US Solar Fund 10 June 2020

US Solar Fund (USF/USFP) targets a dividend of 5.5% of the IPO price, with the aim of growing this steadily as well as generating some capital appreciation through investment in a diversified portfolio of solar power projects in North America. The managers target a total return on investments of c. 7.5% p.a.

The managers, Australia-based (with offices in the US) New Energy Solar Manager, seek to invest in sites at the construction stage. At this stage sites for development will have been secured, and power purchase agreements (PPAs) put in place with investment grade counterparties. USFP provides equity capital and (where applicable) arranges debt and tax equity financing for construction. The managers believe that this approach generates superior returns on capital compared with investing only in operating assets, as many participants only enter the market subsequent to construction being completed (which results in a more competitive pricing environment). The managers can also invest in operational stage projects, if sufficiently attractive pricing means that high enough returns are available.

PPA contracts are typically of an extended tenure, in comparison to UK and European PPA agreements. USFP currently has PPAs which average c. 15.5 years remaining (as of 31/03/2020), with fixed or escalating prices for energy supply over this term.

USFP currently trades on a premium of c. 0.5%, the lowest premium seen in the broader renewable energy infrastructure sector. We examine some of the reasons for this in the Discount section, but with cash flows unimpaired the fund’s NAV valuations have proved resilient during Q1 2020 (see the valuation methodology set out in the Portfolio section).

Most gamblers will aver that there is no such thing as a ‘sure thing’. Despite this, the managers of USFP are operating in a market whereby general demand is close to being assured, but also where pricing for their specific product is contractually assured to a great degree for, on average, the next 15 years.

As such, once all of USFP’s assets are deployed, the 5.5cents dividend stream looks relatively safe to us. The relative merits of the strategy (and the extremely long term contracted cashflows) to other renewable infrastructure funds likely depend on the outlook for global inflationary pressures, and the relative fortunes of GBP relative to the USD.

In a disinflationary or deflationary environment, the long-term fixed price agreements of the PPAs within USFP likely offer a relative benefit; however, the relative lack of flexibility to alter pricing in an environment of wider inflationary pressures could prove a relative headwind. That this is an avowedly USD based product could offer some downside protection in the current environment, with most downside likely emanating from the solvency of the company’s PPA counterparties (though even this does not rule either the PPA or the power output worthless).

For UK income investors, USFP has full exposure to the US dollar, which (when translated back to Sterling) is likely to deliver some variability. That said, historically when the world economy suffers a shock, it is usually the USD that rallies.