Short-term headwinds are creating long-term opportunities for shareholders seeking income and growth from renewable energy investment trusts. Better still, a double-digit dividend hike and a £100 million share buyback announced by Greencoat UK Wind (LSE:UKW) shows that this shareholder’s optimism isn’t wholly based on hopes of “jam tomorrow” .
Recent rises in interest rates - even if, as expected, the Bank of England and the Federal Reserve remain frozen this month - have hit valuations in this sector hard. Rising returns elsewhere have depressed shares in renewable energy and infrastructure, which used to be popular as a form of “bond proxy” before they fell from favour.
Many investors currently prefer to buy the bonds themselves, now that 10-year UK government gilt-edged stocks are yielding nearly 4.5%, supposedly “risk-free”. But fixed-rate gilts offer limited protection against inflation, which would halve the purchasing power of money in just over eight years if the current 8.9% annual rate of increase in the Retail Prices Index (RPI) is sustained.
By contrast, UKW yields 6.4% income and claims to be the only renewable energy investment trust to have raised its dividends in line with RPI every year since it was launched a decade ago. More importantly, it recently renewed its pledge to raise dividends in line with inflation.
Last month UKW, which has total assets of £4.9 billion, announced a £100 million share buyback scheme. It added “in recognition of the very strong cash flow delivered by the business through 2023 to date”, it now intends to pay a higher than expected fourth-quarter dividend, taking total 2023 distributions from the forecast 8.76p to 10p per share.
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James Wallace, an analyst at Winterflood, commented: “UKW’s dividend target of 10p, or an increase of 14.2%, and its £100 million share buyback, which is equal to about 3% of its stock market capitalisation, are underpinned by dividend cover of 2.1 times its earnings, compared to the sector average of 1.8 times earnings, plus strong cash generation, providing real dividend growth.”
This should help to preserve the real value or purchasing power of shareholders’ income. UKW shares, currently priced 18% below net asset value (NAV), might even offer hopes of capital growth if this formerly fashionable sector returns to favour.
That could happen if, for example, the next general election sees Labour win and put into effect its proposals to follow America in boosting investment in renewable energy. So, UKW can be seen as offering a form of insurance against political risk as well as inflation.
Against all that, bad news continues to batter this sector. Soaring costs have made many wind farm plans uneconomic, which was why the most recent British auction of North Sea rights attracted not a single bidder. Similarly, the world’s biggest offshore wind farm developer, Orsted, cancelled two big American projects this week, causing its share price to fall 26% lower yesterday (1 November).
Closer to home - and more positively - UKW claims to be unaffected by the high-profile problems above, because it does not construct new wind farms; instead, it acquires and operates those that are already up and running. However, it cannot avoid being hit by Britain’s windfall tax on electricity generators, which UKW expects to cost it about £50 million over the next five years.
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While UKW has lost nearly 2% of shareholders’ money over the last year, it remains the leader among 22 investment trusts in its sector over the last five and 10-year periods, with total returns of 35% and 125% respectively.
Most importantly for this income-seeking investor, UKW claims that its calculations, including the windfall tax, “show a dividend continuing to increase with RPI is covered even in the extremely unlikely scenario of electricity prices falling as low as £10 per megawatt hour (MWh) over the next five years”.
That’s less than a tenth of the current wholesale price for electricity. This leaves a big buffer to protect shareholders from being disappointed by UKW’s dividends, whatever happens to energy prices in future. So, this small shareholder is happy to own a stake in building a cleaner, greener future - whichever way the wind blows.
Ian Cowie is a freelance contributor and not a direct employee of interactive investor.
Ian Cowie is a shareholder in Greencoat UK Wind (UKW) as part of a diversified portfolio of investment trusts and other shares.
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