Results analysis: Foresight Sustainable Forestry

• Foresight Sustainable Forestry (FSF) has reported its results for the six months ending 31/03/2023. Despite numerous macroeconomic headwinds, the trust proved resilient, with its net asset value (NAV) increasing from £180.6m to 186.6m. The trust’s shares also rose by 1.9% over the period.
• The increase in NAV was mainly driven by revaluations of the trust’s afforestation sites – plots of land that are converted into forestry. Completion of planting at four sites that had been acquired by the trust was a key driver of returns. This provides validation of the argument managers Robert Guest and Richard Kelly of Foresight Group have made since IPO in November 2021, namely that converting plots of land into forestry should prove accretive to NAV.
• FSF’s managers invested £30m in 15 new sites during the period, 10 of which were afforestation sites. The managers have now fully invested the capital FSF raised from a £45m equity placing in June 2022 and did so six months ahead of their target date. However, the managers have not used their gearing facilities and are prepared to deploy further capital if more attractive acquisition opportunities arise.
• Approximately 107,500 pending issuance units (PIUs) were created by FSF’s afforestation investments during the period, contributing a £1.9m increase to NAV. PIUs are converted into UK Woodland Carbon Units (WCUs) – often generically referred to as Verified Carbon Units (VCUs) outside of the UK – in periodic tranches over time once tree growth and the resultant carbon sequestration has been verified.  After verification and conversion has taken place the units become usable as credits for offsetting an entity’s residual carbon footprint. The contribution of voluntary carbon value to the NAV uplift is a sign of the role carbon credits can play in driving returns for FSF. The managers forecast that the remaining 31 afforestation properties in the portfolio still in development will create another c. 850,000 PIUs, as these properties are planted.
• In December, FSF also became the first investment company to receive the Voluntary Carbon Market designation from the London Stock Exchange. The VCM accreditation shows that FSF’s carbon credits are subject to high quality oversight and verification. FSF’s Board plan to allow shareholders the choice to either receive carbon credits from 2030 onwards as in specie dividends to offset their unavoidable emissions, or to receive an equivalent dividend in cash.
• FSF Chair Richard Davidson said: “The long-term demand outlook for sustainable timber in both the UK and Europe remains positive and underpinned by the prevailing decarbonisation agenda. As we embark on the next six months, [FSF] is well positioned to leverage a range of environmental tailwinds whilst it continues to deliver on its business objectives.”

Kepler View

Foresight Sustainable Forestry (FSF) is the only investment trust listed today that provides investors with exposure to the UK’s natural capital and sustainable forestry sector. The Investment Manager, Foresight Group LLP, drives returns by investing in afforestation projects. This takes relatively lower grade agricultural land and transforms it into more valuable forestry once fully planted and the trees are established. Returns are also generated by investing in and upgrading existing forestry sites, with the intention of harvesting and selling the timber they produce, and by tapping into the nascent market for carbon credits, which afforestation sites generate.

FSF only launched in November 2021 but these latest half-year performance figures are positive and build on prior results that suggest the trust’s strategy is working. The Company has delivered a total NAV per Ordinary Share return of 10.6% since IPO and increased its NAV to £186.6 million (30/09/2022: £180.6 million) during the period. As noted, a key driver of returns has been the upward revaluation of land that has been converted into forestry. So far, these revaluations have been stark. For example, one FSF site - Mountmill Burn in Scotland – saw a 97% uplift to its acquisition value when planting was complete. Uplifts to NAV have arguably been compounded by the Investment Manager’s acquisition strategy. The Manager looks to buy direct from landowners, which helps reduce transaction costs and means the Company can proactively target properties that enable operational and valuation synergies when combined with existing properties in the portfolio.

That uplifts to NAV continued in the most recent half-year period whilst timber prices were relatively muted also illustrates the resilience of UK forestry assets to interest rate hikes. Acquisitions in the sector are not typically reliant on large amounts of debt, meaning rate hikes are less impactful than on other property investments. FSF has also traded with lower volatility and at a premium to NAV for several prolonged periods. We think this illustrates the trust is relatively resilient to wider macroeconomic headwinds, such as inflation, as well as offering strong portfolio diversification benefits, given its low correlation to other asset classes, like bonds and equities.

Another core component of the trust’s investment thesis is its ability to generate carbon credits from afforestation sites. Due to the completion of planting c. 955,000 trees at four afforestation properties in the period, the trust generated an additional c. 107,500 pending issuance units (PIUs), contributing a £1.9 million increase to NAV. In total, the Company has a total of £2.5 million of value ascribed to carbon credits from 143,707 PIU’s, all of which are registered with the Woodland Carbon Code. It should be emphasised that PIUs are not carbon credits. They are akin to a promissory note to deliver credits in the future and, once they are validated, are converted into woodland carbon units – carbon credits that can be used to offset one tonne of carbon emissions per unit.

We think the case for carbon credits remains compelling. Net zero targets are only increasing among corporates, as illustrated by the fact that more than 80% of the FTSE 100 firms now have them. This is likely to drive demand for carbon credits in the near future as firms struggle to hit those targets alone and seek to offset emissions through carbon credit purchases. The credits FSF is on track to generate are high integrity and likely to meet even the most stringent corporate ESG standards, as illustrated by the trust being the first investment company to receive the London Stock Exchange’s Voluntary Carbon Market designation in December last year. The Company’s strategy of keeping credits on the balance sheet until 2030 – when they can either be paid in specie or as a cash dividend – will play into these supply-demand dynamics, assuming they come into fruition.

Timber sales are another component of the returns FSF hopes to generate. Timber demand has dampened in the past 12 months, largely as a result of a slowing economy and potential recession. However, the benefit of commercial timber, as opposed to other soft commodities, is that it has an extremely long harvesting window of 5 – 10 years. This means the FSF managers can wait until prices improve before they begin harvesting. Moreover, the growing desire among buyers to onshore production and ensure timber supplies are sustainably sourced may work in FSF’s favour over the long-term.

Taken together, we think all of these factors mean FSF possesses many of the features investors are looking for today. Returns since launch have shown little correlation with equities or bonds, with the trust’s real asset investments proving less volatile and more resilient to rate hikes and inflationary pressures. We are also likely in the very early stages of the carbon credit market. FSF’s strong linkage to this market is likely to appeal to any investor that wants to gain some exposure to it in their portfolio and may provide further uplifts to NAV if the supply and demand problems described above become more acute in the years ahead.