Foresight Environmental Infrastructure – Looking to bounce back

• 02 December 2024
• QuotedData

Looking to bounce back

Foresight Environmental Infrastructure’s (FGEN’s – formerly JLEN Environmental Assets) recent results were a two-part affair, with its operational assets pumping out record cash receipts, but the NAV taking a hit as green hydrogen developer HH2E entered administration.

The failure of HH2E, which could not attract the required investment to bring forward its projects, exposes the risk of investing at an early stage of development in a nascent sector. However, the highly diversified nature of FGEN’s portfolio meant that the impact on NAV was just 2.6%.

The stability provided by FGEN’s successful operational portfolio, which makes up 92% of assets, enables it to take measured exposure to potential gains from construction-stage assets (see our profile on page 9). This gives the manager confidence that FGEN will bounce back strongly in time. The 10.4% dividend yield offers shareholders a compelling reason to wait.

Progressive dividend from investment in environmental infrastructure assets

FGEN aims to provide its shareholders with a sustainable, progressive dividend, paid quarterly, and to preserve the capital value of its portfolio. It invests in a diversified portfolio of environmental infrastructure projects generating predictable wholly or partially index-linked cash flows. Investment in these assets is underpinned by a global commitment to support the transition to a low-carbon economy.

12 months ending	Share price TR (%)	NAV total return (%)	Earnings per share (pence)	Adjusted EPS (pence)	Dividend per share (pence)
31/03/2020	6.3	(0.7)	(2.1)	6.5	6.66
31/03/2021	6.9	1.5	1.5	6.7	6.76
31/03/2022	7.3	34.1	30.6	7.0	6.80
31/03/2023	12.2	13.1	14.9	6.7	7.14
31/03/2024	(15.8)	(1.8)	(2.1)	7.5	7.57

Source: Morningstar, Marten & Co

Interim results

FGEN, which was renamed from JLEN Environmental Assets Group in September, has announced interim results, reporting a total NAV of £720.1m or 109.8p per share at 30 September 2024 – a 3.3% fall over the six-month period. Factoring in dividends of 3.9p, this equated to a flat 0.04% NAV total return in the period.

The fall in NAV was largely attributable to the full write-down of its investment in HH2E, a developer of green hydrogen production projects in Germany that went into administration in November 2024. This knocked 2.6% off FGEN’s NAV (we cover the HH2E story in detail below).

Cash from operational assets at record high

Distributions received from projects were at a record high for the half-year of £46.6m (beating the previous record for the first half of its financial year of £46.2m set last year) and underpinned the dividend with a coverage of 1.23 times. The value of the portfolio fell £85.3m over the period, as shown in Figure 1, due mainly to portfolio sales and the write-down of the HH2E asset.

Figure 1: FGEN portfolio valuation in £m, as at 30 September 2024

Source: FGEN, Marten & Co

HH2E administration

FGEN invested £19.3m into HH2E

FGEN invested a total of €22.3m (£19.3m) into HH2E through Foresight Hydrogen Holdco GmbH. HH2E shareholders also included other funds managed by Foresight Group, HydrogenOne Capital Growth, and the remainder held by the founders and HH2E employees.

HH2E had been working towards the securing of a bankable offtake agreement for hydrogen production ahead of a Final Investment Decision for HH2E’s most advanced project at Lubmin, Germany.

FGEN decided against investing further capital in HH2E

A process to bring in senior lenders and an equity investor was run over the Summer of 2024, no party was prepared to invest prior to a bankable offtake agreement being in place. FGEN, along with Foresight Group, says that it gave consideration to providing further funding to allow HH2E to continue to meet its commitments, but the board decided against it due to risk and capital allocation considerations against the backdrop of the current market environment. With no other option for funding to meet outstanding obligations, HH2E filed for insolvency on 11 November.

FGEN’s investment of €22.3m (£19.3m) into HH2E, which represented 2.6% of NAV as at 30 September 2024, was mainly used to secure orders for long-lead-time equipment and develop HH2E’s first two green hydrogen sites at Lubmin and Thierbach.

FGEN does not expect to recover any of the capital

FGEN’s manager says that it does not expect to recover any of the capital it has invested in HH2E.

It is a disappointing end to a potentially profitable investment in the nascent green hydrogen sector. As we have written about in previous notes, green hydrogen has the potential to play a critical role in decarbonising industrial and heavy transport sectors. The manager says that it is still convinced that green hydrogen will play an important role in the clean energy agenda; however, it feels that the pace of development of the hydrogen market had not been as quick as originally expected and the projects were too early in the development stage to attract the required investment from institutional investors.

The manager adds that having already invested almost £20m it could not keep increasing its exposure while waiting for the offtake agreement to be signed. Given the quantum involved, the manager felt that it was too big a risk.

The investment in HH2E is the only development-stage investment in the FGEN portfolio (we detail construction stage assets, which make up 8% of the portfolio, in the asset allocation sector). The underlying performance of FGEN’s portfolio was strong, recording record cash of £46.6m over the six months to 30 September.

Market backdrop

Reaction to the budget and the HH2E news has seen FGEN’s discount widen to 32.2%

The budget announcement at the end of October caused gilt rates to increase in the UK, as concerns grew that Labour’s fiscal policies could prove to add inflationary pressures to the UK economy and interest rates would remain higher for longer than previously anticipated. This resulted in the share prices of alternative investment trusts, including FGEN, to fall from their already depressed levels, and discounts to widen further. FGEN’s discount at 28 November was 32.2% (from around 15% pre-budget – although the HH2E announcement likely played a large part too – see page 14 for more detail on FGEN’s discount).

Labour government positive for renewable energy sector

The change in UK government has been positive for the renewable energy sector, as evidenced by planning restrictions for onshore wind in England being loosened and the 50% increase in the CFD budget (the government’s primary mechanism for supporting new low carbon power infrastructure, which works by guaranteeing a set price for electricity that generators receive).

The fundamental growth story for the sector remains strong, with supportive green energy transition policies from most global governments (especially in the UK and Europe) requiring trillions of pounds of investment over the next 20 years.

Other drivers of returns

Outside of the HH2E write-down, the other factors that impact FGEN’s NAV were relatively stable over the past six months. We detail these factors and their sensitivities below, beginning with power prices.

Power prices

Power prices have been relatively stable over the last six months, having fallen back significantly following extraordinary highs during 2022 and early 2023, as shown in Figure 2.

Figure 2: UK power prices

Source: Bloomberg – UK baseload

The marginal change in forecasts for future electricity and gas prices compared to forecasts at 31 March 2024 increased FGEN’s NAV by £0.2m in the six months to the end of September 2024.

Fixed prices secured on the majority of portfolio

FGEN looks to de-risk its exposure to volatile market prices and has fixed prices for the majority of its output. At 30 September 2024, the portfolio had price fixes secured at 60% for the Winter 2024/25 season and 43% for Summer 2025 season.

The war in Ukraine (heightened by the US permitting Ukraine the use of US long-range missiles into Russian territory) and the rapidly escalating Middle East crisis could create further volatility for oil and gas prices with risks to the valuation related to power price assumptions both to the upside and the downside.

An increase in electricity and gas prices of 10% would add £41.1m (or 6.3p) to NAV and a 10% fall in power prices would take off £39.0m (or 5.9p).

FGEN’s manager states that in the extreme event that electricity prices more than halved to £40/MWh (they are currently at around £85/MWh), the company would maintain a resilient dividend Scover for the next three financial years, albeit with reduced headroom by year three.

Discount rates

UK gilt yields have remained at elevated levels for a sustained period since government borrowing costs rose sharply in 2021 and 2022, as shown in Figure 3.

Figure 3: Long-term (10-year and 30-year) UK gilt yields

Source: Bloomberg, Marten & Co

The weighted average discount rate now sits at 9.5%

No macro drivers or project-specific factors prompted changes to the discount rates used to value FGEN’s portfolio over the six months to 30 September 2024. However, FGEN’s weighted average discount rate moved out slightly to 9.5% (from 9.4%). This was primarily due to an increase in the value of assets in construction (which are valued using higher discount rates to reflect the increased risk versus operational assets).

There was no change to NAV resulting from changes to the discount rate.

A reduction in the discount rate of 0.5% would result in an uplift in value of £23.8m (or 3.6p per share), while a downward movement in the portfolio valuation of £22.9m (3.5p per share) would occur if discount rates were increased by the same amount.

Inflation

Inflation assumptions remained static

60% of FGEN’s forecasted revenues are contractually linked to inflation (as measured by the RPI) through government-backed subsidies and long-term contracts. Inflation assumptions used to value FGEN’s portfolio (based on actual data and independent forecasts) remained the same at 3.5% RPI inflation for 2024, reverting to 3% until 2030, and then falling to 2.25% thereafter. This resulted in no movement in FGEN’s NAV over the six-month period to the end of September.

Figure 4: UK RPI year-on-year (%)

Source: ONS, Marten & Co

Figure 4 shows that RPI inflation rose to 3.4% in October 2024; however, the potential for inflation to increase further following the chancellor’s budget at the end of October has grown. FGEN’s sensitivity to changes in the inflation rate is about +£21.6m or 3.3p on the NAV for every 0.5% increase in the forecast inflation rate and a decrease of £21.9m or 3.3p on the NAV if rates were reduced by the same amount.

Taxation

As we discussed in more detail in previous notes (links to which can be found on page 15), the UK government introduced a temporary windfall tax on electricity generators – the Electricity Generator Levy (EGL) – in response to higher energy prices. FGEN’s wind, solar and biomass assets are affected by the levy, which saw the government take 45% of revenues above a price of £75/MWh from 2023 to April 2024, and thereafter adjusted each year in line with inflation (as measured by CPI) on a calendar-year basis until the levy comes to an end on 31 March 2028.

A sum of £3.3m was set aside for the EGL tax in FGEN’s latest interim accounts. This compared to £5.2m in the same period in 2023. The manager estimates that the annual liability for the 2025 financial year will be lower, reflecting the drop in power price forecasts year-on-year.