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Investing in solar energy: is it potentially hazardous?

Steep price cut on NextEnergy Solar Fund raises concerns about its heavy debts and profitability of its dividends. Implication for solar stock investors?

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Steep discount of shares in NextEnergy Solar Fund raises concerns about its massive debts and the...
Steep discount of shares in NextEnergy Solar Fund raises concerns about its massive debts and the potential sustainability of its dividend payouts. What implications might this have for the solar investment market?

Investing in solar energy: is it potentially hazardous?

Unfiltered, Candid Insight on the Solar Market through NESF Lens

The UK boasts one of the world's most developed solar markets, with approximately 16GW already deployed. The government ambitions stretch further, aiming to quadruple that figure to 70GW by 2035, reflecting a strong backing for solar as a key low-carbon power source and energy security provider. Given recent geopolitical developments like Russia's invasion of Ukraine, energy security has moved up the priority list.

Solar Sector Hurdles

Despite solar power's affordability under sunny skies, the price that producers receive is often intertwined with natural gas prices. As a result, renewable energy companies saw a boost when the gas price spiked from the beginning of 2022 to August of the same year due to the Ukraine conflict. However, the gas price has since retreated to near its long-term average, causing a slump in shares of renewables firms like NESF, which have plummeted by 40%.

NESF: Down but Not Out

NESF is one of the hardest-hit solar investment trusts, with a dividend yield of 12% and a 30% discount to its latest Net Asset Value (NAV). Its high yield has made it the most popular investment trust choice on platforms like Hargreaves Lansdown, AJ Bell, and Interactive Investor.

However, this yield isn't without risks. One of these might be NESF's debt burden, which reached £533 million as of September 2024 – equivalent to around 1.3 times its market capitalization. Management claims a weighted average cost of debt of 4.9%, with around 70% of the debt being fixed rate.

The remaining £333 million debt consists of long-term interest rate hedged debt and a revolving credit facility (RCF) on a floating rate. This debt must be repaid using the cash generated by solar panels or through asset sales.

NESF management opts not to show the entire £26 million in interest costs from this debt in a consolidated income statement. Similarly, they choose to report £1.14 billion of invested capital, while total assets on the balance sheet are significantly lower, at £771 million. This discrepancy arises from the company reporting as an investment entity on a non-consolidated basis, with investments in solar panels made through holding companies and special purpose vehicles off the balance sheet.

This setup has an uncanny resemblance to the financial products that preceded the 2008 financial crisis. Additional concerns involve the sustainability of dividends and the reliance on short-term funding (the RCF), along with the use of alternative performance measures.

Modest Progress on Sales

In April 2023, management announced a capital-recycling program, aiming to sell five subsidy-free UK solar assets with 246MW of capacity. The aim was to use the proceeds to pay down debt, repurchase shares, and invest in battery-storage facilities.

So far, NESF has completed phase I of the divestment, selling the ready-to-build Hatherden solar project with 60MW of capacity for just £15 million. Subsequent deals for Whitecross (35.22MW) and Staughton (50MW) solar farms fetched £27 million and £30.3 million, respectively.

Despite these deals, the debt burden remains substantial. It's unclear whether NESF will be able to sell enough capacity to pay off the £333 million debt. With only 145MW of the 246MW target sold, it seems the company may struggle to meet its goals.

Evaluating NESF's Discount to NAV

Investment experts find it challenging to determine why NESF trades at a 30% discount to NAV or what caused the shares to plummet 20% since the summer, when the gas price spiked. While sponsored research offered by Cavendish and Longspur Capital arguably makes a case for NESF, it's unclear why the company trades at a discount or why its shares declined since the summer.

There are, however, some helpful tailwinds. Interest rates appear to have peaked with the Bank of England making two cuts. Additionally, gas for next summer is being priced higher than winter 2025/2026, providing some support for NESF's cash inflows and dividend sustainability.

In summary, NESF faces a tough market landscape shaped by sensitivity to gas prices, operational challenges, and macroeconomic headwinds. Despite these hurdles, the company continues to focus on strategic initiatives to create long-term value and maintain an attractive dividend yield.

  1. The price that renewable energy companies, including NESF, receive is often linked to natural gas prices, with a boost observed when the gas price spiked in 2022 due to the Ukraine conflict.
  2. NESF, a solar investment trust, has a high dividend yield of 12% and a 30% discount to its Net Asset Value (NAV), making it a popular choice among investors on platforms like Hargreaves Lansdown, AJ Bell, and Interactive Investor.
  3. Management at NESF opts not to show the entire £26 million in interest costs from their debt in a consolidated income statement, and also chooses to report £1.14 billion of invested capital while total assets on the balance sheet are significantly lower, at £771 million.
  4. Investment experts find it difficult to explain why NESF trades at a 30% discount to its NAV or why its shares have fallen 20% since the summer, despite some helpful tailwinds such as decreasing interest rates and higher pricing for next summer's gas.

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