SMALL CAP MOVERS: Bluefield Solar Income Fund shines

If you’re looking for income, the arguments for investing in solar funds seem simple, even if the weather isn’t particularly sunny.

But even though many investors seem spooked by the aggressive rate hike cycle of the past few years, the argument remains simple.

Simply put, it’s this: backed by a portfolio of solar farms that convert the sun’s rays into electricity and then into cash, these mutual funds can pay out reliable and regular quarterly dividends at attractive annual returns.

Bluefield Solar Income fund was the first solar-focused fund to launch in London in 2013, and has been paying quarterly dividends at or above target since February the following year.

The current portfolio has a generation capacity of 813 megawatts, mainly from solar energy, but with some wind and a growing amount of on-site battery storage. There are another 1,400 MW of further developments in the pipeline.

Value and return

In recent weeks the shares have traded at £1, the lowest since 2016, while the fund’s net asset value was 135.95 pence – meaning the shares are available at a significant discount.

This is despite the shares offering a dividend yield of almost 9 percent, based on this year’s expected dividend of no less than 8.8 pence per share.

So even after the rise in interest rates in recent years has pushed cash rates above 5 percent, the yield should attract savvy investors.

Cashback for dividends

Viewed another way, the shares would need to rise above 163p for the yield to match the current Bank of England base rate of 5.25 per cent.

Viewed another way, the shares would need to rise above 163p for the yield to match the current Bank of England base rate of 5.25 per cent.

These dividends are backed by high levels of regulated, indexed income in addition to contracted power sales.

Last year, 836,232 MW hours of energy were generated, of which just over 700,000 MWh came from solar energy.

Payments for this electricity amounted to £108 million in operating cash flows, minus £18 million in service debt, and trickled down to £90 million in distributable income – more than twice the amount to cover dividends.

So even after paying out dividends, a dividend surplus of £58 million was carried forward, giving investors additional peace of mind.

Electricity prices

Since the massive surge following the invasion of Ukraine, wholesale electricity prices have fallen throughout the year and into the first quarter of 2024, not coincidentally overlapping with the decline in BSIF’s share price.

What seems to have escaped investors is that the fund’s average weighted fixed price remains strong, with a large portion of its income coming from long-term contracts under the renewable obligation (ROC) regime, an indexed income stream.

Moreover, the company’s intrinsic value already takes into account expected lower future energy prices.

The investment manager, Bluefield Partners LLP, can also sell power from BSIF’s portfolio directly into the energy market.

“The power sales strategy has been very successful in capturing higher prices,” said James Armstrong, founder and managing partner at Bluefield Partners.

His team typically focuses on the short end of the wealth curve, between six months and 30 months.

“That’s the most liquid part of the energy markets, where you can maximize the value of the prevailing market while making revenue visible. It is the optimal area to underwrite power contracts for a defensive income investor like Bluefield Solar,” he says.

‘And if the market is as high as in 2022 and 2023, we will fix this for as long as we can. And if the market goes lower, which it is now, we will rotate and maybe have some shorter-term variable contracts.”

To give an idea of ​​how this strategy has worked, BSIF’s average weighted energy price in January was £170 per MWh, compared to around £70/MWh in the prevailing market.

“So we’re generating a lot of money right now, which is great,” Armstrong says. “And so, correspondingly, we’re not as exposed to falling energy prices.”

Sense of perspective

These contracts expire in the next twelve to eighteen months. But the concern about this shows how investors’ perspectives have changed.

Funds like Bluefield Solar paid very attractive, progressive dividends for the first seven or eight years after BSIF and its peers went public, with average wholesale prices between £45 and £55 per MWh.

Wholesale prices peaked above £500/MWh in 2022 and fell back below £100 last December – but that is still almost double what the average was in the previous decade.

So to people concerned about how the funds will continue to pay their dividends, Armstrong says, “the reality is that these funds are working very well and can operate very attractively at lower energy prices than we are currently seeing.”

Expansion plans

In order to grow incomes organically, so to speak, the strategy has always been to expand the generation portfolio.

At the end of December 2023, this included 660 MW in active development and 778 MW in pre-construction, consisting of a mix of solar PV and battery storage projects, as well as some wind energy.

Small and medium-sized offshore wind projects are seen as “very complementary to solar in terms of valuation and generation base,” Armstrong says. “But it’s not a big part of the portfolio.”

Battery storage, on the other hand, is a very important part of the overall renewable energy puzzle for the economy, as evidenced by the presence of several specialist funds in London.

“Storage is the holy grail for all energy systems that are decarbonizing due to the intermittent nature of nuclear generation technologies such as solar and wind. Batteries will play a key role in balancing the electricity grid and creating a proxy for baseload energy.

“But again, it makes sense for us as a minority part of a fund designed for a defensive investor with long-term income,” he says.

Financing partnership

The ability of BSIF and other renewable energy investors to convert their pipeline into electricity-generating assets has been significantly limited by the serious problems in the capital markets, which severely limits their ability to issue shares to raise funds.

In response, Bluefield entered into a strategic partnership agreement with a group of British pension funds, united under the name GLIL Infrastructure, split into three phases.

The first deal was the joint acquisition of a 247 MW UK solar portfolio from Lightsource BP, which was completed in January 2024.

In the second phase, GLIL will purchase a 50 percent stake in a portfolio of over 100 MW of existing BSIF assets at a price in line with the company’s existing valuation – based on current prices, this would be in the should be in the region of £70 million – with the trust using the proceeds to reduce debt and fund developments.

Armstrong says the majority will be used to pay off the revolving credit facility.

Phase 3 is intended to include joint investments in parts of BSIF’s development pipeline that will be connected to the grid in two to three years, if and when market conditions support this.

“It’s good because it helps things along,” Armstrong says. ‘Developments are organic and will wither if you do nothing with them.’

Repurchase

Also on the share price front, in addition to February’s interim results, BSIF announced a £20 million share buyback.

Armstrong doesn’t necessarily think this will affect the stock price, but he says it’s a good use of capital.

‘Because we believe in intrinsic value. Therefore, that’s a good use of capital in terms of what the implied return would be when things get back to normal.”

It is also important to be seen as a buyer in the market and demonstrate that, together with the GLIL partnership, the board and manager are using multiple tools to address the situation.

With the stock beginning to trade at a 27 percent discount to the last updated NAV, investors are starting to appreciate this proactive approach and the long-term fundamentals of the solar market should see that discount narrowing.