Results analysis: Foresight Sustainable Forestry

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.