Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Greencoat UK Wind. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
At the end of October Greencoat UK Wind (UKW) announced that it would be upping its dividend for 2024 to 10p per share. This represented a 14.2% increase on the 2023 target that the board had set and, as at 02/11/2023, implies a forward yield of 7.1%. In addition, the 2023 target has been increased to 10p by way of an increased final dividend of 3.43p.
In the same announcement, the trust’s board also noted that it would be initiating a £100m share buyback programme, which will take place over the next 12 months and is based on a pre-agreed set of parameters.
An increased dividend and the start of a large-scale buyback programme should serve to act as more tangible proof of the set of scenarios that the trust, which invests in wind power projects, outlined in its latest set of results.
We looked at these in more detail in our latest research note on UKW but, in simple terms, they illustrate how the trust would be able to maintain dividend growth and generate surplus cash, even if the power price fell substantially and inflation remained elevated.
The buyback programme is also a reflection of the trust’s confidence in the NAV. Like other trusts that invest in private assets, there seems to be some scepticism about the value of UKW’s holdings. That has resulted in a widening of the discount which, even after the recent announcements, stood at close to 20% as at 02/11/2023.
This is despite the fact that UKW managers have responded conservatively to rate hikes, increasing their discount rate so that it now stands 1% above the level it was at when the trust held its IPO in 2013 and approximately 2% - 3% higher than the trust’s peers.
When you factor in the discrepancy between the share price and NAV, it means that the trust’s discount rate implies a total return of over 11%, inclusive of management fees.
In other words, that would suggest the prospective return for investors in UKW is approximately 6.5% ahead of the return you would get from buying 10 year UK gilts today.
Of course, that is not a guaranteed return and investors must note that risks still remain. However, the managers make a convincing argument given that, even if inflation remains elevated and the power price falls by approximately 90%, they would still have dividend coverage of 1x.
The management team and board have also continued to buy UKW shares. Schroders Greencoat’s founding partners collectively own nearly 2.4m shares (alongside the 4m shares owned by Schroders Greencoat) and the board owns nearly 450,000 shares between them.
That being the case, you could argue that the current equity risk premium is incentive enough to attract investors. However, the wide discount today indicates that is yet to happen. A key reason we believe is behind that is that investors are missing out on the two drivers of returns that the trust has.
Taking a step back, low interest rates have arguably led to a slightly myopic focus on yield. That’s somewhat understandable. If you are getting nothing for keeping your cash in the bank, it can make sense to focus more on what income you can derive from your investments.
It has also muddied the waters somewhat, given that rates at close to zero mean there can end up being little short-term distinction between a trust that passes through almost all its revenue, compared to another that pays out and makes meaningful reinvestment.
UKW fits into the latter category and, since IPO in 2013, the trust has paid out £887m in dividends but also reinvested £877m. That reinvestment drives returns, with more assets paying out higher cash flows, resulting in both rising capital returns and a rising dividend.
This is the key point that many investors appear to be overlooking. Yes, UKW has an attractive prospective RPI-indexed yield today of 7.1%. However, that is only one component of returns. As noted, the implied total return is substantially ahead of this – and that is due to the trust’s substantial cash generation and its ability to reinvest.
We can see the benefits of this playing out at the moment as well. Unlike peers that may struggle to make payments and with the added caveat that energy prices were higher than usual, UKW is on track to generate £200m in excess cash this year, over and above the dividend paid. That means the UKW board has sufficient cash on hand to undertake its buyback programme but that the managers also have a significant amount to reinvest or retire debt.
As noted, that this is all the case and the discount remains so wide is arguably a sign that investors are spending too much time focused on yield. Another factor may simply be the rather cliched point that markets are irrational and the huge amount of political and economic uncertainty we’ve seen over the past two years is unlikely to have helped that.
That means investors in UKW arguably face something of a waiting game, although the prospective yield means they aren’t going unrewarded for doing so. And once the dynamics described above start to come into fruition, then it’s plausible they’ll benefit from more than just a high dividend yield.
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