NextEnergy Solar Fund (NESF) invests in solar power plants, aiming to generate a total return for shareholders of 7–9% a year, including an attractive level of dividend. NESF is managed by NextEnergy Capital Group, a solar power specialist which operates at all stages of the value chain, from development through to asset management and fund management.
NESF’s dividend was comfortably covered by cash earnings at the end of the 2020 financial year in March, and the board felt able to raise the target level by 2.6% for 2021, to 7.05p. This represents a yield of 6.8% on the current share price. Since IPO, the dividend has been increased in line with RPI, but as power prices are currently less correlated to RPI inflation, this linkage is under review.
Falling power prices have been a feature of the market since NESF’s IPO in 2014. Nevertheless, it has managed to maintain its NAV, and has increased its dividend in line with RPI each year. This is partly due to the manager’s expert knowledge of the market through its experience as a developer and asset manager. As discussed in the Portfolio section, this is indicated by the consistent delivery of ‘asset management alpha’. This is generating excess power, and hence revenues, relative to that expected from an asset when acquired.
Despite the dividend being covered 1.2 times by cash, and the track record of strong asset management success, NESF’s premium remains modest relative to peers. As discussed in the Dividend section, the shares trade 7% above par, compared to 9.2% for Foresight Solar Fund and 17.7% for Bluefield Solar Income Fund.
The disparity between the premium of NESF and its two mature peers is hard to justify, and seems to us to be an anomaly. NESF’s assumptions regarding its NAV are not aggressive, and are actually more conservative than those of at least one of its more highly rated peers. If anything, this means the NAV is understated relative to peers, and the disparity between NESF and Bluefield Solar Income Fund in particular is therefore even larger.
Managing to generate stable NAV returns since IPO in a period of falling power prices is in itself an achievement, and NESF’s revisions to the discount rate and expected asset lives have been relatively restrained. The manager’s strong track record of adding value via excess power generation, as discussed in the Portfolio section, and reduction in operating costs has been a key feature. We think this is especially attractive when combined with the expertise and market knowledge the manager has via its development and asset management activities, which give it visibility on new developments, new technological innovations and pricing.
NESF’s share price has not yet recovered from its post-COVID slump, and we think there is therefore a clear case for switching from peers to NESF on valuation grounds alone. Furthermore, over the long term we believe NESF’s managers have proved adept at optimising the company’s assets to the benefit of shareholders, which puts it in good stead over the medium to long term too.
|High dividend, well covered by cash earnings (1.2x)||If power prices fall, cash flows and NAV will come under pressure, although a recovery from COVID-19-induced lows in power prices are already occurring|
|Specialist manager with demonstrable expertise in development, asset management and fund management as well as in energy sales||Valuation of assets difficult for non-specialists to assess|
|Anomalously low premium relative to peers, despite conservation NAV assumptions||High levels of gearing (72% of NAV) including the preference shares, although preference shares have advantages and overall levels are not out of line with peers|