Greencoat UK Wind 19 September 2019

Greencoat UK Wind (UKW) provides a pure investment exposure to UK wind farms, with the aim of delivering a high, RPI linked, income return for shareholders whilst maintaining capital value in real terms.

We have recently launched an Environmental, Social & Governance (ESG) analysis section as part of our standard fund profiles. From an ESG perspective, UKW clearly ticks the “environment” box in that investing in UKW provides the long-term capital which enables an increase in renewable energy provision in the UK, and the shift to a lower carbon economy. The managers estimate UKW prevents over 1m tonnes of CO₂ per annum from being emitted with thermal generation being the alternative. We calculate that this is equivalent to 0.8kg per share. Setting this into context, a flight from London to Milan emits 181kg of CO₂ (Source: Atmosfair). A £10k investment in UKW is equivalent to 5.6 tonnes of CO₂ “prevented” per year.

In other respects, Greencoat as manager is clearly a keen proponent of ESG, and aware of their responsibilities therein. Greencoat were signatories to the UN-supported Principles for Responsible Investment (PRI) in 2016 and provide a lot of detail of how they incorporate ESG issues in their decision-making process and asset management.

Wind is a resource that the UK has plenty of. In 2018 it was a significant contributor to the UK’s electricity supply – meeting 17% of the country’s total demand (renewables as a whole contributed 30%). As such, it is likely to remain one of the central planks of the UK’s strategy to achieve a lower carbon economy. Greencoat UK Wind (UKW) currently owns a portfolio of 35 wind farms around the UK, which together generate enough electricity to power 940,000 homes and is the largest renewable infrastructure fund listed on the LSE with net assets of £1.9bn.

UKW remains amongst the best performing of the renewable infrastructure funds since it launched in 2013. Since launch, the company has delivered strong total returns comprising the 6p dividend which has risen with RPI, and capital growth of 23.9%. In share price terms, shareholders have enjoyed a total return of 96.8% in just over six years. Despite the considerably lower volatility that the company exhibits, on a NAV total return basis UKW has outperformed the FTSE All Share Index total return since launch by over 30 percentage points.

UKW’s main objective is to pay a high dividend to shareholders that is linked to inflation (RPI) and to preserve capital after taking inflation into account. The trust has a target for 2019 of 6.94p per share, representing a 2.66% increase over the prior year, and in line with RPI for December 2018. This year so far, UKW has paid two dividends totalling 3.47p which is in line with the target. Since launch (and based on the dividend target for 2019) the dividend has risen by 2.95% p.a., which compares to the retail prices index of 2.6% p.a. over the same period. At the current share price, the prospective yield is 5.0%.

Around 50% of the company’s cashflows are directly index-linked, with the remainder being exposed to electricity prices. As such, electricity prices, which are assumed to have a correlation to inflation, affect UKW’s ability to grow the NAV by RPI in the long term. Given the high dividend cover of 1.7x on average, the company expects to be able to continue to grow the dividend by RPI on an annual basis over the long term.

UKW has been growing strongly, and during 2019 so far has invested in excess of £600m funded from equity issuance and re-investing surplus cashflows supplemented by debt facilities. Net assets are now £1.9bn. Shareholders benefit from this growth in the form of a declining OCF, which has been coming down rapidly and through operational economies of scale within the business. As at the end of 2018, the OCF was 1.13%, a reduction from the 1.24% level at the end of 2017, and 1.46% at the time of initially listing. The published forecast OCF from the managers for 2019 was 1.08% at the beginning of the year but with over £500m of new equity raised during the first half of 2019, we expect the run-rate OCF to be nearer to 1%.

Many of the listed 'alternative income' funds continue to trade at significant premiums – and UKW is no exception on a current premium to NAV of 13%.

UKW should appeal to all sorts of investors. We continue to believe that UKW offers valuable income and diversification properties to portfolios. To date, the company has delivered on all of its promises. Dividend growth has matched RPI, and the capital value of the NAV has risen ahead of RPI. The company employs a modest amount of longer-term and short-term gearing to enable it to pay a high level of dividends, as well as (in an average year) to reinvest around a third of cashflows in new assets to maintain the NAV in real terms.

From an ESG perspective, UKW’s attractions are abundantly clear. The manager’s efforts in terms of the PRI’s six principles will clearly have a positive effect at the margin, but in our view the main attractions to ESG investors will be positive effect that investing in UKW has in helping the shift to a lower carbon economy.

In our view, political risks are the main external risk to be aware of, but there seems to be increasing acceptance that renewable energy should form a core part of our long-term energy mix. Barring any major changes to the political landscape or long-term power prices, the company should be able to continue to reinvest surplus cashflows to maintain the NAV in real terms. Relative to many funds, the key drivers - and risks - to returns are entirely uncorrelated. The dividend yield of 5% looks attractive in this context, although we would caution against chasing the share price too high given the magnifying effect a reversal of the premium rating will give to share price returns should the company hit any road bumps in NAV terms.