Alan Ray
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Updated 11 Jul 2024
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Disclosure – Non-Independent Marketing Communication

This is a non-independent marketing communication commissioned by SDCL Energy Efficiency Income. 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.

  • SDCL Energy Efficiency Income’s (SEIT) annual results to 31/03/2024 show a  NAV total return of -4.7%. SEIT paid total dividends of 6.24p (2023: 6.0p) and the NAV decreased to 90.5p (2023:101.5p).
  • At the current share price, SEIT yields c. 9.4%. Dividends were covered 1.1x by cash and based on current projections the board announced dividend guidance for the year ending 31/03/25 of 6.32p and reaffirmed the goal of a progressive dividend thereafter.
  • The main driver of the NAV decline was a 90bp increase in the weighted average discount rate (WADR) to 9.4%, with this increase taken in the first half of the year to 30/09/2024. Of the 11.7p decrease in NAV per share, 10.8p was due to movements in discount rates.
  • During the year, £161m of investment into mainly existing assets was made, with these expected to be value accretive.
  • Cash inflow from investments increased 8% to £92m.
  • Post-year end, UU Solar was sold for c. £90m, a 4.5% premium to its valuation at 30/09/2023, which, along with external valuations of some assets, helps to provide 'proof' of c. one third of the portfolio, the valuation policy and hence the NAV. The proceeds were used to reduce short-term debt.
  • Adjusting for this sale, and on a consolidated basis, considering debt both at the trust level and debt within individual investments, SEIT is c. 32% geared on an LTV basis (or c. 43% as a percentage of net asset value).
  • SEIT's portfolio's Scope 4 emissions were 972k tCO2. Scope 4 emissions in this context are defined as emissions that have been avoided through greater efficiency.
  • SEIT currently trades at a c. 26% discount to net asset value (12 month average 31%).
  • Tony Roper, chair, said “As the world seeks to address the practical challenges of the energy transition and efforts to decarbonise, energy markets and their supply chains face scarcities and price volatility. In this context, investing in more efficient supply, demand and distribution of energy, which is SEEIT's focus, becomes increasingly important and valuable. We believe that SEEIT remains well positioned to benefit from this opportunity."

SDCL Energy Efficiency Income (SEIT) invests in projects with an exclusive focus on energy efficiency either by providing on-site power and heat generation, avoiding the inefficiencies inherent in long-distance energy transmission, or projects that make more efficient use of energy, thus reducing overall demand. The portfolio is invested across the UK, Europe and the US, and we will publish a full note in due course. You can use the buttons beneath this article to follow SEIT and be notified when we publish on it.

The increase in the weighted average discount rate (WADR) identified above as the single biggest factor in the overall outcome for SEIT to 31/03/2024 is, it’s important to note, principally a market factor rather than an increase driven by a change in the risk profile or mix of SEIT's portfolio. And, it represents an unrealised loss. It's interesting then that this increase, and the consequent decrease in NAV, was taken in the first half of the year, with the second half being flat, and here we are nearly nine months later at the time of writing with actual rate cuts from the ECB, Switzerland, and Canada hinting that the same might be over the horizon for the US and the UK. It seems unlikely that there will be a simple one for one relationship between rate cuts and discount rates, or the discount to net asset value for that matter, but if SEIT and its peers' wide discounts are principally explained by higher interest rates, then one can reasonably see the reverse as a catalyst for the discount to narrow in the medium term.

Meanwhile, at an operational level, the trust has continued to make progress, seeing earnings growth and making value enhancing investments in its existing portfolio. And if we step back briefly from the specifics of SEIT, our regular readers will know that there is an inexorable trend among real estate investment trusts (REITs) in the UK and elsewhere emphasizing the performance of buildings, notably relating to energy costs. SEIT's portfolio isn't, of course, just about buildings, but the fundamental principle of energy efficiency is the same. The annual Scope 4 emissions noted in the summary above are approximately equivalent to average emissions from over 850,000 cars and while on the one hand an investor with specific ESG goals can add this to their tally, the figure is also one way of measuring real world financial savings for the businesses and public bodies that are SEIT's counterparties.

SEIT isn’t of course alone in trading on a very wide discount and the reasons behind that have been well-explored over the course of the last two years, but briefly boil down to higher interest rates leading investors to take a very cautious view on valuations on private assets, particularly where risk-free rates are an explicit input into the valuation, combined with more attractive valuations for traditional government and corporate bonds as a result of those higher rates.

The SEIT team notes that the underlying portfolio return, if it was left to run off to maturity, would be c. 9.4% p.a. if current gearing just ran off on schedule and 11% levered if gearing was maintained at current levels. Factoring in the discount, the share price return could, if the price converged with NAV, and taking off ongoing charges of c. 1.1%, could result in returns of 13-14% p.a.. Clearly this relies on all investments performing as forecasted, but is a good indication of what the discount could actually mean for returns.

SEIT sold one of its largest assets post-year end for a premium to its last valuation, which is the kind of proof of valuation that investors across SEIT's peer group have been asking to see for the last two years. This, combined with the point we are in the rate cycle referred to above, means that pieces are beginning to fall into place for first, a stabilisation in asset value and second an improvement in SEIT's c. 26% discount, which means that its covered dividend is equivalent to a c. 9.4% yield measured at the share price. As the chair notes, the underlying trends behind SEIT are only getting stronger, and this discount and yield seem like a very good point for a long-term investor to initiate a position.

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