Foresight Solar Fund aims for sustainable dividends payout

Foresight Solar Fund is powered by green principles, harnessing capital from large scale solar power plants.

 Foresight Solar Fund

Foresight Solar Fund (FSFL) is a London Stock Exchange listed investment trust focused on solar power, launched
on 29 October 2013.

The fund’s objective is to pay sustainable and progressive quarterly dividends. The managers aim to preserve and,
where possible, grow capital through reinvesting excess cashflows not required for paying dividends.

FSFL acquires large-scale solar power plants, principally in the ­UK. U­p to 25% of the gross asset value (GAV) of FSFL and subsidiaries, calculated at the time of investment, can be invested outside the ­UK. U­p to 25% can be invested in construction assets.

No development risk is taken. The company buys assets once they are operational or during construction, funding the construction by paying in stages, subject to progress.

Foresight Solar Fund 
Price102.0p
Market cap£619.9m
NAV*93.9p
Premium to NAV8.7%
NAV**95.6p
Premium to NAV6.7%
Yield6.7%

* Excluding income. ** Including income. As at 30 September

The fund targets total return to investors equivalent to an unlevered internal rate of return of 7-8% after accounting for fees and expenses. It seeks to achieve these returns through active management of its plants. It does not use an investment performance benchmark and has a total-return focus.

FSFL  launched with seven contracted assets, totalling 136 megawatts  (MW). The portfolio currently holds 58 assets, including 50 in the UK, four in Australia and four in Spain.

In 2017, it acquired four assets in Australia, which account for 146 MW of total installed capacity. Connection issues delayed them becoming operational but these have now been largely resolved.

Of the four Spanish assets, one is expected to become operational in the third quarter of this year and three in June 2022. The total installed capacity is 994 MW, once fully operational.

Having raised £150m of equity from both institutional and private investors at launch, FSFL has evolved into a mature and diversified solar asset manager with  £1,016.8m GAV and £580.6m net asset value (NAV) at 30 September 2020.

FSFL’s growth and geographic expansion has been financed through a combination of long-term debt and revolving credit facilities. It has raised £666.2m in equity since launch.

Performance

The fund has performed very competitively against the MSCI World High Dividend Yield Index. To end-January 2021, it outperformed the index by 3% over one year, 5.6% over three years and by 5.9% since launch in NAV terms.

As measured against its peers, FSFL retains the highest yield but lags behind its counterparts over three and five years.

We estimate a higher distribution policy by its sector peers has contributed to the fund’s underperformance. In addition, FSFL’s disclosure in the reports, accounts and investor presentations was poorer than that of its counterparts, although this has since been addressed.

Investor understanding of solar businesses and relevant funds remains relatively inadequate and, all else being equal, those companies that present information in a more digestible way have an advantage.

We believe the fund’s interim report disclosure for the first half of 2020 is more transparent relative to the previous periods since launch, and in parts is now better than that of its peers. We welcome such a development from FSFL, which stated it will maintain disclosure in its H1 20 format.

Investment strategy – Foresight of evolution

FSFL pursues active power price strategy management to ensure around 60% of the next year’s revenue comes at fixed prices through government subsidies. Most of the UK portfolio was acquired between 2015-18 and it has 20 years’ contracted subsidised revenue from the time of commissioning.

Acquired assets are held until the end of their useful life. The land on which the plants are based is leased by FSFL, usually over the corresponding term. The average remaining subsidy life for the UK portfolio is 15 years. These subsidies are 100% inflation-linked.

Though it is some time until subsidies on its UK assets expire, the FSFL team books merchant revenue on a rolling basis, to time and book contracts at higher prices when energy prices rise.

The balance of energy for sale on the market is negotiated with energy buyers. This Power Purchase Agreement (PPA) and/ or merchant revenue also becomes ‘fixed’, typically when the contract is signed.

While PPAs tend to be shorter-term contracts of one to four years, and provide less protection against falls in long-term power price assumptions, FSFL is working to secure longer contracts, particularly for its international assets. As the number of companies seeking to decarbonise their electricity demand rises, the market for PPA commitments is likely to grow.

The fund managers diversify exposure by asset and geography, and use a number of third-party providers such as developers to reduce business risk.

ESG principles are embedded in FSFL’s business and culture. The UK portfolio generated enough clean energy to power 173,000 homes for a year during the first half of 2020. As a signatory to the internationally recognised Principles for Responsible Investment in its 2020 assessment, Foresight Group maintained its A+ rating for strategy and governance and improved its infrastructure score from A to A+.

Battery storage is the recent evolution of FSFL’s strategy added to future solar projects. For an incremental cost, battery storage can reduce some of the volatility of solar generation, enabling greater flexibility over when it is sold to the grid. In the context of income streams moving away from fixed-price subsidies towards more volatile merchant revenue, this could help maximise the value of the energy produced.

The manager’s view – a rich source of cheap energy

Portfolio manager Ricardo Pineiro is a partner at Foresight Group and head of the UK solar team. Since joining the company in 2011, he has overseen the acquisition of more than 70 solar power plants in the UK and internationally.

Pineiro believes solar energy will grow considerably as a proportion of global energy generation from current levels, having become the cheapest sources of renewable energy.

The UK currently generates around 13 gigawatts (GW) of energy from solar, and National Grid estimates indicate capacity to double by 2030 at 9% compound annual growth rate, if the UK remains on track to reach its net-zero carbon emissions commitment by 2050.

As the opportunities for further investment in the UK are limited, FSFL is diversifying geographically using power purchase agreements. The renewable obligation mechanism, whereby the UK government subsidised solar assets at fixed rates, was closed for all assets built after 1 April 2016. This led to the rate of solar installation in the UK to slow sharply in recent years. In addition, assets in the secondary market, particularly those backed by government subsidies, demand higher valuations.

Some Australian assets within FSFL’s portfolio also benefit from subsidies, although the proportion of annual subsidised revenues is significantly lower than in the UK. All Spanish assets are subsidy-free.

As renewable energy sources replace carbons, power prices are likely to continue to fluctuate, depending on whether this process is slower or faster than the market expects.

Declining costs in the solar energy industry attract more players building more capacity, which puts further deflationary pressure on power prices. This so-called ‘cannibalisation’ is another factor that contributes to power price volatility.

Source: Victoria Chernykh and Dan Gardiner of  researchers Edison Group

Further reading: Bluefield Solar Income Fund review

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