Greencoat UK Wind 14 August 2023
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.
Greencoat UK Wind (LON:UKW) owns a diversified portfolio of 47 wind farms operating around the United Kingdom, illustrated in the Portfolio section. It is the largest trust of its type on the London Stock Exchange, with a market capitalisation of £3.4bn, and the shares give investors unhedged exposure to the revenues from the electricity that the wind farms generate, as well as to index-linked subsidies which run long into the future.
UKW’s attractions are not only in the high dividend yield that the shares offer, but also the link to UK inflation (as measured by RPI). During 2022, UK RPI increased by 13.4%, and the board has stated that the company’s revenues allow it to “confidently target a dividend of 8.76 pence per share with respect to 2023”, reflecting an increase in line with this inflation figure. UKW is the only renewable energy infrastructure trust with a long pedigree to continue to directly link dividend targets with inflation.
For the first time, the recent interim results show the managers’ expected dividend cover at different levels of wholesale power prices (see Dividend section). UKW’s fixed revenue base (linked to inflation) means that dividend cover is extremely robust, even in the face of lower power prices. This, in our view, will provide reassurance to investors on both the ability of the trust to continue to pay an attractive dividend, and that UKW will continue to have surplus cash to reinvest, providing good total NAV returns as well.
UKW’s blended asset-level discount rate is now 9%. To get an equivalent discount rate for the equity (or NAV), we must adjust for the structural gearing employed by the trust. On this basis, the discount rate is 11%. Deducting annual costs of c. 1% per annum, this results in an assumed total NAV return over the long term of 10% per annum, if UKW’s long-term assumptions play out.
UKW’s proposition is a relatively simple and attractive one: to invest in wind farms at 9% IRR (the asset-level discount rate as at 30/06/2023), employ modest levels of low-cost debt and pay a dividend linked to inflation, reinvesting any surplus cash flows to grow the NAV. This is exactly what the board and managers have delivered, now for more than ten years.
As we discuss in the Gearing section, UKW has a robust balance sheet, further strengthened by the expectation that UKW will have c. £200m of excess cash flows (after meeting the dividend) per year to reinvest, pay down debt or, in view of the discount at which the shares currently trade, buy shares back. UKW’s managers describe the trust as self-funding, without the need to issue equity. All things being equal, this should have a positive impact on the Discount narrowing.
At the current share price, UKW offers a prospective dividend yield of 6%. Whilst this still offers a c. 200bps premium over the GRY of long-term government bonds, the dividend yield is only half the story. As we discuss in the Portfolio section, with the discount rate having been increased by a further 1% at the time of the interim results, the prospective NAV return of 10% looks attractive on a risk-adjusted basis against many other investment opportunities. The assumptions underpinning the NAV are conservative, and the managers point out that the portfolio has proved robust in the face of downside power price sensitivities, whilst offering upside to power prices, inflation, asset life extension, asset optimisation, new revenue streams, and the interest rate cycle.
- High dividend yield well covered by cash, and “self-funding”
- Continued commitment to RPI-linked dividend growth, yet trading on a discount to NAV
- Uncorrelated assets, and committed pipeline of investments
- Some fixed-rate gearing will need to be refinanced over the next few years, probably at higher interest rates
- Gearing exacerbates underlying asset valuation movements
- Valuations based on long-term assumptions which may (or may not) prove optimistic