Bluefield Solar Income Fund – Fundamentals shine despite discount

• 24 April 2024
• QuotedData
• Andrew Courtney

Bluefield Solar Income Fund

Investment companies | Update | 24 April 2024 

Fundamentals shine despite discount

The manger comments that, in common with the other trusts in the renewable energy sector, the last six months have continued what has been a challenging period for the Bluefield Solar Income Fund (BSIF). It adds that the trust’s ongoing fundamental performance has failed to reverse a steady slide in its share price which began back in May 2023. Despite this, it says the company has continued to deliver solid NAV growth and market-leading shareholder distributions thanks to a range of contractual arrangements that underpin its assets.

Positively, the manager notes, the falling share price does not appear to be a reflection on the trust itself, but rather broader macro-economic conditions and negative sentiment surrounding UK companies and renewable energy infrastructure in particular. It says that the board has signalled its dissatisfaction with the situation by authorising a £20m share buyback, which is currently underway. The manager adds that with growth accelerating and a recently announced strategic partnership providing an avenue for the ongoing development of its pipeline, the outlook for the trust remains attractive, as does a well-covered dividend yield approaching 9%.

Focus on value accretive renewable investments

BSIF aims to pay shareholders an attractive return, principally in the form of regular sector-leading income distributions, by being invested primarily in solar energy assets located in the UK.

Market Background

BSIF’s share price may be reflecting broader macro-economic conditions and negative sentiment surrounding UK companies and renewable energy infrastructure in particular

The manager says that the renewable energy sector has been a victim of the rapid rise in global interest rates that began back in 2022. At its peak, risk-free returns from government debt climbed above 5%, which it says impacted on the appeal of renewable energy assets. The manager added that compounding the issue was the rise in discount rates and financing costs, which weighed on the ability to drive capital returns. It says that these dynamics have added to the pain caused by the general underperformance of the entire UK equity market, which it says has suffered from slowing growth, stubborn inflation, and a lame duck government. This led to suggestions that the economy may be staring down the barrel of stagflation, it adds.

Improving outlook for the UK

The manager says that for the moment, the fortunes of the renewable energy sector appear tied to those of the broader economy and that given the challenges faced over the last 12 months, it was difficult to see where a positive catalyst might emerge from. However, in recent months it says we have seen some signs of improvement.

The positive news is headlined by February’s inflation data, which was down sharply, falling to 3.4% from 4.2% the month prior

The manager notes that the positive news was headlined by continued progress on inflation which, after a steep decline in February, fell to 3.2% in March. The reading marking the slowest annual rate since September 2021. Promisingly, it says, the data shows many of the underlying components of the CPI index are also falling including the service sector figure which it says typically reflects domestic rather than imported pricing pressures.

Promisingly, the manager highlights that steady wage growth suggests that we are beginning to see some stability in the labour market, and it says that sustained real earnings should provide a much-needed boost for GDP.

Even so, the manager believes economic growth remains a concern, and with the ECB still at the terminal, it says there appears to be considerable headroom to lower interest rates.

The manager says that with the renewable energy sector one of the worst-affected by the previous rise in rates, it was hoped that any easing of financial conditions would result in a sustained uplift. However, despite gilt yields falling by almost 50 basis points from their peak, the share prices of both BSIF and the broader sector have continued to deteriorate. Because of this, the manager suggests that there may remain other factors at play.

Power Prices

One possible explanation, it says, is falling power prices. According to the manager, despite appearing to undergo a structural resight higher post-COVID, these have retreated from their highs, which has impacted on NAVs as medium to longer-term forecasts are reduced as shown in Figure 2.

However, the manager says that BSIF has maintained strategies that greatly limit the impact of any power price volatility.

The manager highlights that BSIF’s strategy is to lock in power sale contracts for individual assets not covered by long-term contracts for periods between 12 and 36 months. It says that this helps to mitigate much of the volatility inherent in energy markets, which it comments has become particularly elevated in recent years due to escalating geopolitical tensions and ongoing supply disruptions. Entering into 2024, the company had more than 78% of its merchant revenue sold forward to March 2025, with the strategy securing power price fixes at levels that are materially higher than the latest industry forecaster expectations, as highlighted in Figure 3 below:

The manager says that in addition to its power price management, BSIF also benefits from a range of inflation-linked contracts, which account for almost two-thirds of the company’s revenues. It says that this means that increases in RPI have the effect of boosting both earnings and the valuation of BSIF’s assets. In combination with the company’s price-fixing strategy, the manager comments that the structure provides both the advisors and investors with excellent visibility over BSIF’s medium-term revenues. It says this also provides a hedge against an increasingly uncertain interest rate environment.

The manager says the success of these strategies is highlighted in the company’s recent interim results with strong revenue growth and dividend cover well in excess of 2x. This, it adds, consolidates BSIF’s position as arguably one of the more reliable income options for investors in the UK.

The manager observes that another potential overhang is the ongoing issues surrounding investment trust cost disclosures. The manager says there is currently a campaign to reform these regulations, which, it is hoped, will help improve sentiment towards the entire investment trust sector.

The manager thinks that with the UK’s economic outlook steadily improving, and BSIF continuing to execute on its fundamental performance, current discounts could provide a very attractive entry point for a trust.

Interim results

The manager highlights that BSIF has continued to generate solid returns despite its falling share price, saying the fundamentals of the portfolio are as good as they have ever been in the 10-plus years that the fund has been operating. The manager adds that the company’s recent interim results, released on February 28 for the six-month period ending 31 December 2023, show no signs of this momentum slowing, with a number of record returns and a full-year outlook, which it says has continued to improve.

BSIF’s headline revenue return was 91.6m, a 17% year on year increase and more than double that of the equivalent period in 2021.

The manager continues that despite irradiation levels some 13% below those experienced in the second half of calendar 2022, the company’s headline revenue return was £91.6m, a 17% year on year increase and more than double that of the equivalent period in 2021. Total funds available for distribution reached a record high of 70.2m and, as noted, dividend cover is now well in excess of 2x with a total dividend of almost 9%, one of the highest in the sector.

BSIF’s NAV over the six-month period fell slightly from 139.7p at 30 June 2023 to 136.0p at 31 December 2023 with the positive impact of inflation and power price forecasting offset by dividend payments, highlighted in Figure 4.

Development pipeline

The manager says that the company has also maintained its focus on the build out of its development pipeline, the extent and value of which it says is significantly underappreciated by the market. During the second half of 2023, the company secured planning consents on 137MW of solar projects and 90MW of battery projects, while post period end one project of 50MW solar received consent. The wider pipeline grew to approximately 968MW of solar and 563MW of battery storage (with a full breakdown available on page 9 of this report). Of these developments, over 600MW are consented solar sites, with a significant share of this capacity holding valuable 15-year CPI indexed linked contracts.

The manager notes that these investments not only establish a significant growth ramp for BSIF, but also provide the portfolio with what it says is considerable financial flexibility. It adds that in the event that funding markets remain closed in the near term due to the company’s stubborn discount and broader economic challenges, BSIF has the option to sell some of this pipeline to third parties. The manager says that with these assets predominantly held at consented value, such a strategy could provide an immediate boost to NAV while generating additional liquidity for the portfolio to either refocus on other developments or pay down debt.

GLIL Infrastructure strategic partnership

The manager outlines that given the challenges present in the current market, the board has been evaluating how best to continue this development programme while maximising value for its shareholders over the long term. It says that having explored various options, BSIF has announced a Strategic Partnership with GLIL Infrastructure in December 2023. GLIL is a partnership of UK pension funds that invests into core UK infrastructure and has a £3bn portfolio of infrastructure assets.

It says that the partnership is a significant development and allows BSIF to deliver on a number of key areas. Primarily, it allows the company to maintain its investment momentum in what continues to be a difficult time for public infrastructure funds, it adds. The manager continues that the deal also increases the diversification of the company’s revenue base, provides external validation of its assets, reduces debt, and creates additional liquidity for the fund.

It says the partnership can be broken down into three main phases, the first of which occurred post-period-end in January 2024, with BSIF investing £20m alongside £200m from GLIL to acquire a 247MW portfolio of UK solar assets from Lightsource bp. BSIF’s ownership stake in the portfolio is 9%.

BSIF announced a Strategic Partnership with GLIL Infrastructure in December 2023

The Lightsource bp portfolio is predominantly diversified across southern and central England and comprises 58 operating sites: 184MW backed by feed in tariff subsidies, 15MW by renewable obligation certificates and two subsidy-free projects totalling 48MW. It says that through the period 2023 to 2035, the proportion of fixed and regulated revenues from the portfolio is projected to be approximately 80%. The acquisition raises the level of regulated revenues in the BSIF portfolio whilst also increasing the proportion of FiT income. The deal also facilitated a £10m repayment of BSIF’s revolving credit facility, which is discussed on page 15.

The manager continues that phase 2 comprises a provisional agreement for GLIL to acquire a 50% stake in a portfolio of more than 100MW of BSIF’s existing solar assets, at a price which is in line with the company’s existing valuation. It says the proceeds of this partial sale will be used in part to fund BSIF’s participation in the rollout of its development pipeline and, as appropriate, to reduce debt. This phase is expected to be completed in the first half of 2024.

The manager says that in phase 3, Bluefield Solar and GLIL intend via the strategic partnership to commit capital jointly to a selection of the company’s development pipeline, assuming market conditions are supportive. It says the identified development assets are expected to be grid-connected over the next two to three years.

Altogether, the manager believes the relationship shapes as an important development at a crucial juncture for BSIF. It says that in an ideal world, the company would have the financial flexibility to develop some of these assets under its own steam. However, the manager notes that this is unrealistic given current conditions and the agreement appears to be the next best alternative, given the time pressures attached to some of the existing consents in BSIF’s pipeline. It says the deal also removes some of the development risk associated with the pipeline at a time when the industry has been faced with dramatic cost blowouts. The manager also adds that the added financial flexibility should allow the company to achieve keen pricing on any future projects given discounts across the rest of the sector.

Portfolio

BSIF operational portfolio as of 31 December 2023, consisted of 812.6MW, which was made up of 754.2MW solar and 58.4MW onshore wind. This encompasses 129 solar PV projects (87 large-scale sites, 39 micro-sites and three rooftop sites), six wind farms and 109 single-stick wind turbines, spread across England, Wales, Scotland and Northern Ireland.

During the period to 31 December 2023, the combined solar and wind portfolio generated an aggregated total of 376.05GWh (31 December 2022: 391.8GWh), representing a generation yield of 462.8 MWh/MW (31 December 2022: 511.4MWh/MW)