Bluefield Solar Income Fund Limited (DRX) Earnings Call Transcript & Summary

Thank you very much. Good morning, everyone. It's James Armstrong here, and I will be sharing the presentation with Neil Wood from Bluefield. We are appropriately socially distanced. I'm in Wiltshire, and Neil is in London, but thank you for listening in. And we are delighted to announce we just saw the best ever set of results from an earnings basis against one of the most obviously challenging years really in sort of in this young sector's history and certainly in the company's history due to the COVID pandemic, and it's only fitting before we get into the presentation to say a huge thank you to the Bluefield employees who have been responsible for these results, not least they're all working from home since March 23. So over the next 30 minutes or so, Neil and I will look to explain what has been achieved and more importantly, how we have achieved it. And then, obviously, we'll be pleased to take your questions. So going into the presentation on Page 1, record earnings. So we have delivered gross earnings of over 12p per share, which is our highest ever earnings. High target dividend of 7.9p per share, which we think is the highest dividend in our sector at an average of about 15%. And we've also carried forward almost 2.25p per share in earnings, including last year's 0.6% carry forward, giving record gross earnings, net earnings, on target dividend and carry forward. And the dividend cover post amortization was 1.3x. So how have we done this? Because also, just thinking about that sort of looking down on the bottom of Page 1, we've done it through having what is currently the lowest risk portfolio with solar as people are beginning to recognize that solar is the lowest risk technology in renewables. And we've also got a very low power strategy. So where do these earnings come from? So on Page 2, the realities of the result is that the -- we performed incredibly well during the sort of backdrop -- really sort of the power market generally and also with, obviously, COVID, which we'll kind of reference as we go through. But the reality is the seeds of this performance has been laid over a number of years, and they're sort of centered around very high-performing assets that are managed by an excellent team and married to a highly effective power strategy. So if we take it sort of in sequence on to Page 2. So we had our feedstock. So irradiation was higher than sort of historical normal period. It was actually really good. It was a very, very good irradiation period. And it's actually the first time -- since we IPO-ed in 2013, it's been outside that kind of that bound -- that sort of typical bound where you have plus or minus sort of 6% or 7%. As many of you know who have followed Bluefield, is that one of the great things about solar is its predictability and intensity within the narrow bound. And in fact, this year, it was outside that -- outside of sort of that -- what we expect to be a long-term average. There is -- I mean, we should have no -- we don't see any pattern -- the pattern over the last 2 years, obviously, is too short to sort of measure for any sort of pattern in terms of climate change. However, I think we wouldn't say that we are seeing what we see as sort of greater sort of inter-month sort of peaks, which we certainly witnessed, as you might all remember in sort of April and May when we were all stuck at home. It was very, very sunny. But yes, there is sort of -- it is -- if you look at the kind of -- look back from 2013 to 2020, the power source has remained within the forecasts that we've made, which is within that quite sort of narrow bound. But you still have to have, obviously, the portfolio, and this is very key, and then the team to be able to capture it. And so the generation, the second point there, is we have very, very high generation of plus 8.3%. The performance was excellent again. You'll note in the report -in our report, though, the performance ratio is slightly down, largely due to something we've mentioned before, it's clipping. So when you're getting very high periods of irradiation, the -- typically the plants aren't set up necessarily to be able to deal with some extremes. And so the top of the production is clipped. So there's a little bit an element of that. There were some isolated issues of performance, but -- which we sort of list out, where there was some -- which was dealt with very effectively by the operation and maintenance teams also partly in the sort of the start of lockdown, which was quite a challenging period. But generally, the performance was extremely high, and we expect that to continue. And the engineers, just to note, are sort of now putting in place their winter program to look at any work that might need doing over sort of [indiscernible] period now. And then last, but not least, which is obviously how do we convert that into money, into earnings to deliver the sort of the record performance. It was through the sort of the power strategy. Now I can say now that we didn't -- very transparently, at IPO, we did a scenario plan, a pandemic and an oil price war in our scenario planning. But it's been a really, really good test of how well our power strategy is because we're the -- I think we're the first renewables business to report on the full year earnings that has had a quarter -- full year quarter under sort of the COVID sort of lockdown situation. And obviously, we've delivered very, very strong earnings with an annual surplus. It's important with an increased dividend forecast for the current year. And the way that we've done it, and we've spoken about this, just to [indiscernible] sort of sharp focus of how well the power strategy has held up is it really comes from 3 things, which we've worked on since 2013, which we've always -- the first thing is we've always adopted the strategy of trying to buy assets that don't have financing at the asset level. So the reason for that is because if you have a bank involved that finances your asset, they will ask you to enter into a long-term suboptimal power contract, which doesn't create a flexibility for you. So that's the first thing. So Neil talked about the acquisition we made post the period, [ Amper ]. We really like that asset for a number of reasons -- or that acquisition, but it was also because it was unlevered. And that's the first thing. The second point, which is linked to that observation of having no banks involved, is that it gives you the flexibility to be able to have flexible power contracts, where you can go out to the market tender and you can try and capture as much of the forward curve as you can, which is kind of 6- to 36-month contracts, which we have. And that's something which is something that we've adopted. And the third bit of that, the final of this observation about the revenue is working very well is that you -- we've always looked to have contracts coming on and off periodically so that we flatten the undulations in the market. We'll come back to this in just a few minutes. But it has worked very, very well. It's a very defensive strategy. It's actually quite low-risk, but it's also delivered a very -- it's done its kind of job. And we went into the COVID crisis with over 90% of our contracts fixed. And we have ridden that -- sort of that dip, which was very, very precipitous in that -- as the lockdown started. So we'll come back to that in a moment. On Slide 3, what have we done with the cash? So again, many of you will be familiar with this. So taking the left-hand column, so the 12p per share earnings. We have amortized again. So we've got amortization profiles with Aviva, which is 2.5p. We have some reserves brought forward. So we have over 10p per share, the shares to be able to -- for distribution. And we have also paid out 7.9p per share and carried forward 2.23. Just to say, for a question around carrying that much higher level of reserves, we think it's very appropriate in terms of there is uncertainty out there. We're obviously in the middle of a very unusual situation. It's exactly the right thing to do in terms of why we have higher levels of that sort of carryforward, and we think it's appropriate for the period. The final thing, Neil will talk about the valuation, which is -- has held up very well. It is a function -- I suppose the thing to say about that is that we have a very low-risk portfolio, and we're also delivering very attractive, in fact, the highest dividend in the sector from that portfolio. There is also a correlation in terms of valuation and where the market is valuing the kind of the predictability and the forecastability of solar cash flows relative to other assets. And you should see -- and as the market matures, I suppose you will see this, is that there will be more discernment about the difference between different technologies and different cash flows and different risk profiles. And solar, quite rightly at the moment, is obviously being valued -- those types of cash flows being valued most highly. So Neil can come back to that as we go through. So on Page 4. So further to my comments a few minutes ago, we thought it'd be useful just to quickly analyze the benefits or the sort of -- the benefit of our fixing strategy against a floating strategy and taking the last 2 years. So we've got it -- on the top half of Page 4, you've got obviously this graph, which shows baseload and our average weighted in blue. So baseload is in green and the average weighted price is -- Bluefield Solar is in blue. We've taken sort of June '18 -- so July 1, 2018 through to June '20, 2 full financial periods, to try and see what was the kind of the trade-off in terms of our strategy, which was adopting, obviously, a fixing strategy in those, which would be, obviously, just to stay forward-floating. And to repeat, the reason we adopted this model was to try and maximize the value of the short and forward curve, but also to create certainty and lower risks for our shareholders because, obviously, this is all about income. It's all about earnings. And we're trying to deliver it in as low risk particular way as possible. So if you look at -- so the interesting sort of analysis is that you look at sort of -- so you're looking at the second half of 2018, the green line, as some of you might recall, there was really quite a lot of sort of big price inflation for various reasons through the second half of 2018. And you can see the green line, which is the floating, is obviously -- we lag the blue line, our weighted average [indiscernible]. I mean we lag that because we've got contracts which show fixed contracts, which are at a lower rate. But then you see through the sort of the second half, the back end of 2018, you see our blue line rising. And what we're doing there is that we were -- we saw that there was a very, very steep sort of rise in power prices, and we're restriking as many contracts as we could in that period and fixing them out for a period so that we could capture this peak. And we had that flexibility because we had -- we have contracts coming on and off. We didn't have a bank telling us what we could do. We could go after the market. And that means that we managed to end that year at GBP 55 per megawatt hour. So we fixed it very well. Now if you start from 20 -- beginning of 2019 and then pretty much until sort of June '20, you see that, obviously, the market drops very significantly. And you've got this really -- the energy markets were dropping before COVID. You then got the kind of the oil price forward and you've got COVID. So you have this kind of confluence of factors. What you can see there is obviously, suddenly, we're outperforming or we're benefiting from the fixes because the market is dropping like a stone, and we're doing well. Now we expect that it should sort of even itself out. But certainly, in the last couple of years, we see, in the first period, it was pretty even. But in that period between -- and the last 12 months, we've benefited to the tune about GBP 10 million through what is actually a more defensive strategy of fixing out. Then you can see it also dropped a bit. The bottom half of Page 4, you can see that, obviously, we have obviously been impact -- everyone gets impacted. We've got some fixes coming off. But still, the -- when you look at -- we've dropped about GBP 7.5 per megawatt hour, but the sort of the floating is double that. So even in that scenario, we've done pretty well and we've still got a very high average fix. So it's a bit of -- it's a snapshot. It's one of the reasons that you can look at why the earnings are working well, and that's something you should note. Since we've IPO-ed, that strategy has been very successful. So with that, I will hand over on to Page 5 [ to Neil ], who will talk about the earnings and the valuation.

Thank you, James. Now before we jump to earnings and valuation, we thought it was just worth pausing on a slide that we've shown for a number of reporting cycles and so I'm conscious that many on the call are familiar with the content. But the reason we feel it's important to keep coming back to this particular slide is because it helps to remind us why the risk premium attached to solar is lower than any other renewable technology. And as we've spoken about before, and we show on the left of the slide here, this is due to the predictability of irradiation levels, so the feedstock of the plants, the robustness of operating equipment and of course, the -- of earnings. So there is a straightforward renewable technology. But to achieve consistently high levels of operation, as the company has done year in, year out, it takes a highly dedicated team and as James has already described, one of the -- one that has performed exceptionally well during the COVID-19 pandemic. As the portfolio suffered, only really a very limited number of outages despite enduring a period of unprecedented societal disruption. And finally, on the right, our time on it numerical graphic helping to illustrate how irradiation over the year has been converted by the plants into revenue on a per megawatt peak basis. So if we move over the page onto Slide 6 to consolidated portfolio earnings. So as James has outlined already in the presentation, the company's financial performance each year since existing has essentially been built from 3 central tenets: one, consistent portfolio operational performance; two, a power fixing strategy that smooths out market volatility; and three, prudent management of operational costs. However, as a business that is judged on its earnings, it's imperative the financial performance of the portfolio is straightforward to reconcile the distributions available and made to shareholders, and that's what we consistently try to do on this slide. And it's evidenced by the interaction between the financial results table at the top and the graph detailing distributions to shareholders during the financial period at the bottom. Now in the year to June '19, the company posted record earnings, but the financial performance to June '20 has been even stronger as revenue rose to circa GBP 70 million and underlying earnings to GBP 44.6 million. Now revenue of GBP 69.7 million has been driven by outperformance in generation, as James has mentioned, circa 8.3% of our budget as well as the continuing benefit from PPA fixes achieved in September '18 when power prices reached 6-year highs. But it's also been driven by the absence of fixes during the period April '20 to June '20, as James was discussing earlier when power prices fell so dramatically. Contained within other revenue of GBP 3.8 million is circa GBP 2.1 million from council tax rebates, GBP 670,000 of liquidated damages and insurance proceeds and circa GBP 800,000 from ROC recycle, late payments and mutualization amounts. Going onto the cost section. So portfolio costs, those are the operational costs that -- the underlying SPVs bear of GBP 14.7 million, has continued to be carefully managed, with the increase against prior year principally the result of fees paid for support in relation to receipt of council tax rebates, expenses incurred with respect to planned preventative maintenance activities in relation to some high-voltage equipment upgrades and a small number of sites where transformer replacements were required. Group operating costs have risen on prior year simply as a reflection of an increase to corporation tax paid by the company's U.K. holdco, and that's increased to GBP 1.2 million. Deducting interest costs of GBP 4.6 million in relation to the company's 18-year amortizing loan with Aviva, and the RCF with RBSI results in underlying earnings for the period preamortization of long-term debt of GBP 44.6 million or a record 12.03p per share. And as the chart below the table illustrates, the strong financial performance over the year means even after debt repayments of 2.5p per share and meeting full year target dividends at 7.9p per share, the company is entering FY '21 with carried forward dividend reserves of 2.23p per share. So if we turn over the page to Slide 7 and valuation parameters. Now in the same way that earnings represent the most important figures for distributions, the Directors' Valuation is the most important number in respect to the company's NAV. And how it is prepared on a willing buyer/willing seller basis, it's crucial it is comparable -- or is a comparable reflection of transaction values for the reporting period. Now since Bluefield Solar Income Fund listed in 2013, investor appetite, understanding and comfort with renewable assets have increased year-on-year in solar status with a low-risk generating asset combined with increasing competition for noncorrelated income from sustainable sources has resulted in market participants continuing to apply lower discount rates and in the recent times, extended asset life assumptions in transactions. So both -- by applying a levered equity discount rate of 6% reduced from 6.5% in December '19, the latest power curves from the company is now 3 leading forecasters and increased asset-light assumptions to 40 years across circa 245 megawatts portfolio. The Directors' Valuation sits towards the middle of the value range for subsidized U.K. further asset as at 30th of June '20 and as illustrated by the black dots on the chart. However, as the recent [indiscernible] ESG earnings, which is just shown as the far right green dots on the chart of a 365 megawatt portfolio, which is comparable in our [ visual ] ROC weighting to the companies to circa GBP 1.37 million per megawatt demonstrate asset valuations post period end has continued to rise. And so I think it's important to obviously note that future directors' valuations will, of course, need to adjust accordingly to it. And finally, in August, the company completed the acquisition of Project [ Amper ], a 64-megawatt ground-mounted portfolio, and that's shown by the blue dot on the right of the chart for an initial consideration excluding working capital of GBP 102 million. Now the portfolio benefits from an average subsidy tariff of 1.8 ROCs compared to circa 1.4 ROCs for the ESG earnings portfolio. And as such, its high proportion of regulated revenue, which was circa 66% at the time of acquisition until 2033, naturally drives a higher pound per megawatt valuation than the majority of solar portfolio transactions shown in the graph. And in addition to this, [ Amper's ] -- or in addition to [ Amper's ] highly regulated revenue streams, as James was mentioning, it was also unlevered and so it offered an ideal opportunity for the company to achieve its aim of optimizing overall leverage from low 30s to mid-40s as a percentage of GAAP. Furthermore, even accounting for this high purchase price, as the chart in the top right of the slide shows, the company's weighted average price post its acquisitions still remains over 5% below that of the wider market. So if we turn over to NAV movements on Slide 8. This slide is a correlation between NAV movement in the top graph and the numerical impact of the portfolio valuation in the bottom graph as a result of the core valuation assumptions we've just been discussing on the previous slide. The NAV movement chart highlights the absolute movement of circa GBP 3 million between the June '19 and June '20. NAV has been driven effectively by a reduction in the fair value movement of the company's investments, which has been materially offset by an increase in retained earnings of the company's direct subsidiary, Bluefield SIF Investments, with dividends paid, income released to the company and net operational costs effectively canceling each other out. However, clearly, the most important number in the top graph is the decrease to the rebased portfolio valuation of GBP 11.7 million. So after inclusion of acquisitions of GBP 13.9 million in the period, this portfolio valuation movement is essentially the interaction between a material change in long-term power forecast, which have reduced the portfolio value by circa GBP 56 million, which have been offset by the positive effects of GBP 15.1 million from the continued success of the company's life extension program as a further 139 megawatts since June '19 period to being valued on an extended life basis and the uplift of GBP 42.7 million as a result of the discount rate being amended to ensure the valuation of the portfolio as a whole continues to prudently reflect market pricing. And the graph is obviously bookended by the negative movement of cash released in the portfolio of GBP 48 million. That's the cash paid from the SPVs to the U.K. holdco and the positive contribution of GBP 40.7 million, the balance of portfolio return, in effect, the impacts of 12 months unwinding of the discount rate. And turning over the page to Slide 9 and concluding the section on valuation is a tornado chart of key assumptions and the impact flexing them has on the Directors' Valuation as at 30th of June 2020. Now as expected, they highlight -- valuation returns are most impacted by the long-term swings and overall energy yield, with power price movements plus or minus 10% and asset life changes of plus or minus 5 years, making up the second and third biggest value drivers. And with that, I shall hand over to you, James.

Thank you, Neil. So on to Page 10. Just to sort of finish out, just a quick observation on ESG. So I mean, ESG, prior to COVID, ESG remains the most important theme. It's obviously the most important long-term theme in the financial markets that we're investing today. And hopefully, the report this year reflects that sort of focus from Bluefield from the investment adviser, where we've got 18-or-so pages of the report from the Board and Bluefield Partners and the service companies. And hopefully, it highlights not obviously only the positive environmental impact, which I think has obviously been there since the beginning, but also the high levels of aligned and transparent governance from the Board, the social initiatives the company is taking and also the investment adviser. And we hope it will be obviously very interesting in terms of a very detailed breakdown of those and that very important theme. In terms of on Page 11, the response to COVID. So we thought it's appropriate just to mention that -- obviously, this ongoing issue, which is obviously seeing no sign of abating at the moment. It's obviously -- it's been an incredibly positive response from the Bluefield team. We've had 50 people who are focused on Bluefield Solar across 3 businesses working remotely for 6 months. And the performance of the company, obviously, after the period end and also the fact that we've announced a higher dividend and progressive dividend, is a testament obviously to their ability, their dedication, but also the management systems we have in place to work, to move so effectively from getting everyone to work from home from March 23 and to be able to do that with no disruption to the service for the investors. And in fact, to have specific situations where the engineers are designated key workers. But we have a situation which was Hill Farm had issues of transformer issues and the fact that we had -- they could -- they worked very quickly and very efficiently to deal with that in March, where we needed to get that plant up and running because we're about to hit -- we're coming to the earnings period for the first time. And I think it is a -- it's something which, again, thinking about the kind of the stress test. It's been a really great example of the coordination of the investment adviser, Bluefield Partners; the -- and obviously, Bluefield Services acting as investment adviser -- or sorry, the asset manager and monitoring business; and then Bluefield Operations on the operation and maintenance side. Having that has been a real benefit, having that coordination, where you've got 3 distinct businesses working on distinct parts of the value chain, that they're all working towards a common goal. And I think it has served the company extremely well. So the final slide on Page 12 is just to cover off again the mandate change because, obviously, we've had a very good year. It's also been a very good 7 years since we IPO-ed. And what was the purpose really to mandate change. And really, the way we look at it is how do we marry together our focus on income. It's always about income and earnings and dividends. And how do you manage that with managing risks in the way that we have, but also recognizing that the U.K. energy market is going to change. And it's going to decarbonize, and that presents a new sort of opportunities but also challenges. And I think what we've -- so the first thing is, which you'll see from the changes that we are -- we've remained a solar fund. It's what Bluefield is serving, a fund, and that hasn't changed. We're not a multi-technology fund like JLEN or TRIG or ORIT. We have 75% of our investments are going to solar. We don't need winning for the strategy, and we don't need to change that. So overwhelmingly, we are remaining a solar-focused business, and that's appropriate. But we've also recognized that as the energy market moves, because it's very different today than it was 7 years ago, it's going to be very different in 7 to 10 years' time. And we think that there is -- it's prudent and sensible to look at adding in complementary technologies, first of all. So they're talking about -- we're not talking about doing things like anaerobic digestion or biomass. We're talking about onshore wind and hydro. We're talking about technologies that are closest to -- if you take the accepted view that solar is the lowest risk of all, the simplest, does what you kind of expect it to, what are these -- what are the technologies that fit closest to that if you're talking about delivering a stable income? And those are onshore wind and hydro. And they're complementary in terms of generation profile, risk and management and all those things. So it's a very specific change, which reflects kind of the DNA of the business over the past 7 years. And then the third bit, the final point, is about a consequence of decarbonization is that you're going to have much higher levels of intermittent generators. You're going to have loads of offshore wind, increased levels of solar, increased levels of onshore wind most likely. And as a consequence of that, it's going to be likely to have higher levels of intra-day and day forward price volatility because you've got -- there's higher levels of unpredictability about the energy source and the energy generation. And so as a result of that, you have to have a strategy as you evolve your strategy to look at adding in when appropriate, when the time is right, some element of storage, whether it's factory storage or some other form of storage. And that's right because, again, thinking about our job of protecting our earnings and enhancing them and trying to manage that source of that eventuality, it's a necessity. The first-line effects have lots of regulated revenues, which are not affected by intermittency or indeed, COVID. But going forward, it is something which we think is facing the working -- we are working very hard with third-party advisers and looking at it. We don't think it's ready to be -- we don't think the market is ready to be -- investable at the moment, which is the storage market that we think -- obviously, it's going to play a very significant part, it has to, in the renewables mix. And so it's absolutely appropriate to have that. But going forward, looking forward, what are we going to look at? We think the last 12 months and particularly the last sort of 9 months has proven that having uncorrelated defensive revenues, having those types of low-risk assets remain a growth focus for us, and that's what people should expect as we seek to grow the business as our shareholders have asked us to do. And so that is it. On Page 13, just finishing up where we are. It's been a really, really good year. We're very proud of the team's results and efforts. And obviously, with the carryforward we've got, we've obviously sort of set the foundation for another very, very good year of earnings.