaining the NAV in real terms through reinvesting surplus cashflows (after the dividend has been paid). In an average year at the current size, we calculate that UKW must therefore reinvest around £90m per year into new opportunities. In this regard, investors will be reassured that UKW has committed to purchase a significant number of windfarms once they come into operation. This may be one way that the managers are able to continue to invest in a competitive market and still deliver on the target returns, but it also helps to provide investors with good visibility on future investments.
UKW’s model involves the use of structural gearing, to boost returns, and flexible short-term gearing to help it acquire assets before raising equity capital. The structural gearing (which has a range of maturity dates ranging from 2022-2026), has an average cost of just 2.51%. In contrast to many peers in the AIC Renewable Energy Infrastructure sector, UKW buys its assets unencumbered by debt, and so gearing is simple to understand and is unsecured.
As at 31/03/2021, total gearing amounted to a total of £940m, equivalent to 28% of total assets (or 39% of NAV). This is made up of £700m of structural, fixed term borrowings (with a weighted average maturity as at the end of May 2021 of 3.5 years) and a flexible credit facility of a maximum of £400m. At the time of writing, the company has drawn down £240m of this amount. Offsetting the gearing, as at 31/03/2021, UKW had cash balances of £82.2m, meaning that net gearing was 25% of total assets (or 35% of NAV as at that date). UKW can be geared to a maximum of 40% gearing on a gross-asset basis (or 66% of net assets), but the managers do not expect gearing to rise this high over anything but the very short term.
Over the long term, the managers expect gearing to be in the 20–30% range (of total assets), and so the current level is towards the top end of this range. UKW has commitments to buy assets worth £533m over the coming years, which compares to the remaining balance of the flexible credit facility and cash which totaled £242m as at 31/03/2021. As such, we would envisage the company raising further equity to fund commitments and new investments should they secure them.
When compared to the long term returns achievable from UKW investments with the interest cost, employing gearing serves as a useful boost to returns. Having said that, using leverage to generate a high income is potentially more risky, given its propensity to amplify valuation changes and (in a worst case scenario) to impact the ability of a trust to continue to pay dividends and/or potentially force asset sales at lower valuations. In contrast to several other peers, the fact that UKW only employs gearing at a trust level rather than on a project level, means that it is not amortising its borrowings. This exposes the trust to repayment risk at the end of each loan’s term but, on the other hand, it allows the trust to maintain its gearing level over time. We estimate that UKW has an average duration of its fixed debt of 3.5 years (as at the end of May 2021), with the most immediate repayments of £150m due in the summer of 2022.
2020 provided a good stress test for many funds and strategies. To this end, we would suggest that UKW was not found wanting, although the share price was not immune to the panic that hit markets in Q1 2020. As the graph below shows, the share price recovered much of the losses very quickly. However, the shares were trading at their highest point ever reached at the start of 2020 (153p) and, so despite the bounce back and a solid NAV total return, share price total returns since then have been disappointing. The current premium of 11% (Source: JPMorgan Cazenove) represents something of a derating over the year, in common with the peer group experience. That said, UKW has gone from trading at a premium to peers to being in-line with the peer group average, which we view as unjustified as we discuss in the Discount section.
TOTAL RETURNS since start of 2020
Past performance is not a reliable indicator of future results
In our view 2020 shows the strength and resilience of UKW’s relatively simple model. The twin long term objectives of the trust are to grow its dividend in line with inflation (RPI), and at the same time preserve the NAV in real terms (i.e. accounting for RPI inflation). The managers aim to achieve this by investing in wind farms with a target for a long-term total return of between 8-9% and using low-cost structural gearing to enhance returns for shareholders (see Gearing section). In terms of sustaining these returns as the company grows, the independent board sign-off on each acquisition, which we think should help reassure investors that growth is not being pursued at the cost of returns.
To maintain the NAV in real terms, UKW aims to reinvest surplus cash, and in this way has reinvested £163m (to 30/12/2020). The NAV has grown from launch at 98p to 122.2p per share (excluding the dividend), representing c. 25% growth in capital to 31/03/2021, which compares to RPI growth of c. 19%. Over this period, the discount rate applied to value the assets has fallen by 100bps – significantly less than bond yields over the same period. The rest of the discount compression from 8.2% at launch to the current 6.9% is the result of a mechanical change derived from the shift in assets in the portfolio (assets with very little power price risk have lower discount rates). UKW currently has the highest (unlevered) discount rate amongst its peers.
A combination of the high and rising dividend, and the NAV growth has led to strong total returns since IPO and over the past five years. Indeed, UKW remains amongst the best performing of the renewable energy infrastructure funds since it launched in 2013. We show NAV total returns since IPO in the graph below. Over five years, the trust has also outperformed the UK equity market (as represented by a Vanguard FTSE All-Share tracker) by 18.4% in NAV total return terms, but also the peer group by 9.8% in NAV total return terms.
NAV TOTAL RETURNS
Past performance is not a reliable indicator of future results
As the above illustrates, the NAV has been strong and uncorrelated with volatility in the equity market. The share price has had a beta to and volatility of less than half of the FTSE All Share over five years (Source: Morningstar), and so we believe that over the long term UKW’s trading history illustrates that it is an attractive complement to equity portfolios. That said, as with any investment, there are risks presented by renewable energy infrastructure assets. The main risks borne by investors, we would suggest, are those long-term assumptions that are baked into the valuations which make up the NAV. As we discussed earlier, long-term power price expectations have been coming down over the past few years, but now seem to be relatively stable. However, the risks are illustrated by the increase in corporation tax rates announced by the UK Chancellor from 2023, which the Greencoat team project for “the medium term” before stepping back to the current rate. This reduced the NAV by 2p, although JPMorgan Cazenove estimate that if tax rates remain at the 2023 rate indefinitely, this would reduce the NAV by a further 2p. The most recently published sensitivities to changed assumptions on long-term factors can be seen below. The trust’s inflation assumption remains at 3.3% to 2030 (when RPI comes to an end), and 2.3% thereafter.
Source: Greencoat Capital
Past performance is not a reliable indicator of future results
UKW remains the only renewable energy infrastructure fund to explicitly state that its aim is to grow dividends in line with inflation. So far, as we illustrate in the graph below, it has grown dividends each year since IPO. Each dividend has risen in line with inflation, with the target for the following year based on the December calculation of annual RPI. Since listing in 2013 to the end of 2020, the dividend has risen by 18.3% cumulatively, which compares to the Retail Price Index rise of 17.4% over the same period. The 2021 dividend target of 7.18p means the shares offer a prospective dividend yield of 5.5% which, in the context of other income sources, we believe is attractive.
As we note in Performance, UKW’s ability to grow the dividend by inflation over the long term rests on its ability to re-invest surplus cashflows (as determined by the dividend cover) but also on underlying cashflows managing to keep up with (or exceed) inflation. The graph below shows that of late, dividend cover has been lower than the managers’ budgeted expectation of 1.6-1.7x. 2019’s lower dividend cover can be explained by a lower average wind speed than normal. 2020 saw a higher wind speed, but saw its own challenges in the demand for energy falling dramatically during the initial lockdown as well as specific unplanned issues with a few of UKW’s assets. For the current year, it is early days yet. However, we understand that the team are optimistic that despite wind speeds being lower than usual in Q1 2021, higher wholesale energy prices mean that dividend cover should be in line with budget.
DIVIDEND AND CASH GENERATION
Past performance is not a reliable guide to future returns
As regards long term cashflows keeping up with inflation, it is worth noting that by value 61% of the portfolio has revenues derived from fixed payments (which are linked to inflation), and 39% being influenced by power prices. 37 of UKW’s 38 wind farms operate in the ROC (Renewables Obligation Certificate) regime that was historically the way the UK government incentivised all renewable power development. ROCs offer generators an RPI linked incentive payment for electricity generated. This gives a good amount of visibility on income, which is helpful in terms of the company delivering on its objective to provide a covered dividend which rises with inflation. However, it does also mean that revenues are influenced by short term power prices (Greencoat does not sell forward electricity, unlike some peers). That said, we think 2020 shows the strength of the model; with even the significant reduction in power prices seen in the first half of 2020 due to lower COVID-19 lockdown demand, the trust was able to generate cash equivalent to 1.3x the annual dividend over the year.
In the graph below we show the power price history that UKW has been exposed to. Prior to 2020, the average wholesale price over the previous seven years was c. £45 per megawatt hour. In the first six months of 2020, the average was c. £28. Since then, electricity prices have more than recovered. As we illustrate below, the average price for 2021 (to the end of April) has been c. £64. This is good news so far in the context of the company’s aim to hit the dividend target for 2021.
ELECTRICITY PRICES: DAY-AHEAD BASELOAD CONTRACTS - Weekly AVERAGE (GB)
With the closure of the ROC regime, new renewable assets being built will either be under the CFD regime (typically offshore) or will be subsidy-free (typically onshore in Scotland where the wind strength makes these projects viable). CFD projects provide a fixed payment for generation of power for a finite period, whilst subsidy-free projects give pure exposure to the wholesale power price. UKW’s committed investments, which will start operating in 2021 into 2022, are a mix of subsidy-free and fixed-price projects. The managers believe that, when combined in appropriate proportions, a mix of CFD and subsidy-free projects will provide a similar cashflow profile to ROC assets with similar returns. That said, the team expect that a good proportion of future purchases will benefit from ROCs.
Greencoat Capital is a boutique asset manager focussed exclusively on renewable energy and energy-efficient sectors, with offices in London and Dublin. The two managers who have responsibility for UKW each have 24 years of investment experience, mainly in the infrastructure and renewables sector. They are supported by a team of 14 professionals who monitor and manage the turbines directly. Each turbine is usually covered by O&M contracts from the manufacturers, although we understand that increasingly savings can be extracted by opening up O&M contracts to others. Greencoat Capital manages over £6bn of renewable assets and is entirely independent and not linked to any developer, which the managers believe is helpful when it comes to acquiring assets at keen prices.
UKW is a UK-domiciled investment trust. The chairman is Shonaid Jemmett-Page, who was the COO of CDC Group, the UK’s development finance institution. The board has a high degree of expertise specific to renewables and wind-powered electricity generation. Unusually for an investment trust, the board must approve each asset purchased. As such we have a high degree of confidence that in this specialist area shareholders can be expected to have their interests looked after. In our view, the board’s independent oversight becomes especially necessary should fewer new assets be available for reinvesting cash flows, resulting in prices being bid up and potentially diluting shareholder returns with lower returning assets being added to the portfolio.
The graph below illustrates to us that UKW and the wider sector have enjoyed strong demand for their shares over most of the past five years. In March 2020 the shares were not isolated from the panic in markets, which saw a discount appear (albeit only very briefly, and on small volume) as a function of a rapid drying up of liquidity in the market. UKW’s board has authority to buy shares back to protect the discount from widening significantly, but it is worth noting that the board is powerless to prevent a derating of the shares from a premium to a level in line with NAV. In share price terms, over the short term, this can be painful for investors. In the case of the Renewable Energy Infrastructure sector, premiums re-established themselves quickly once the market volatility subsided, but there is no guarantee that this will happen in the future.
Over more recent months, the premium for the sector and that of UKW has come back. More latterly UKW, which has typically attracted a premium rating to peers, now trades in line with the peer group average on a premium of 11% (Source: JPMorgan Cazenove). We believe that the reduction in the average premium rating for the sector is likely a combination of share issuance across the sector, but also worries about the impact of a very significant build out of renewable energy assets on long term power prices. Bloomberg published a report in early April with a bearish outlook for long term power prices. We understand that UKW’s managers believe their outlook is overly negative, because in their view Bloomberg seem to ignore demand side developments (such as green hydrogen). Their belief is that, as power prices fall from future developments, the industry will adapt so that the power price is largely maintained.
Whatever the outlook, we believe UKW justifies a premium to peers given UKW’s investment returns have so far been higher than the peer group average, commensurate with the fact that wind is typically considered a higher risk technology than solar assets, and reflects UKW’s higher valuation discount rate. Additionally, UKW has been able to pay a covered dividend as well as reinvest surplus revenues to maintain the NAV in real terms.
PREMIUM/(DISCOUNT) TO NAV
As we note above, the board has a stated intention to buy back up to 14.99% of its shares in the market if the discount to NAV is ‘material’, providing that in the board’s view it is in the interests of shareholders to do so. A longer-term discount control feature is that a continuation vote will be held if the share price averages a discount of greater than 10% over a 12-month period.
UKW’s growth has delivered advantages to investors. Aside from enabling it to acquire significantly larger sized assets and benefit from economies of scale in operating them, the OCF has fallen significantly as a direct result of this growth. This is largely thanks to the tiered management fee structure which is designed to allow the ongoing costs to reduce as the trust grows. As a result, the most recently published OCF is 1.03%, with guidance given that assuming no further equity is raised, this will fall to 0.98% for the current financial year. In our view, paying a fee of sub 1% of NAV seems good value given the very specialist nature of the asset class, and the attractive income that UKW generates. The KID RIY cost as at 31 December 2020 was 1.21%.
UKW’s tiered management fee translates into a blended fee of c. 0.93% of NAV (Kepler estimate) at the current net asset value of £2.4bn. The fee structure comprises 1% on NAV (not gross assets), with a further 0.2% paid in equity (new shares issued at NAV, or bought in the market and awarded at NAV) for NAV below £500m. The fee declines to 0.9% (and an equity fee of 0.1%) on NAV over £500m, and 0.8% (no equity fee) over £1bn of NAV. There are no performance fees or acquisition fees for assets bought.
HISTORICAL ONGOING CHARGES
Source: Greencoat Capital
UKW’s ESG attractions are in some ways relatively obvious, and may in part be reason for such a strong premium having developed at times. By buying developers’ projects (or in some cases, forward funding) UKW is contributing to the build out of renewable energy, and enabling developers to recycle capital into new projects, thereby contributing towards efforts to achieve ‘net zero’. The current portfolio generates enough electricity to power an estimated 1.2 million homes (or displace around 1.5m tonnes of CO2 which would otherwise have been emitted through thermal generation). As such, for an investor wanting exposure to a sustainable theme as well as a high income, UKW represents a credible choice in our view.
As noted by Prime Minister Boris Johnston in September 2020, the UK has the potential to be a “Saudi Arabia of wind power”. In contrast to solar irradiation, wind is something that the UK has plenty of when compared with other nations. In this context, the UK government’s stated ambition to quadruple offshore wind farms over the next ten years can be seen as credible. However, the scale of the challenge is undeniable, and the managers believe this will continue to offer them a good pipeline of assets to buy.
UKW published a full ESG review of 2020 at the time of the final results. Aside from reducing greenhouse gases, the board sees the trust’s role in a number of other ways, including a responsibility to manage habitats at wind farm sites and ensure safety for contractors and communities that the wind farms are situated within. The team have habitat management plans for all 38 of their sites, and report on a number of specific initiatives related to peat restoration and managing the landscape to encourage wild birds. At the Stronelairg site, UKW has enhanced the habitat for native birds, encouraging golden eagles and other protected species to visit. At Dunmaglass, the team have been restoring peat, by building a number of dams to slow run-off and enable it to regenerate and increase biodiversity.
In terms of safety, 17 of the 38 wind farms are having safety audits during the year. In 2020 a serious accident occurred at the Tom nan Clach asset, following which we understand the operating contractor reviewed and revised their health and safety policies. In terms of local communities near UKW’s turbines, the trust makes considerable annual donations to support local organisations through community benefit funds, which are usually agreed as part of a site’s original planning permissions. During the year, UKW set aside £3.8m to benefit local communities and social projects. With the challenges presented by the pandemic, Greencoat set aside 10% of these funds to help with COVID-19 response activity, and pushed forward an early release of funds to safeguard key community projects.
Greencoat Capital has been a signatory to the United Nations-backed Principles for Responsible Investment (PRI) since 2016. In the 2020 PRI assessment, Greencoat Capital maintained its A score in the Strategy and Governance reporting module and achieved an A+ score in the Infrastructure module. The team (and board) believe that managing ESG issues produces better results for its shareholders and also for stakeholders across wider society. As such the managers consider ESG at every stage of its management activities. Aside from incorporating ESG into its risk analysis in the due-diligence process when buying assets, it also monitors operations from an ESG perspective.
In conclusion, UKW’s impact of its strategy towards achieving a low carbon economy is abundantly clear, and the managers consider ESG in every activity they perform to achieve this strategy. As such, we believe that UKW is likely to continue to appeal to those investors who consider ESG an important part of their investment portfolio.