Re-examining the fundamentals behind Greencoat UK Wind

Re-examining the fundamentals behind UKW…by William Heathcoat Amory

This trust has been awarded a rating by Kepler Trust Intelligence for alternative income… Find out more

Overview

Greencoat UK Wind (UKW) was the first renewable energy infrastructure trust to launch in the UK, and it contributes around 2% of electricity generation in the UK each year. UKW’s success has been the result of a straightforward investment proposition, and a focus on the higher financial returns and cash flows from wind farms relative to other renewables assets, not to mention the scale economies that come with having a £5bn portfolio of assets.

We discuss the financial returns that UKW has delivered for investors in the Performance section. At a basic level, UKW gives investors a relatively pure exposure to the economics of wind farms. Those economics, in their simplest form, rely upon a basic ‘price × volume’ equation; i.e. how much electricity the wind farms produce and the price received (via subsidies and merchant power prices). UKW generates a predictable amount of power over the long term. On the other hand c. 50% of UKW’s lifetime cash flows are exposed to merchant power prices that vary over time. Long term, the ‘energy transition’ is in full swing. Electricity demand looks well set to increase thanks to widespread adoption of EVs, heat pumps, and not forgetting AI and data centres. This growth in demand should underpin both power prices and the demand for additional renewable capacity.

Operational wind farms are highly cash generative, and UKW’s high structural dividend cover gives investors a degree of comfort that the dividend will be paid through the ups and downs of energy prices and wind speeds. As we discuss in greater detail in the Dividend section, the inflation-linked dividend that UKW has paid since launch is core to its attractions. Having a high dividend cover is beneficial as it gives the trust flexibility to deploy surplus income accretively into the best opportunities available to the manager. Reinvestment into the portfolio is key to sustaining cash flows that underpin the dividend (wind farms depreciate over time, and have an assumed 30-year operating life). We expect the manager to increasingly allocate excess capital towards reinvestment to deliver an evergreen portfolio, supporting its sector leading CPI-linked dividend pledge.
 

Analyst’s View

UKW’s long term NAV total returns have been 7.01% per annum since IPO to 31/03/06 (Bloomberg). Whilst the years since interest rates rose in 2022 have detracted from UKW’s strong track record, we believe the fundamental attractions of the investment proposition have not been impaired. Underpinning everything is the trust’s ability to contribute very significantly to UK homes’ and businesses’ energy demands. As we discuss in the Dividend section, UKW has structurally strong dividend cover. This enables the trust to not only weather short term volatility in energy prices and wind speeds, but also provides enough excess cash generation (post dividend payment) to reinvest into the portfolio to ensure an evergreen portfolio capable of supporting the sector leading CPI-linked dividend pledge.

On the other hand, there has been scrutiny on the subsidy regimes that apply to renewables, given the high cost of energy in the UK and tight public finances. No one expects UK politics to return to stability any time soon. The truth is that the UK needs to continue to attract long-term private sector investment in renewables (and other infrastructure) so the government would need to be very careful about impacting the confidence of investors. Further, renewables is both quicker to market and cheaper to deliver than the alternatives (gas and nuclear).

As we discuss in the Discount section, worries about what a new energy price regime will look like are part of the reason for UKW’s shares trading at a wide discount to NAV. With the manager focussed on maximising NAV total returns and the reinvestment of excess cash flows (see Performance section), whilst also de-gearing the trust to below its self-imposed limit of 40% of GAV, there is clear potential for any resolution in political worries to boost shareholder returns through the discount narrowing. In the meantime, shareholders stand to benefit from the attractive dividend yield of 10.2%.

Bull

• High dividend yield, well covered by cash flows, gives plenty of flexibility to managers for accretive investment activity
• Continued commitment to CPI-linked dividend growth, yet trading on a wide discount to NAV
• Diversified portfolio of institutional-scale assets, spread around the UK

Bear

• Discount to NAV may persist, meaning UKW cannot augment organic reinvestment with new equity
• Gearing exacerbates underlying asset valuation movements
• Valuations based on long-term assumptions that may (or may not) prove optimistic

 
 
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_{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.}