NextEnergy Solar Fund (NESF) invests primarily in long-life solar power generating assets, with the majority of the total return coming through a high dividend, with a yield currently of 7.1% on the share price. The renewable space has seen increasing waves of capital enter, with net zero and post-pandemic infrastructure commitments only increasing the pace. In order to continue to drive growth whilst maintaining the level of returns on new investments, improve the diversification of risks and revenue sources, and protect dividend cover, NESF is broadening out its geographic scope and asset mix and is venturing into private funds.
Historically the portfolio has been invested mostly in the UK with significant holdings in Italy. In June, NESF announced an investment of $50m (3.5% of GAV) in NextPower III (NPIII), a private fund with solar assets in various OECD countries. As we discuss in Portfolio, this investment is intended to increase the return potential and dividend cover as well as provide diversification. The manager has identified opportunities to increase the exposure to the battery storage market too, where attractive returns are available in a critical piece of renewable energy infrastructure.
In the year to March 2021 NESF raised the dividend despite the turmoil in the power price markets caused by the pandemic and lockdowns, and the dividend remains covered. As we discuss in Dividend, the board is targeting an increase next year too. The majority of NESF’s revenues are fixed due to subsidies or forward purchase agreements (hedges) to fix the price of power being sold, with the manager employing a dedicated trader who was able to boost the income earned last year through NESF’s rolling hedging strategy.
NESF’s yield is boosted through the strategic use of Gearing. The trust has £200m in preference shares as well as gearing at the asset level and revolving credit facilities. As of the end of March, debt was 43% on a GAV basis (75% of NAV). The trust trades on a 3.2% premium to NAV.
NESF offers an attractively high yield, largely inflation-linked, from an investment in an asset class with strong ESG credentials. The past year has been a difficult one for the sector given the volatility in the power price. In the short term the manager has clearly handled it well in our view, with their hedging decisions in particular adding value. Their long-term strategy for dealing with diminishing returns in the UK solar market seems sound, building on the manager’s experience and expertise and taking full advantage of opportunities presented by their broader business with the investment in NPIII.
After a rough year we can see some potential tailwinds for NAV and the share price: if the manager is right that the market is too pessimistic on future power prices it could mean NESF stands to benefit as this is realised. Secondly, if the new investments provide a higher dividend cover, it could lead to improved sentiment towards the trust.
Risks remain, of course, and a structural decline in power prices would be problematic for NAV. High gearing levels would increase the sensitivity of NAV to this development. However, the 3.2% premium to NAV is low relative to the peer group and to NESF’s own history, which potentially reduces the risks to the share price somewhat.
|Highly attractive yield, with substantial proportion inflation-linked||High levels of debt (although these remain comparable with sector peers)|
|Contributes to the renewables industry, supporting key ESG concerns of many investors||Despite drive to diversify, retains key risk exposures to the UK and the power price|
|Expertise of manager is well-established with advantages for acquisitions and ongoing management||Dividend cover not high (around 1.1x), although manager making moves to increase it|