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

Good morning, and welcome to Bluefield Solar's Annual Results for the period ending June 2021. Over the next 45 minutes or so, Neil Wood and I will break down the report into 3 sections seen on Page 1. First, we will look at the summary of the year. Second section will cover earnings and valuation, Neil will go through that. And then I will finish up with future plans for the business, including what we perceive to be some of the emerging opportunities and challenges for the company. So on to Page 2, just a bit of background by way of introduction to Bluefield Solar, in an increasingly complex sector in terms of fund strategies, we remain pleased about the outperformance for the company on an earnings and dividend basis from what remains a simple and lower risk investment strategy. Bluefield Solar invest in the lowest risk renewable technologies with the highest level of visibility and predictability in terms of earnings. And we then actively manage the assets to enhance returns. This means that we invest overwhelmingly in solar, and then we look to carefully add complementary technologies where appropriate. So far, this means that we have invested primarily, obviously, in solar, with a small exposure to heavily regulated wind assets. At the time of issuing the results, we have the -- from this low-risk portfolio, we have the highest earnings, with the highest level of regulated revenues from what is the lowest risk portfolio in the sector. So on to the highlights for the year on Page 3, the period highlights. It's been a very busy and also a very successful year for the company in terms of our activities. We have delivered 8p per share for shareholders and dividend comfortably covered by in-year earnings, and this is post amortization. And we are pleased to announce this morning an increase to the target dividend for the financial year ending June '22 of 8.12p per share. We have made some fairly significant acquisitions during the period. We acquired 134 megawatts of regulated solar assets in 2 deals between July and January. And we also completed post period our maiden wind and storage acquisitions, and Neil will talk about that in just a few moments. And very significantly, we have built out our solar pipeline of developments to over 700 megawatts. We've got first accredited asset, which was mentioned earlier in the early results called Yelvertoft. We have completed the materiality assessment to address key ESG issues, which I will talk about in a few moments. And we've also broadened the mandate to include wind and solar, which obviously explains the acquisitions I've just mentioned. And we would say that we were obviously disappointed by the negative total return in the sector, whilst obviously the dividend and the earnings has been very strong. We were obviously disappointed by that, which is due to a sector-wide rerating, which has seen Bluefield Solar's share price drop in this period. But that's something we will also talk about later. And obviously, we think that there is significant potential upside for the share price based on the visibility of earnings that we have and the dividend yield, which is an offer to date. So moving on to Page 4, operational highlights. So for those, I seem to say the same thing every year since 2013 when we IPO, but for those keen Bluefield Solar watchers amongst you, solar farms really are a very predictable way of earning electricity -- so generating electricity and obviously earning income. It is fundamentally different in terms of volatility to all other renewables. And that's why we chose solar as our lead technology for the fund. And as you can see, the irradiation and the generation in the period was circa 1% below what we targeted in July a year ago. And that's been obviously very consistent year in, year out. Worth ranging so this is the story that comes out of this slide, there is the revenues where they're close to 3% above where we expect them to be. And if we go on to Page 5, that sort of -- the revenues and the earnings are sort of only just partially explained by these results. So at the top of Page 5 there, you can see that we've delivered 11.34p per share, which is close to our record earnings. Obviously, last year, we had 12.03p, which was our record earnings. So we delivered in excess of 23p per share during a global pandemic, which is -- obviously, we're particularly pleased about, and earnings, which we think are testament, obviously, to the stability of the strategy that we have adopted. What it doesn't really say though in terms of the current earnings is that the story of the recovery of the power markets during the period where Bluefield has started to restrike power contracts at much higher prices is only partially being shown through here. And as you'll hear as we go through about the power strategy from Neil and myself, you'll see that Bluefield Solar is going to benefit significantly from this increase in the power markets going forward. You can see just very subtypical on Page 5, where we have continued to amortize our debt, which we think is very important during this period where we've got very high levels of regulated revenue. We brought forward significant reserves, and so we had over 11p per share, which was available for distribution. And obviously, we -- the aforementioned 8p per share has been paid for investors for the financial year, and we've carried forward over 2.5p per share, which is, again, a record carryforward. And the NAV has held up well. Neil will talk about the valuation in just a moment, but it's obviously held up at just shy of 116p per share. So on to Page 6. So some of the ESG highlights, obviously, a very key area which we will talk about in various places throughout the presentation. But some really great stats, and we are generating as a business which is a sort of the -- a record number of homes powered, which is 187,000 homes, which is a good milestone. If you take the numbers in terms of average households, that means that we are powering from our renewable energy a city the size of Bristol, which is great for our [indiscernible] in business and another pleasing stat. Consider on a sunny day this summer that we just had and when we have them, until mid-afternoon we're providing circa 3% of the U.K.'s electricity. So a lot of very good positive stats that are coming through. Materially, though, for the business if we go on to Page 7, is that we said to the market in the interim results that we were going to undertake as part of our commitment to ESG, a materiality assessment to evaluate the key opportunities and risks in relation to environmental, social and governance issues. And we have done that. We've engaged with some key stakeholders across the business, so these would be shareholders, advisers, industry professionals, the Board. And we identified 16 material topics which had -- could have significant impact on the business. And they were rated from -- all of them are important, but they were rated from sort of lower risk to high risk. And we see on the sort of -- if you look at the matrix on the -- on Page 7, where you've got the right-hand side of that matrix, you've got half a dozen very key areas, which include ethics and compliance and human rights, occupational health and safety, areas which we will obviously be looking at in detail and then we will work with the Board, to implement a strategy around those which we will adopt, and we will update the market on in the interim results. So a very key bit of, I think, creating some structure, we hope and the robust reporting framework for our shareholders around that very important topic of ESG. And so with that, I'm going to hand over to Neil, who's just going to talk about some of the recent acquisitions and the power markets and then is also then going to talk about earnings and valuation.

Thank you, James. So as you have already outlined, following the shareholders' approval to broaden the company's investment mandate to permit 25% of gross asset value into complementary non-solar renewable technologies, the company has enjoyed a tremendously successful period of acquisitions as it has acquired over GBP 250 million of operational renewable generating assets since June 20. And furthermore, it has done so on a very selective basis with each acquisition fitting perfectly within the company's very specific growth strategy. Solar acquisitions of 134 megawatts between June '20 and June '21, which took the company's operational solar portfolio to 613 megawatts, close to a 30% rise over the 12-month period, have been followed by execution of first investments into complementary renewable technologies. These occurred post period end in July and August '21, respectively, as maiden investments were made into wind, a 12.5-megawatt portfolio of Feed-in Tariff backed single-stick turbines with circa 92% regulated revenues and co-located solar and storage as the company acquired the project rights to a 45-megawatt solar and 25-megawatt battery system. Whilst these investments not only represent immediate repayment of the support shareholders gave in approving the broadening of the funds mandate in July '20, they have crucially also enhanced the company's exciting position for material future growth, be it through further purchases of subsidized assets or significant investment into new built unsubsidized assets. As the portfolio as a percentage of fixed revenues over the life of the subsidies has risen to over 65%, which for context is higher than sector averages of circa 60% for ROC accredited solar portfolios and materially higher than the 50% average from ROC accredited wind portfolios. Moving on to earnings and valuation. So the first slide in the next section is on power price movements and looking back over the past 18 months. So its been well documented how volatile power markets have been since the world first went into lockdown in March '20, as the immediate effect of a dramatic drop in electricity demand resulted in day ahead power prices falling to a low GBP 24 per megawatt hour in April '20, before rising steadily during the remaining quarters to being briefly above prepandemic levels during December '20. However, as the global economic recovery gathered pace in spring '21 and lockdown measures began to ease across the world, demand for gas, in particular from Asia, coupled with low storage levels in Europe following cold winter in 2020, so concerns begin to amount around gas reserve levels ahead of winter '21. The result, compounded by very low wind generation during summer '21 and rising carbon pricing due to increased thermal generation, has seen price expectations across both the day ahead and season ahead market surge to a succession of monthly record highs over the past few months. Indeed, at the time of this recording, power continues to climb for winter '21 and summer '22. Whilst record prices are positive for generators, they have highlighted the challenges energy supply companies face matching rising wholesale prices with fixed customer tariffs. Sadly, this pressure has resulted in a number of the newer and smaller energy suppliers entering administration. This is in contrast to the company's position, which, due to the fact that it has over 80% of its PPAs with 2 of the largest energy companies in the world, and the remainder with investment-grade counterparties is highly insulated from the risk of supply default. Despite the dramatic level of volatility over the past year, the careful application of the company's rolling hedging strategy where, on average, 25% of the portfolio is fixed each quarter, typically 2 to 3 years, has meant that the average price achieved by the company over the period, as shown by the bottom left-hand graph, has remained relatively stable. The result is that the company has delivered record earnings without exposing shareholders to the risk attached to highly volatile power markets. And not only this, as James is discussing further, but the flexibility of its hedging approach has meant that the company has also been capturing value from rising power markets by fixing over 312 megawatts between Jan '21 to date at average pricing on an installed capacity basis of between GBP 61 to GBP 68 per megawatt hour for contracts starting during Q3 '21 and into 2022. In doing so, it has not only created revenue certainty, as shown by the chart in the bottom right, as at the 30th of June, 2021, of 88% for the 12-month period to June '22, but secured value for shareholders in the coming financial year at levels above previous forecasted expectations. Turning over to consolidated portfolio earnings. Now as we have outlined since these were first listed, the company's financial performance continues to be built on 3 central tenants: consistent portfolio operational performance, our power fixing strategy that smooths out market volatility and prudent management of operational costs. However, as a business that is judged on its earnings, it's imperative to financial performance of the portfolio is straightforward to reconcile to the distributions available and made to shareholders, evidenced on the slide by the interaction between the financial results table and the graph detailing distributions to shareholders during the financial period. Now as outlined previously in the presentation by myself and James, during the period, the company completed 2 material operational cellar acquisitions, a 64-megawatt portfolio and stand-alone 70-megawatt asset. The careful structuring of the timing of the economic benefit the company received from these acquisitions being January 2020 and April 2020, has resulted in these 2 investments enhancing the company's portfolio earnings by a highly pleasing circa GBP 5.1 million in the period. So taking the component parts of the table in turn, portfolio income of GBP 80.3 million is ahead of target as despite generation being fractionally below, budget revenues before accounting for the net impact of earnings from acquisitions were 2.8% ahead as the company took advantage of rising power markets and secured PPA pricing ahead of expectations. Portfolio costs, eg: The operational costs within the underlying SPVs, of GBP 19.4 million, were in line with expectations with the increase against June '20 driven principally by the additional 134 megawatts of assets acquired in the period and the limited financing costs associated with this. Group operating costs of GBP 7.5 million have risen compared to June '20, driven principally by the company's GBP 45 million equity raise in November '20 as well as a moderate increase in corporate tax estimates for the period to June '21. Deducting interest costs of GBP 4.7 million in relation to the company's 18-year amortizing loan with Aviva and its RCF with NatWest results in underlying earnings for the period pre-amortization of long-term debt of GBP 48.6 million or 11.3p per share on a weighted average basis. As the bar chart below the table outlines above budget earnings and highly accretive acquisitions means after debt repayments of 2.17p per share, a full year dividend of 8p per share as well as an adjustment for shares raised post period ending July '21 that the company has grown effective carried forward dividend reserves to 2.67p. Moving on to valuation 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 of the company's NAV. And as it is prepared on a willing-buyer-willing-seller basis, it's crucial it is comparable -- it is a comparable reflection of the transaction values for the reporting period. As the bar chart at the bottom of the slide on discount rates illustrates, since Bluefield Solar listed in 2013, investor appetite, understanding and comfort with renewable assets has increased year-on-year. As such, given increasing competition for noncorrelated income from sustainable sources, it is no surprise this has resulted in market participants continuing to apply ever lower discount rates and extended life -- asset life assumptions in transactions across the renewable spectrum. By continuing to apply a levered equity discount rate of 6%, the latest power curves from the company's 3 leading forecasters and increased asset life assumptions of between 30 to 40 years across 490 megawatts, which is circa 80% of the company's portfolio as at 30th of June, 2021. The director's valuation of GBP 1.26 million per megawatt continues to sit prudently below the middle of the value range of GBP 1.2 million to GBP 1.4 million per megawatt, that the investment adviser has observed in transactions for comparable subsidized U.K. solar assets. And supposing the valuation of the portfolio at the period end, the acquisitions made by the company during the period, shown as light blue dots on the far right of the bubble graph. The dot on the top right represents the 64-megawatt portfolio, which benefits from an average subsidy tariff of 1.8 ROCs and very high proportions of regulated revenue, close to 66% at the time of acquisition until 2033, whilst the lower blue dot is the 70-megawatt asset, which is accredited under the 1.4 ROC branding. Now as detailed on the previous slide, both of these acquisitions have already delivered immediate benefit to the earnings profile of the company's portfolio as a whole. Turning over to NAV movements. Now this slide illustrates the correlation between NAV movement in the top graph and the numerical impact on the portfolio valuation in the bottom graph as a result of the core valuation assumptions shown on the previous slide. Over the 12-month period, the NAV per share has declined slightly from 117p in June '20 to 115.8p in June '21. As the top graph illustrates, after accounting for the equity raise in November '20, the 1% fall in NAV has ultimately been driven by the net effect of a drop in the valuation of the portfolio of GBP 19 million being offset largely by an increase in the fair value which is inherently an increase in equity reserves of the company's direct U.K. subsidiary, Bluefield SIF Investments. Taking a specific look at the drivers behind the drop in portfolio value of GBP 90 million, the portfolio valuation movement graph illustrates before this is essentially the result of 3 key factors: reductions in long-term power price forecast over the life of the investment, effectively out to 2050, have lowered the valuation by GBP 18 million, whilst updates to long-term tax rates following the 2021 spring budget, which outlined corporation tax rate, will rise to 25% from April 2023 have impacted the valuation negatively by GBP 14 million. However, this cumulative decrease of GBP 32 million has been partially offset by positive movements of GBP 19.1 million from an increase in asset life assumptions with 80% of the portfolio value between 30 and 40 years of operational life, following continued success of the company's asset extension program. And finally, concluding the section on valuation is a tornado chart of key assumptions and the impact flexing them has on the director's valuation as at the 30th of June, 2021. Now as expected, their highlight valuation returns are most impacted by long-term swings in overall energy yield, with power price movements of plus or minus 10% and asset life changes of plus or minus 5 years making up the second and third biggest value drivers. And lastly, on this side of the chart, also outlines the positive impact rising inflation would have on the company's earnings and valuation. And this is due to its highly regulated revenue base, meaning income rises would exceed the inflationary impact on operational costs. But that's all. And back to yourself, James.

Thanks, Neil. So to finish up, we're going to talk about the future. And so on Page 16, the future respect of the strategy for Bluefield Solar is actually going to be based a lot around past as we've had considerable success. And we think that success is sustainable. If you look on the charts on Page 16, obviously, the most compelling where you look on the top left, where we have the sector-leading dividends, which have been delivered through covered earnings and post amortization. And just to reiterate, that's with a portfolio that for a selling income fund is the lowest risk portfolio in our sector, being 98% U.K. solar, with the balance being U.K. wind and with the highest regulated revenues in the sector and the highest levels of contracted revenues, which is delivering the top left there, which is the highest covered dividend in the sector. So clearly, if you go on to Page 17, we're going to look to double down on that to make sure that we can obviously continue that success. So the focus that will remain for the portfolio overwhelmingly is going to be around solar fund. So we've got some 600 megawatts of operational solar assets and some 700 -- over 700, which are currently in development. The 3 points that we should raise about why we chose solar and why we continue to prioritize solar is it's highly predictable energy source. So we've mentioned many times before that's daylight hours driven. It's why over the past 8 years when we've reported, we've always had a very close correlation between our target energy generation and actual. It's a very simple proven technology to convert the radiation to energy and it's done very predictably. And we've also focused very much on having very high levels of regulated income. In fact, the solar market has the highest levels of regulated income in the sector due to legacy issues with the ROC accreditation. So we're going to continue to focus on that and look to drive that out. So -- as I say, we've got over 600 megawatts, which are operational solar assets, and over 700 which are in development. The plan for the development pipeline currently is threefold. So what we're going to look to do is to acquire some subsidy-free; secondly, acquire using CfDs when they come through, which is obviously a slightly further -- it further outs the process in terms of that scalable market; and then the third is to sell to third parties. And it's very important to remember that we start this position, this process with the highest level of regulated revenues in the sector. So typically, there's sort of circa 50% regulated revenues, and we have in excess of [ 65% ]. And therefore, even thinking about adding some of the subsidy free assets, which we can obviously manage and optimize and drive out higher returns from, we will still remain even with a very large amount of subsidy-free assets, one of the highest levels of regulated revenues in the sector. But we've also looked at, obviously, as we were in the period, we have broadened the mandate and on Page 18, we have looked at sort of the analysis we did was to try and see in a very competitive market. Where there are asset classes, where returns have not been distorted by, unjustified in our view, reduction in discount rates and also where we can actively manage assets in order to drive out higher returns. And if you look at the sort of the chart on Page 18, where you see returns, which we think are very much in line with the sort of the risk reward that we'd expect to see for our shareholders is another area where you've got the -- obviously, the subsidize solar, some subsidized onshore wind. And then you've got the subsidy free, particularly subsidy-free solar, which obviously all in and that's what's the bottom area. You do have different technologies as we've spoken about on previous occasions, which have much higher risk profiles in terms of their earnings generation or their complexity. So one of those is anaerobic digestion, another one is batteries. So just taking something like anaerobic digestion, if you are investing in that asset class, you should be demanding a significantly higher return than you would get from the core technologies of solar and wind. And one of the challenges we think for investors at the moment is that some of these -- because of the weighted money that's coming into the sector, which has been mentioned by Neil, is that what you're seeing is you're seeing some of these more complex assets being sort of in terms of discount rates being driven down, so prices are very high. Batteries is a different -- batteries is a new market, which we are obviously very keen on and we've spoken about it, but it demands a much higher return. So when we're looking at -- we think it fits very nicely into a low-risk portfolio as a section of that portfolio, but we also expect to see it generate significantly higher returns because of the risk profile of the revenues. And that's something we're going to talk to the market about much more as we go through and develop that side. But the area really is to say that we are very comfortable still where we're looking at particularly subsidized solar and subsidized wind and subsidy free so that they still offer good risk-adjusted returns. So moving on to Page 19. One of the areas I mentioned there in terms of our analysis is looking at assets where we can actively manage. And one of the big differentiators for Bluefield is this life cycle approach we have to investment where we have individuals and expertise at every stage of the life cycle from development through to operation and maintenance, they're looking after the assets for the long term. And we've -- it's really -- for us, it's divided into sort of 4 key businesses, which starts with development, goes into investment, asset management and operations. And you'll see from the numbers on Page 19 is that the Bluefield approach is very operationally focused. So we have -- there are 16 people that are working on the Bluefield fund on the investment side, which also includes something which is quite unique to us, which is construction engineering where we have teams that will go out with Neil and the investment team to our technical analysis when we're looking to make acquisitions or indeed pre the construction phase of an asset. But you'll see beyond that, you've got -- we have another 50 people who are included in areas which are noninvestment based. So we've got the development pipeline has come through our business, which is run by Jonathan Selwyn who has been responsible with a partner on developing that development pipeline. And then you've got 20 people who are involved in asset management and reporting and finance. And then a further 28 who are the operations and maintenance team who are in the field day to day. To give you an idea of that sort of activities, since the beginning of 2019, the operation and maintenance business have traveled some 750,000 miles, which is to and from solar farms, which is actually to the moon and back, which shows how active their sort of analysis and their work on site is. They've also produced something like 20,000 reports when on-site. So you've got this very, very detailed granular asset management and operational capability which has been one of the key distinguishing factors for us. And it's something where when we're looking at new acquisitions, that's one of the areas that we're looking to see what we can add in that sort of platform expertise. Okay. Last couple of slides for me is just on the -- building on what Neil said about the power strategy is we've been really pleased about how the earnings have been so robust during this very unusual period. As I say, we've had the experience of going through the pandemic, where in March '20, we went into the pandemic and lockdown with circa 90% of our revenues already contracted out, and we delivered record earnings that year, and we've almost delivered record earnings again this year having gone through that. And we obviously have this strategy of periodically fixing every quarter where we can the contracts. And it's something where, obviously, in the market today, as Neil's sort of slide showed, is obviously, we're going to miss some of the upside. But we are pretty comfortable with that because obviously, we have such high levels of certainty for our shareholders in terms of what the revenues are going to be. But on Page 20 on the right-hand side, you can see that there is real future upside. So at the end of this period that we are reporting on, so the average price per megawatt hour was just shy of GBP 50. And that is a pretty solid performance considering the sort of the undulations that we've had during COVID. But if we then roll forward some of the new contracts which are coming on in 2022, we're seeing that rise to almost GBP 57. So that obviously hasn't -- benefit of that hasn't been seen by the shareholders so far. And we have in 2022, we've got a potential for circa 300 megawatts to be restructured. Obviously, there is the expectation, depending on how the markets go, but there's going to be some more restrikes which are going on. And so we think there is -- there's obviously certainly some upside, which is coming down and benefit coming down the pipe for the shareholders. And then finally, the slide just in terms of where we see some of the opportunities and challenges for the market and for Bluefield Solar. So I mean, if we take the challenges, I will start with which maybe seems slightly counterintuitive, which is energy price inflation. So I think when you look at any chart around and obviously, the dislocation that's happening with the energy markets at the moment in terms of extraordinarily high pricing. Clearly, the position is unsustainable. It's obviously taking -- its making businesses go out of supply companies are going bust and also there's going to be significantly higher energy bills for the consumer. And obviously, that is challenging politically. And so I think what we -- obviously, we're watching closely, is that there's going to be -- we need to see a very good long-term thinking from policymakers to obviously trump short-term politics. There is also the usual but, in the industry, there is a usual concern over future power prices. So there's a wide range, and we've spoken about this before, there's a wide range of outcomes of what long-term forecast of how being and the cannibalization returns for renewables as deployment increases. And we repeat the fact that we think we fundamentally disagree with some of the low forecast, certainly, albeit seen from [ BNEF ], which we think are based around assumptions which are not particularly achievable, but it's something which obviously investors are quite concerned about. And the third thing we would say in terms of just challenges to be aware of is supply chain. And this again, this is not unique to solar. But within the solar industry, there are a number of sort of key challenges: one, which is concerns around labor practices in terms of the supply of modules and production modules; secondly, which is a big issue at the moment is module price inflation, which is happening across the world. And this is going to be exacerbated by the fact that China, which is the biggest exporter, is also looking to prioritize supply of modules into China. So there could be increased pressure. So there are some headwinds that are in place, which investors need to be aware of. But on the positive side, the opportunities are very strong as well. You've got COP 26, which is obviously a big push for the government. So public policy has never been so supportive. Certainly, not in the 15 years I've been looking into solar. You've got broad political and public support for renewables and decarbonization. In fact, yesterday, it was announced that there will be a target of 100% renewable energy by 2035. So that's very -- all very, very positive. And clearly, also, just thinking about inflation again, is that inflation is beneficial to Bluefield Solar. So we have -- 2/3 of our revenues are linked to RPI. But the majority of our bank debt is -- has a fixed level debt. So we have a very favorable capital structure, which means that net earnings would be boosted in an inflation environment. So the sort of the counterweight to that point about sort of energy price inflation is obviously -- will be very beneficial. And obviously, the point about energy price inflation is clearly that as a generator of energy and we're going to be the beneficiaries of that. The issue is that structural imbalances in the market, we think, remain. We spoke about this as long ago as 2 years ago, where decarbonization of the energy markets is going to be challenging in terms of getting decarbonizing and getting renewables on the grid is going to create some levels of volatility. And you're seeing this obviously very significant at the moment. This is part of the challenge that we're seeing at the moment, and it's why we're seeing the highest pricing of power since our IPO in 2013. So it's going to be beneficial, obviously, for generators and obviously beneficial to storage, which is one of the strategies that we have obviously adopted and have spoken about to the market over the past couple of years. So overall, on balance, we think there are some, obviously, as there always are some concerns and some challenges. But overall we think that the opportunities remain very strong. And certainly, in terms of the strategy we adopted, we think that there are many reasons to think that we will be able to sustain the outperformance that we've delivered again this year. And with that, we will -- that's the end of the presentation. We do have in the deck, we also have an annex, which has a number of different slides where there is some additional information if people would like to see that.