NextEnergy Solar halves dividend in attempt to fix discount

NextEnergy Solar (NESF) has unveiled a set of measures to fix its entrenched discount, which sat 35.3% below its net asset value (NAV) as of yesterday’s close – something that new chair Tony Quinlan described as ‘irrational, but a reality’. This is slightly wider than the 32.3% average amongst its peers in the Renewable Energy Infrastructure sector.

One of the standout changes is a halving of its dividend from 8.43p to between 4.0p to 4.6p, which is likely to ruffle some investor’s feathers, according to Peel Hunt analyst Markuz Jaffe.

‘We suspect the prospect to be poorly received by income seeking investors – particularly where NESF has been attracting lots of interest from retail investors,’ he said.

The reduced dividend, NESF argued, will free up an additional £40m over the next five years which can be used to pay down the trust’s debt to between 40% to 45% of gross asset value. Some of this will also be financed through asset disposals, such as the sale of a 100MW solar portfolio yesterday for £119m – a £46.2m uplift on the trust’s initial investment.

However, this long-term benefit may not be appreciated by income shareholders who bought the £307m trust for its high yield, according to J.P. Morgan Cazenove analyst Christopher Brown.

‘We think its current shareholder base will largely be focused on the income element of its returns and so will take the significant dividend cut as a negative, and will care much less about the potential for higher future returns (“jam tomorrow”),’ he said.

‘The reality is that NESF has been overleveraged and needs to cut the dividend and sell some assets to get leverage to a more sustainable level, which is a fundamental reason why we have been underweight NESF.’

NextEnergy Capital CIO Ross Grier defended the trust’s gearing, noting that leverage is part and parcel with investing in infrastructure – not the headwind it is often characterised as.

‘Leverage has been a bit demonized in the sector unnecessarily. It’s an important part of how you extract value from infrastructure assets,’ he said.

‘Our leverage has always been conservatively structured, well priced, and intelligently thought out based on how the assets change over their subsidy life, so what we’re not left with is a significant sting in the tail that we know exists in in other platforms.’

Grier added that the trust is ahead of the curve in reducing the dividend to pay down its debt, with many other renewable trusts facing scrutiny over the long-term sustainability of their lofty yields.

‘That’s what we’re combating most robustly here. There’s a clear forward strategy, a clear roadmap, an aligned board and manager, and there’s a dividend policy that that can’t be discredited by a gray cloud of people not believing in the sustainability of that yield,’ he explained.

‘Ultimately, where we’d love to be over time is selectively fundraising to grow – not just doing that discount removal process. It’s deliberately called a reset to try and remove any of that additional noise and just build confidence back in the sector and platform.’

With its leverage reduced, the trust also aims to use the extra money from its reduced dividend and asset sales to increase its allocation to energy storage assets. This is an  area it identified as being complementary to its existing portfolio, particularly through the winter when its solar assets are producing less energy.

By re-investing this capital back into growing the portfolio, NESF hopes to increase its long-term total return potential to between 9% and 11%.

But while Brown found the decision to pay off debt via a reduced dividend to be ‘broadly sensible’, he remained ‘unconvinced by the argument about adding significantly more battery assets’.

‘Co-located battery assets may be less risky in terms of revenue generation because they are used to smooth the generation profile of the solar asset, increasing its capture price relative to baseload electricity prices, rather than just trade power.

‘But it is those trading opportunities that offer the greatest return potential and so it is not clear that the IRR is necessarily better than a standalone battery asset (and these too have highly uncertain future merchant cash flows that are a derivative of power prices),’ Brown said.

Nevertheless, NESF is convinced that the new changes, while tough, ground the trust in the reality of energy markets. The firm’s investor relations senior vice president Peter Hamid noted that the trust’s yield is still among one of the highest in the investment trust universe, even after the reduction. That paired with a higher total return target could make it more attractive for the right investor.

‘The yield is still around 7% to 8% as of close yesterday – which is very attractive for an income investor – but what we’ve done is removed that uncertainty in the market where everyone is talking about how sustainable the yields are,’ Hamid said.

Ahead of the review, some analysts speculated that the trust should find a buyer to mitigate some of the headwinds it faced, but Grier said this was not the main consideration of the strategy reset.

‘A merger partner is not necessarily the starting point. What we’re really aiming to do is narrow the discount over time,’ he said.

‘What we are all aware of as a sector is there’s no single silver bullet that re-rates the sector overnight. What we’re doing is continuing to add those robust data points that show that the discount is unreasonable, like the disposal that we did yesterday, where, yet again, we’re disposing at NAV. That just really does demonstrate that that valuation disconnect exists.’

The changes will come into effect at the end of the year, which Grier hopes will ‘give shareholders a nice, long runway for investors to get really comfortable with this change and understand the fundamentals of that market’.