Considering the temptation of NESF

A tidy 12% yield from Next Energy Solar – is this an OB2025 idea?

The Oak Bloke

Show me the money the OB says. Read on to find out what I found.

The forward yield is a very impressive 12%. (based on a 8.43p per share dividend). A 14.4% return when you consider the 2.4% buy backs.

Other points of note are its sales of assets as a 14%-21.5% premium to NAV (a further programme begins in 2025). Consider that vs NESF’s 28.2% discount to NAV. If 14% is indicative of the portfolio then the true discount to NAV is actually 37%.

This is the operating portfolio:

Consider that electricity demand will increase by 56% over the next 10 years.

Yet we see the “experts” proclaim that the NAV should be reduced by -£17.8m due to gas prices and short-term power demand expectations.

2024 consumption was higher than than 2023. Perhaps the “experts” are a little confused over what NESF sell? Solar Panels do not produce Natural Gas but power experts do appear to emit hot air.

Meanwhile the Dept for Energy Security & Net Zero tell us that consumption of Electricity is up and other forms of energy are down.

Energy storage assets are a growth area for NESF. These enable NESF to capitalise on existing infrastructure including existing grid connections and inverters, meaning OPEX is optimised, but also that solar generation can be sold at optimal times (i.e. early evening). The idea being that the 92 UK sites could be retrofitted over time with energy storage. Currently 1 50MW site live, a second pre-Construction of 250MW, a smaller 6MW co-located storage 1 has planning, and 4 applications are in progress.

Interestingly, the power price forecasts include a “solar capture” discount, which reflects the discount on pricing in daylight hours versus during baseload hours. With the introduction of storage such a discount would disappear – so create a positive reversion for the NAV that not only do you add the asset to the NAV but you also remove the solar capture discount too.

Forecast Prices & Discount Rates

NESF reveals substantial drops due to discount rates increasing to 8% and short term power prices falling also.

When you strip out that “noise” and focus on the real movements roughly inflation protections offsets power price forecast changes, income nearly covers dividends (and in the 25% higher irradiance in 2022 would have fully covered the dividend), while asset capital gains offset project losses and other losses.

Looking forward it appears that Power Price forecasts will eventually return to a positive, as will the discount rate. It wasn’t clear to me that the forecasts are considering the subsidies, the ROCs and the hedges that NESF employ. Much of current year is hedged and several years ahead also.

Considering the valuation beyond the “Power Price”

A further proof point is that the fund is selling assets at a premium is a strong proof point. But I considered simply following the money.

Now with the HoldCo and the obfuscation that goes on that’s easier said than done. But I persevered and think I managed to find some good insight.

It was at this point I decided tempting NESF was not going to be an Oak Bloke 2025 idea after all.

Why?

What was the “but” for the Oak Bloke?

In the yellow line I took the income (I’ve doubled the numbers for 2025 because we only have the interim result) and then I deducted the overheads but also calculated the depreciation by taking the difference of the HoldCo EBITDA and EBIT.

All looks really positive doesn’t it? But what if we consider depreciation AND dividends.

Ouch.

If NESF didn’t operate the obfuscating HoldCo structure this is what I believe the real picture would look like.

The “real profit” where we hope income exceeds the replacement cost of capital. And it does. However this real profit needs to pay dividends and it doesn’t fully cover that.

Also of concern “Investment Income” is down in FY25. There is a degree of further obfuscation by NESF as to the reasons why.

Part of the reason for this fall is the extent of the actual vs budget output.

If you look at the “expected” values in the chart below the differences add to nearly 40GWh or 7% of the budget. The report speaks to a 4.5% below budget (excluding i.e. plus factors outside NESF’s control). So 2.5% was beyond control perhaps.

Certain metrics like cash flow appear pleasing – that the assets can generate a cash return able to cover the dividend. Moreover I also observe a comment about the 25 year life of assets and the fact that there’s no reason why the assets cannot be used beyond 25 years – subject to lease agreement and also to replace defective parts. NESF do speak to doing this – and nowhere is that in the price. Given the assets are around 10 years old extending 25 year old assets to a 30 year life would drop depreciation by a third – or £15m per annum. The sale of assets at a premium could be explained by the depreciation policy simply being too aggressive.

But the problem is I just don’t know if that’s the case, or at what cost.

Taking the FY25 real cash flow as earnings values NESF at 12X at today’s share price.

But the EBIT of £82.4m doesn’t reconcile with the reported earnings. If I instead use the “real profit” earnings FY22-FY25 of £23m the calculation is nearly 18X the share price.

Conclusion

Whilst NESF offers a great dividend and is selling its assets at a premium I am concerned when I value this on a simple cash generation minus depreciation minus dividends basis.

I find the numbers are not sustainable. To determine the income I’ve used the £15.2m cash returns plus £6.5m dividiends from HoldCo to TopCo.

I’ve reviewed a lot of comments in the chattersphere. No one seems to have noticed the drop in income!

What I saw as boring and safe with upside I now see as fairly valued at the current price. The nearly 50% drop in “investment income” worries me. Arguably dropped over what is potentially the better 6 months of the year too (the summer months).

The fact that NESF don’t address this anywhere worries me. The moving of some returns to repayment of intercompany loans could be a way to hide the evidence?

The 7% fall in availability will explain part of the reason it’s sure. The lower 6.9% yield is connected and will explain part of it too. But why not just be open about that?

Perhaps the other reason for the fall in income is that power prices are falling and the UK is about to enjoy years and years of cheaper electricity after all. Labour did promise cheaper bills didn’t they? Right now we are in the midst of a colder winter for Europe in 2024 and my power prices just increased. With our new government knifing Oil & Gas in a populist tax grab of a globally leading 78% margin rate I’d be surprised if it’s the reason. Plus what about all the subsidies and PPA pricing?

But again we simply don’t know.

I conclude to say I would question the sustainability of the dividend. It is “covered” only if you ignore depreciation. In other words NESF is eating its seed corn by paying current dividends.

After coming close to including it, NESF is not one for the OB 2025 ideas, despite the alluring attractions. (the OB idea SEIT does stand up to this same scrutiny by the way)

Will this be the final episode for NESF? 8pm on Christmas day is when all’s said and done (including the incident on the boat maybe?).

Regards,

The Oak Bloke

Disclaimers:

This is not advice