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 '22. James Armstrong and Neil Wood here from Bluefield Partners Investment Adviser to the Bluefield Solar Income Fund. So turning to Page 1, the introduction slide. What we're going to talk about today? We operate in an incredibly attractive sector, and we've had a particularly good year and have laid the foundations for multiyear earnings growth, all of which is very positive, but we will also address recent market developments. And as such, we'll split the presentation into 3 parts. The first section covers the results, which has been very pleasing, delivering record earnings and the highest dividend in the sector. The second section led by Neil will cover the valuation. Here, we're going to look at some sensitivities. We understand the concern about -- the recent concern about discount rates, but we think it's very overplayed and we also think the single input shouldn't be taken in isolation. And Neil will walk you through this and show you why that is the case. However, it is worth highlighting at this point that the company's discount rate has increased from 6% to 6.5% to reflect the higher risk-free rates and also the changing portfolio composition. And then finish up, the third section, I will sort of peer into the future and look at how the solar market and the renewables market is evolving, the opportunities that we're seeing and the public policy measures that are coming through for the renewable industry and why the industry has some unique opportunities ahead, which could be and should really be transformative for the industry. So moving on to Page 2, the Period Highlights. So earnings and dividend on the top left there. We've delivered record earnings and highest dividend in the sector again for the -- now the eighth year running, which is in an asset, which is 8.2p per share covered by in-year earnings and also post debt amortization. And this consistency of delivery of earnings and results in different market conditions is something that I'll come back to in just a few minutes. The dividend is actually higher. As many of you have noticed, is higher than indicated by the Board. We started off with a dividend target of 8.12p share. In addition, we can also forecast out for the next few years dividend cover of close to 2x cover, which is due to the earnings generation that we're seeing from the sale of power. Net asset value is also higher at in excess -- just in excess of 140p per share, and that remains very robust. We'll hear that from Neil and especially when you consider our increase in discount rate. And we'd also say it remains very robust, partly because of the demand for the types of assets that we manage and for index linked to cash flows. On the top right, we had a very busy investment period to over GBP 300 million of solar, wind and battery acquisitions, which looked good at the time and now increasingly look very, very good. We're very pleased with how those are bedding into the portfolio. And to support that oversubscribed fundraises, 2 fundraises in the period just in excess of GBP 250 million. And last but not least, on the bottom right, the really exciting update in terms of the future is the continued growth of the development of our pipeline, our primary pipeline, which is now in excess of 1 gigawatt. Development is the DNA of Bluefield, and this will enable the company to grow efficiently, effectively and also by providing very accretive investments over the coming years to our shareholders and also giving a multiyear visibility on the growth of the company. So moving on to Page 3. Just a quick snapshot of the current portfolio. So we're now at around about gross assets of about GBP 1.3 billion market cap as at June was just shy of GBP 800 million. And the generation and the portfolio again, has performed very, very well. It's in line with budget. I should just say that this period stopped short of the sort of heat wave that we had, which was in the second half of the summer, which will be part of the current year performance, which obviously is very -- has been very good for solar fund. But generation is very good. Majority of revenue is still sort just shy of 60% regulated RPI-linked acting like an index-linked bond. And the long-duration -- average duration is just in excess of 13 years. So it's very, very attractive and the balance of the revenues comes from selling electricity, which has, obviously, also been very, very positive in this current environment. And we're going to talk about that as we go through the presentation, but the -- our ability to capture higher power prices is something which is going to benefit our shareholders for a number of years to come. So moving on to Page 4. We'd like to -- for the watches of Bluefield Solar. This will be familiar. Page 4 and Page 5 is we'd like to show your our earnings and what we do with those earnings and show that we are delivering a covered dividend for shareholders. So if we look on Page 4 with the highlighted column, which is the financial year '21-'22, we've got the total underlying earnings of just in excess of 12p per share. It's been a record just beat our best previous year, which was in the COVID year. So that's 12.04p per share. We've amortized our debt, so 2.5p per share of amortization and we had reasonably strong reserves coming forward. And we've got -- we had almost 12p per share available for distribution, which enables us to give the dividend of 8.2p per share with a carryforward of almost 3.5p per share. And as I mentioned, you've got the net asset value there of GBP 140 million -- just an excess of 140p per share. If I move to Page 5, a different way of just showing that, which we show in the bar chart is on the top, you've got underlying earnings of around about GBP 67 million, which converts into just an excess of 12p per share. And then you can see that with the carryforward we had almost 14.5p per share to be able to play with. And if you look at the bottom half there, you can see we do a comparison from the previous year, but you can see how those numbers on the previous page translate into the covered dividend. So just before I hand over to Neil, if we go on to Page 6. So we've got the dividend, which is great of 8.2p per share, which was a dividend yield of [ 6.3% ]. So it remains to be very attractive. And I should just add, actually, just before we get into this, that we are -- that we're carrying forward reasonably high levels of carryforward earnings, but that we are not a full payout model. And then obviously, we would -- whilst we continue, though, to expect to be the highest payer in the sector, we're not a full payout model. But the story really here is about the earnings going forward. Now the background to this is due to the strategy that we designed at IPO. We have the ability to fix power at the short end of the [ power cut], which is the most attractive for -- the most attractive part of the market to be able to fix. So for the electricity that we sell to the grid, we don't float. What we look to do is we look to fix those contracts for between 12 and 30 months. We've done this very consistently since IPO. Now what the bar chart on the bottom of Page 6 shows is that we have delivered sector-leading dividends covered by in-year earnings every year since IPO and that we've managed to maximize revenues by creating the -- whilst creating very highly certain revenue streams for our shareholders. But what we wanted to focus on is if you look into on the right-hand side, if you look within the red dotted box, this shows a very interesting earnings period because it covers the pandemic and also the energy crisis. The 2 extremes of market conditions. But throughout, we have delivered what we said we were going to whilst creating, in our view, an optimal risk/reward profile for our shareholders in all conditions. And this is the point which our strategy is really emphasizing in these extremes is the ability to be able to deliver in different conditions. So if you look at the period, which is on the -- within the box, which is sort of June '20 to June '21, there we're dealing with the COVID pandemic. And I can say with no word of a lie that we were very pleased in March 2020 that we had over 90% of our revenues fixed as we went into lockdown, which insulated us from the fairly precipitous drops in power prices in 2020. And in fact, it enabled -- we actually had a record earnings period in that time. And it enabled us to actually have a very robust earnings going forward. Conversely, we're now going into -- obviously, we will slightly lag. When you've got a fixing strategy, you'll slightly lag when the market suddenly goes up. But if you look at the future projections for June 23, June 24, we didn't go any further than that. But you can see the sort of the pattern. We are capturing very, very high power prices going forward. And what we've always said is we don't know the future, but we do know what we can strike for the next 3 years with our power contracts. And as you can see, it's going to be very favorable for our shareholders with in excess of 2x dividend cover going forward. Now just to make this absolutely clear, this is not a dividend forecast and the earnings obviously could move up and down a bit, but we have a very strong sense of where we will be because of the fixes that we've achieved. And what's really exciting about this is it gives us the opportunity to have additional options in respect to those earnings, one being the reinvestment of our proprietary pipeline into those -- using those earnings. So with that, I will hand over to Neil to talk about the valuation and the sensitivities on Page 7.

Thank you, James. Turning to capital structure first. So this slide outlines the company's capital structure and how it has enabled the fund to flourish since listing in 2013. Now whilst many investors and shareholders are familiar with the capital structure that is a mix of debt and equity as the chart outlines, what is paramount as the way the debt is structured, as this has the ability to aid and impede equity returns in equal measure. To ensure the debt in the company's structure works for the shareholders and not against them, Bluefield Solar has deliberately structured its debt at portfolio [ hold care level ], whilst avoiding insertion of debt at project level. So what does this mean in practice? And why is it so important? Well, in practice, it simply means no assets have a loan direct from a third party into the individual project company. But the reason this is so important is because of the operational flexibility this provides. And so rather than being caught up in prescribed lender consent, the project company has enhanced flexibility to determine courses of action that are in the best interest of the equity holders and not just the lender. Key operational examples of this are the active management strategies around lease extensions and capital works programs the company has been deploying over the last few years. Both are delivering material value to individual projects and the wider portfolio through enhancing the life of the assets. But both the work streams that in a different structure than the companies could become restricted through the requirement of onerous lender consent. And the same is true around PPA fixing. With Bluefield Solar having the freedom to apply a dynamic rolling power price strategy, where up to 25% of the portfolio can be fixed each quarter, as James was outlining earlier, for up to 3 years. And this pricing is secure following competitive tenders across multiple offtakers. Now this is significantly different to the situation in many renewable financings, where our borrowers locked in to one counterparty on a long-term offtake agreement with conditions to fix power for a minimum periods of 3 to 5 years at often unfavorable discounts to prevailing power prices. And this is something that the current power market, due to the elevated pricing levels, is mainly accentuating. If we turn over the page to debt strategy, I'll connect you to the benefits of the capital structure is the position of the company's debt arrangement. And that the overall leverage limit set at 50% of gross asset value, but currently only sitting at 35% is comfortably below lender limits. This ensures cash flow [ cover ] on debt ratios sit materially above lender levels, resulting in limited risk of equity distributions being impacted. Structurally, the company has arranged debt over 3 time horizons. The first is the short term, and that reflects redurable funds available under the company's RCF to support acquisitions. The second is the medium term, and this is financing that has a limited tenor in order to secure favorable gross margins over those of longer-term debt, but it's deliberately structured to include a long-term swap in line with regulated revenues of projects. And this is to materially insulate the company from refinance risk and adverse interest rate movements at any point from the time the loan was entered into and either refinancing or maturity. And then the third is long-term debt. And this is sized to ensure it is fully amortizing within the life of the subsidies, completely insulating the company from interest or a refinance risk over the life of the loan. And so stepping back, overall, with low gearing, as I mentioned before, leverage is 35% and only GBP 110 million of debt not fully hedged out of the GBP 460 million. The company has very limited exposure at this point to any changes in long-term interest rates. Turning over to the page to Power Prices and the Power Price Strategy slide. So following on from the capital and debt structure slide, the key operational benefit enjoyed by the company from its gearing approach is the flexibility to strike power purchase agreements with considerable discretion. And this enables it to not only maximize value from near-term power price movements, but also to smooth out exposure to market volatility. And as James has also mentioned previously the result is that the company has delivered record earnings without exposing shareholders to the risk attached to highly volatile power markets. Now the flexibility of this hedging approach has meant that during this period of unprecedented power price rises driven initially by the recovery of the global economy from COVID-19 and then Russia's unprovoked invasion of Ukraine, the company has been able to achieve average pricing of GBP 114 per megawatt hour as at June 22. And then it really accelerates since June as the chart illustrates, where average pricing of GBP 350 per megawatt hour, GBP 250 per megawatt hour GBP 150 per megawatt hour over the next 3 years, all of which are at levels considerably above the blended forecast curve as used in June '22 have been struck. And the result is the company has secured value for shareholders in the coming financial years at levels which provide a high degree of visibility in respect to the company achieving over 2x dividend cover. So turning to valuation parameters. 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 as it is prepared on a willing buyer and willing seller basis, it's crucial, it is a comparable reflection of transaction values for the reporting period. Now demand for U.K.-based renewable assets, record power prices and rising near term inflation have all combined to drive an uplift in valuations. With CPI and RPI running at 30-year highs in 2022, the director's valuation has reflected this and applied RPI at 10.9%. The consensus on inflation as at the period end remains split beyond 2022. And so 3.4% has been applied for 2023 with 3% until 2029 before dropping to 2.25% thereafter as RPI is replaced by CPI each. As the company is a net beneficiary from inflation and even more so following recent highly regulated revenue acquisitions, these changes result in a positive uplift of circa GBP 60 million from June '21. Inclusion of the latest power curves from the company's 3 leading forecasters as well as PPA fixes in the period have contributed circa GBP 99 million of additional value compared to June '21, an astonishing figure and one that is principally a result of surging estimates of power prices for the period to 2025. Looking beyond the mid-2020s, the forecasters have held predictions around medium- and long-term power prices closer to curves released over the past 12 months. However, the full extent of the rise on the valuation from these 2 factors is inevitably being lessened by the significant increase in interest rates since December 2021 as the Bank of England moved its base rate from 0.1% to 1.75% as at the 30th of June. As a natural consequence of rising interest rates and inclusion of 58 megawatts of onshore wind within the portfolio, it has been necessary to increase the discount rate within the 30th of June valuation to a weighted average of 6.75%, an increase of 0.75% from the discount rate applied since June 2020. In conclusion, considering the highly regulated nature of the company's portfolio and its low level of leverage, the directors are satisfied the valuation for June 22 is squarely placed within the universe of values seen across transactions over the past year for portfolios of comparable size and technology mix. And turning over to a slide on valuation sensitivities. In light of the recent release of the mini budget by the government and the significant impact that this is having, at the time of presenting, on the prospects of further rises in gilt rates, a bespoke sensitivity to the June 22 directors' valuation has been prepared. Now this looks to quantify the potential effects of 4 key factors connected to the impact of the mini budget that influence the valuation of the portfolio. The purpose of this analysis is to outline that whilst guilt rate rises could be perceived as precipitating a further increase to discount rates. And in fact, in our sensitivity, we have chosen to increase both interest rates and the discount rate by 1.5% from those used in the assumptions for June '22. The impact of these 2 factors needs to be viewed in connection with a continuation of 19% corporation tax and the likelihood inflation in the near term will be higher than the assumptions of 3.4% in 2023 and 3% in 2024. And the result is that the sum of these push and pull factors on the valuation is a relatively limited potential net reduction of 3.6p per share.

Thank you, Neil. On to Page 12, which is about Future Growth. And the Bluefield story is centered around our ability to find, control and maximize primary pipelines of assets. And that's how the company was built, and it's how the Bluefield Group is resourced with expertise across development and construction funding stage of an acquisition. It's the DNA of Bluefield Solar and it's one of the differentiators of the company, and it's one of the reasons for the consistent outperformance we've delivered relative to target returns and peer group over close to a decade. So what we have coming down at the pipe is that we have announced a full controlled pipeline, which is in excess of 230 megawatts of solar and storage, which is requiring some near-term funding of about GBP 120 million. But in addition to that, we've got over 1 gigawatt of developments, which are being developed through our proprietary pipeline. And this gives us a huge strategic and financial advantage as we look to strategically and steadily grow the company going forward. And what makes us even more advantageous and what is really exciting for us and for our shareholders, we believe, is that now for the first time, we have the ability because of the earnings profile we've mentioned to be able to not only self-develop the assets but also to self-fund some of the assets with the reinvestment of earnings. On Page 13, just a quick snapshot of the ESG activities, which are very many and varied. And we've got a number of additional slides in the appendix. We're now producing enough electricity to power us, see the size of leads. It was Bristol to quite recently for those recent acquisitions we've gone up. But in respect of the ESG objectives, we have some very clear targets outlined. And what's very important to us in terms of these policies is that we want them to be measurable in order that our policies can be analyzed effectively by shareholders and observers. We want this to be very quantitative rather than just qualitive because that's the way that we can actually show progress. And it puts the -- in a very high bar in terms of what we're trying to do. So the initial part, which we said we were going to commit to was a very robust ESG strategy, which is aligned to BSIF's stated purpose of Renewable Energy Delivered Responsibly, and that has a number of measurable, quantifiable KPIs in that, which will be developed over time and that shareholders will be able to see. We've also started a major biodiversity policy. Bluefield Solar is in the unique position where we have over 3,000 acres of solar and wind farms. And we have the ability to really improve the ecosystems on those sites over the coming decades. And we also know from talking to shareholders, one of the most important areas for them in terms of the improvement of biodiversity, which is a key consideration and consequence of climate change. And that's something that we're going to work and we started the program there. And then we've also published our first climate-related financial disclosures. So the TCFD recommendations in line with those, which is again, a very significant step forward. So an enormous amount of activity, a great deal of progress and much more to come on that side. So the penultimate slide on Page 15 is on public policy. And when you hear Jacob Rees-Mogg, the Business Secretary, announcing that we need to promote faster deployment of renewables, you should realize that he's just realized something about renewable energy. And that is as the business minister, who is tasked with increasing energy security as rapidly as possible and as cheaply as possible, and then the best options are solar and wind. I've left off net zero here just because I was talking about the current Business Secretary, but that is also a broadly and rather universally acknowledged benefit of renewable energy. But just to give you a little snapshot of this, in terms of the recent CfD auctions that saw 2.2 gigawatts of solar being awarded CfDs. The pricing of those was broadly half the cost of [ CPC ] and depending on which day you're talking about it between 4 to 10x cheaper than the current price of gas. And importantly, there is also the ability, particularly with solar, but also potentially with some recent announcements, increasing wind to be able to deploy it very, very rapidly. And that is another key attractiveness of energy, particularly when in the context of energy security. Now in respect of how the government is approaching general sort of more structural policy. There is an ongoing consultation, which is called the Review of Energy Market Arrangements, or REMA for short, and that is looking at a whole host of potential improvements to how the energy markets run. The one thing we would say, we're an active participant. We will be working with the initial consultation and finding so there are a number of initial bits of submission, which are going through at the moment for the beginning of October. But the one thing to say is that none of these changes are going to be quick. Our advice is on this estimate the lead time for many of the key policy proposals to be between 5 to 10 years. So it's not going to happen overnight. More immediately, we are reaching out to government to see whether we can be part of the solution for the very urgent cost of living crisis, which is being driven by energy increases. And one of the things which has been put in the press, and this is mainly focused on it on a voluntary swap and one of the ideas, I should say, is the voluntary swap of the merchant revenues, if you have rock assets, the merchant revenue is being swapped into a CfD. And it's incumbent in my view that the industry -- the renewable industry, broadly and solar industry in Bluefield should engage with the government to see whether there is a mutually beneficial outcome to both our shareholders and also consumers. I don't think they're mutually exclusive, and I think they can't be. But it's as part of the government's proposal means that the industry -- the renewable industry, has the opportunity to make itself even more central and vital to the government's energy plans. I think that the industry should really look to try and engage very positively with the government over the coming weeks and months on this. So to conclude on Page 16. The last few days have been a really good example of how the market has become fixated on one factor and has lost sight of the bigger picture in our view. And we hope the results for Bluefield Solar has demonstrated this. We've delivered record earnings from a very high-quality portfolio. We've locked in very significantly higher earnings for future years. And the company has with the tailwinds of inflation and higher power prices, the ability to deliver very attractive risk-adjusted returns for the foreseeable future for our investors. And we believe that there are very significant -- particularly with our proprietary pipeline there are very significant opportunities for the company going forward.