James Smith, manager of the Premier Miton Global Renewables Trust, looks at the performance of Greencoat UK Wind vs the UK 10 Year Gilt.
For information purposes only. Any views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
It has been a difficult couple of years to be an investor in the UK renewable energy investment company sector. Historically, the sector had, for the most part, traded above published net asset values, and regularly issued new shares to a willing market, eager to gain exposure to the high yields and strong inflation linkages on offer.
Fast forward to today, and premiums have become discounts, and share issues have become buybacks. Instead of new companies coming to market, many now face continuation votes.
This has come as somewhat of a surprise, certainly to me. Governments have been generally supportive, and power prices surged in 2022 and 2023, giving many companies meaningful cash injections (despite windfall taxes). Index-linked revenue streams are prevalent in the sector, and higher inflation has allowed several companies to deliver attractive, in some cases, double-digit growth in dividends. In addition, the outlook for the sector remains bright, with new sources of demand from power-hungry data centres, and large corporate energy users eager to purchase renewable energy in line with their environmental policies.
I believe most of the sector’s weakness can be laid at the door of higher interest rates, and investors’ perception of what these mean for sector value. Higher interest rates, all else equal, would reduce the NAV of a renewable energy investment company, as future cash flows are discounted to present values at a higher rate. However, it is worth bearing in mind that interest rates are high in order to combat inflation, and these companies benefit from higher inflation.
Mathematically, and with reference to the ‘valuation sensitivities’ published by companies in the sector, in valuation terms inflation and interest rates largely cancel each other out, and published NAVs have not moved a great deal over the past couple of years, in contrast to share prices.
However, investors have become over-focused on interest rates, and the sector has traded with a high degree of correlation to bonds. Using the example of Greencoat UK Wind, a sector bellwether, currently the largest holding in the portfolio, and comparing its share price to the 10-year Gilt yield (presented inversely, i.e. an increase in interest rates leads to a falling share price and vice versa) illustrates this point.
Case study: Greencoat UK Wind
Greencoat UK Wind share price vs 10 Year Gilt yield
Source: Bloomberg data 30.12.22 – 31.05.24.
Past performance is not a reliable indicator of future returns.
Greencoat’s share price has clearly been correlated to the Gilt yield (the left highlighted area in the chart). However, over recent months the relationship appears to have broken down (right hand area), with the share price making some gains despite yields moving higher.
I believe that the share price is beginning to reflect some other, more positive, factors, although it remains at a discount to published NAV.
These include:
- Recovery in gas prices: Gas prices have a major influence on UK power prices given that gas fired generation remains a substantial part of the power sector and operates with high marginal costs compared to other forms of power generation such as renewables or nuclear. UK gas prices have increased by approximately 50% from lows seen in mid-February despite heading into warmer summer months.
- Recovery in power prices: As could be expected given the movement in gas prices above, UK power prices have increased by almost 40% over the same period.
- Share buyback: Greencoat commenced a £100m share buyback program in Q4 2023 which could also be helping to underpin the share price.
Some other, but not all, companies in the sector have seen a similar pattern, and a move to renewable investment companies’ share prices reflecting fundamental factors, rather than simply interest rates, is to be welcomed. This should, I believe, help share prices to trade back toward their NAVs.
James Smith, Premier Miton Global Renewables Trust PLC
