Ian Cowie: yields above 9% with inflation-busting dividend growth

Massive power cuts this week in Spain and Portugal can be blamed on climate change - or net-zero nonsense - depending on your environmental and political views. Some of my more swivel-eyed friends claim it’s all down to Spain’s heavy reliance on renewable energy, while others favour less-straightforward analysis of disruptive oscillations in alternating current (AC) electricity.

Whichever explanation you prefer, these blackouts brutally demonstrate the importance of energy infrastructure. It’s a binary business; when you flick the switch, either the power comes on or it doesn’t.

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So, bargain-hunting income-seekers, who favour investment trusts focused on real needs, should consider the deeply out-of-favour Association of Investment Companies (AIC) “Renewable Energy Infrastructure” sector. The average dividend yield is an eye-popping 9.6%, which has risen by an inflation-busting 5.8% per annum over the past five years.

Despite all that, the average discount across 19 funds in this sector is just short of -30%. The explanation is that nothing fades as fast as fashion and these investment trusts enjoyed a brief vogue, when risk-free returns available elsewhere were next to zero.

Unfortunately for these high-yielding funds, the Bank of England base rate bounced back from its Covid nadir of 0.1% in December 2021, and hit 5.25% in August 2023. That dramatically reduced the relative attraction of income from renewable energy infrastructure funds, which are far from risk-free.

Here and now, the Bank rate has subsequently slipped back to 4.5% and might yet fall further. Meanwhile, plunging renewable energy infrastructure share prices have pushed up their dividend yields to the point where they might present bargains today.

Easily the most extreme example of this is SDCL Energy Efficiency Income Ord (LSE:SEIT), the top yielder in its sector. Total assets of just over £1 billion generate 13.4% dividend income, which has risen by an annual average of 15.8% over the past five years but remain priced -48% below their net asset value (NAV). Phew!

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However, it’s important to beware that dividend income is not guaranteed and can be cut or cancelled without notice. Another worry is that the NAV, which includes assets that are not listed on any stock market, might prove to be misleading.

Another copper-plate caveat is that past performance is not necessarily a guide to the future. SEIT shareholders could be forgiven for sincerely hoping so, because this fund has shrunk investors’ money by -11% over the past year, after falling by -32% over the past five years. Launched in December 2018, it lacks a 10-year track record.

Gore Street Energy Storage Fund Ord (LSE:GSF), with £510 million assets, is the next-highest yielder in this sector. It specialises in industrial-scale batteries, which can temporarily balance electricity demand and supply, by contrast to short-term extreme oscillations, which some say caused Spain and Portugal to blow a fuse.

More happily, GSF yields 11.9% income, rising by 9.3%, but delivered a meagre total return of 4.2% over the past year, following a loss of -14% over the past five years. Mr Market remains skeptical, with the shares trading 42% below NAV.

Similarly, the £1.1 billion NextEnergy Solar Ord (LSE:NESF), yields 11.9% dividend income, rising more modestly by 4.7% per annum, with total returns of 6% over the past year, -6% over five years and a gain of 40% over the past decade. The shares trade -28% below their NAV.

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Lower dividend yields have led to higher capital growth at Harmony Energy Income Trust Ord (LSE:HEIT). This is another industrial batteries specialist, currently offering no income but which leads its sector over the past year with a total return of 102%.

Launched in November 2021, it lacks medium or longer-term data. The explanation for doubling shareholders’ money in a year is last month’s agreed £191 million takeover bid by Foresight Group, pushing HEIT shares to trade at a premium of 3.9% above NAV.

That demonstrates the potential for profits when shares that had been shunned return to favour. More sustained medium and long-term total returns were generated by Greencoat UK Wind (LSE:UKW), the £4.5 billion offshore wind farm operator, that is the sector leader over both five and 10-year periods with total returns of 13% and 80% respectively.

Sad to say, UKW fell away to a -13% loss over the past year and currently trades at a -23% discount to its NAV. But this shareholder remains glad I popped some into my ISA for tax-free income, with UKW yielding 8.9% dividends, rising by 7.6%.

Climate change deniers and solar skeptics probably wouldn’t touch renewable energy infrastructure shares, even with a well-insulated barge pole. But eye-stretching dividend yields are beginning to attract institutional interest and bargain-hunting income-seekers might consider following suit.

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.