Greencoat UK Wind: interest rate rises have left us grossly underpriced

Stephen Lilley, fund manager of Greencoat UK Wind (LSE:UKW), tells interactive investor’s Collectives Editor Kyle Caldwell, why he feels it is unjust that the investment trust is trading on a rare discount.

Lilley also gives his outlook on its prospects, makes the investment case for wind assets over other forms of renewable energy infrastructure, and explains that board members have been increasing their personal stakes to take advantage of the discount, currently over 10%. 

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Kyle Caldwell, collectives editor at interactive investor: Hello and welcome to our latest Insider Interview. Today in the studio I have with me Stephen Lilley, fund manager of Greencoat UK Wind. Stephen, thanks for coming in today.

Stephen Lilley, fund manager of Greencoat UK Wind:Very welcome.

Kyle Caldwell: Over the past decade, Greencoat UK Wind has achieved its dividend target of growing the income in line with RPI inflation and the underlying investment performance, the net asset value (NAV), has also beaten RPI inflation over that period. What are the prospects for the next decade? Could it potentially be an even better period for the trust, given that we’re going through a transition towards a global green economy?

Stephen Lilley: You’re right. We set out 10 years ago to have a dividend that always increases with RPI. That’s how we designed it and that’s why we started off at 66p, and to preserve NAV on a real basis, which we’ve done, I think a (return of) 69% versus 46% of RPI compounding.  I’m not sure I can necessarily guarantee that we’re going to do that again, but we are in an environment where there is substantial growth.

The nice thing is that in 10 years politics has come towards us, if you like. So, it doesn’t go back to the days of, say, Vince Cable, who we had sign off a £50 million investment into our IPO. All the [political] parties are very much behind what we’re trying to do. But the nice thing from going from here through to £200 billion of assets, not £100 billion but £200 billion, is that by the time we get to the end of the decade, we’re of a size and significance that we can play, and we can be quite significant.

A lot of the talk at IPO, and Vince Cable required this I guess, is to have the money that went back to RWE and SSE recycled into building offshore capacity. That recycling story is as valuable now as it was 10 years ago. And a lot of the build-out going from £100 billion to £200 billion, almost all of it is offshore, so it’s even more relevant.

And because we’ve got such a big balance sheet by now, we’re capable of moving large volumes of capital and being quite significant. The benefit of being able to [do] that is that not many people can, and therefore we can get some good value on investments. So, we’re really excited about the next little while. Re-investment is there, if you like. There’s a lot of capacity that we could buy.

The real frustration today is given that we’re trading at a discount, we can’t raise equity very easily, so we’re stopped from doing that, but hopefully we can get the proper stories across. People can understand what we are in terms of return, and we can continue that pathway forward.

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Kyle Caldwell: So, for investors looking at exposure to renewable energy infrastructure, there’s other options such as solar, hydro, [and] energy storage. So how would you make the investment case for Greencoat UK Wind?

Stephen Lilley: We think that investors should look at [it] all because there’s a need for capital across the sector. How we’d characterise, I mean you can’t expect me not to be biased here, and investors can take their own view of the validity of the argument. Solar is more commoditised, if you like, there aren’t massive solar parks, [but] there are massive wind farms.

We bought one recently at £50 million, Dalquhandy up near Glasgow. We also invested £400 million out [at Hornsea 1], but because there was debt there as well, basically an EV of £1.1 billion last year. So, we did both of those. And South Kyle will come in shortly at £300-400 million, so those are big assets.

Solar farms aren’t quite like that. A lot of the solar funds are competing against each other. There isn’t the same type of big, small, etc, it’s more commoditised, if you like. So, we think that probably drives returns down on solar as a consequence. The solar funds have probably got something to do about looking at the cost of capital and we’ve always been massive believers in the capital asset pricing model. How can you not be? Because ultimately investors don’t have to do anything like this, they could do something completely different. And therefore, the risk-free rate is really important. So, we very much cared for our discount rate and return from the last 10 years.

But over the last little while, as interest rates have gone up, really cared for that, and our discount rates gone up substantially. We think in the solar sector there’s probably a need for them to address that fact, and that’s probably why they’re trading at a discount quite substantially.

So, I think there’s that, but solar assets are good assets, as long as they’re priced properly, no reason why people shouldn’t do that. In terms of things like battery storage, we think that battery storage is relevant. It’s not really infrastructure in the sense that it’s not really reliable 30-year cash flows. There are ancillary services that batteries can do, for instance voltage regulation or reactive power, but we can also do that inside the turbines as well. So, yes, they can get paid for that. Is it really long term? Can you really arbitrage markets long, long, long term? Not so easily. So, yes, investors should look at those, but it’s a different thing, it’s not a 30-year income stream. So, they should look at them differently. I would debate whether it’s infrastructure.

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Kyle Caldwell: There are also some investment trusts that invest in a mix of renewable energy. I’ve heard the argument that some have exposure to both solar and wind to benefit from when the sun shines and when the wind blows. So, they’re benefiting throughout the whole year. What do you make of those approaches?

Stephen Lilley: If you want to invest across technology, choose two businesses. We have the best wind management team in the sector. Not Lawrence [the co-manager of Greencoat UK Wind] and I, I think we’re OK at we do, but the engineers that sit inside the manager, not subcontracted outside, but who care because they are in the manager.

We think having that expertise is important to the focus and the drive, knowing what’s happened at every single turbine. When we’re on co-investments with utilities, telling them a little bit about some things that we should be doing, and they value that as well. They value that cross-fertilisation. So, there is a great benefit in being experts, and anyone who says they're an expert of everything is arguably an expert of nothing. Arguably. People may disagree with that.

Kyle Caldwell: The renewable energy infrastructure sector, it’s been under a bit of a cloud of late due to interest rate rises going up. So, this caused a repricing of risk assets. How has that impacted the valuations of your investment trust?

Stephen Lilley: Well, it’s impacted valuations. It’s also impacted the share price. And I think the share price, for me, it means that the market isn’t particularly efficient and it’s why all our management team, as people may have been able to see in terms of RNSs, and half the board as well, have been buying shares. I think it’s grossly underpriced. Obviously, that’s a sales pitch! But you can see that our money has gone where our mouth is on this. We bought a fair bit of stock over the last few weeks. In one sense we can’t do much about the share price, but we can do something about the NAV and we can talk about, like we’re doing now, some of the messages and the relevance on those messages.

But in terms of the NAV, we have over the last year, taken the discount rate [up] quite substantially because we believe in the capital asset pricing model. How can you not? And therefore our NAV will have come down from that. The fact that our NAV has not fallen in the last year is because we’ve had massive cash generation.

I think it was George Osborne who talked about fixing the roof while the sun was shining, or the fact that people didn’t, [but] we did. Last year, we took the benefit of high cash generation to fix the roof, so that as NAV would go up because we just had cash coming into the business, we also took the discount rate up quite substantially. So that as we get to this point in time, we think that our net asset value is very good, and the assumptions in there are very strong. As long as we get to explain the return, as we’ve talked about a few times in this conversation, we should compare well with other things that people can buy. If there was an efficient market, people would look at our NAV and think ‘actually that’s OK, I should buy at that price.’

Kyle Caldwell: As you mentioned, Greencoat UK Wind is trading on a discount. I think over the past couple of years, you’ve typically traded on a premium. Are those rises in interest rates the reason you’re trading on a discount?

Stephen Lilley: We’ve been trading at a premium for nine and a half years, it’s not just two. But for the last six months probably, yes, it probably is about interest rates. There are other things that in our half-year results, what we’ve done with, where our refinancing risk that’s all sorted, and will be [able] to talk about that in our half-year results. The same with power prices. As we said, if power prices were zero for the next five years, we’d still pay a dividend, etc., so that’s all pretty straightforward. So, we’re going to talk about that in our half-year results.

But it would appear that as interest rates have gone up, the sector in general hasn’t responded as quickly as we think it needed to. In other words, they haven’t fixed the roof while the sun was shining last year, as we had the ability to do and, therefore, the whole sector's off. And is there some contagion, if you like, to us? There is a little bit probably and all we can do is explain what we are.

And so, yes, discount rates have moved in a certain way. But if we can talk about return, and it's not just people buying on a dividend yield, but they've got that reinvestment as well, if we can talk about that, then hopefully we should in an efficient market, explain [that] and return to a premium.

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Kyle Caldwell: You mentioned earlier that some board members have been buying shares recently. Has the board been proactively buying back its own shares to try and rein in that discount?

Stephen Lilley: We’ve had one or two questions from shareholders about that. It's something that will be in our armoury. We haven't done it yet. We're hoping that with the half-year results, we'll been able to explain, and have some benefit from that.

For most of the time in the last six months, we were trading at a very small discount. Now, it's a bit bigger, so it becomes more relevant, I guess.

One or two shareholders have said: ‘Would you do that’? We are in active dialogue with the board about that. At this point in time, we want to have a chance to explain it first. At some point, we might do that because, ultimately, there's a lot that can be done in that area.

But having said that, there's quite a few things that we might look at buying, and we might recycle assets. And there's a bit of that that we're still trying to work out; what is the right way through for the next little while?

The first thing we want to do is just to have a chance. It's why we really can't wait to get to 27 July and go through our half-year results and all those messages and hopefully nail some of those things. If you believe in an efficient market, hopefully they will get nailed and people will understand that. Hopefully we can do that and then the other things such as selling assets, buying assets at a discount, [and] buybacks, start to come on to the agenda if we can't solve it by explanation.

Kyle Caldwell: Do you personally invest in Greencoat UK Wind?

Stephen Lilley: Yes. As with Laurence as well, I think we own somewhere between £750,000 and £1 million worth of shares each.

Kyle Caldwell: Stephen, thank you for your time today.

Stephen Lilley: Thank you.

Kyle Caldwell: That's it for this episode of our Insider Interview series. You can check out the rest of the series on our YouTube channel, where you can like comments and subscribe. Hopefully, see you next time.