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

Good morning, and welcome to Bluefield Solar's interim results for the period ending December 2022. James Armstrong and Neil Wood here from Bluefield Partners Investment Adviser to the [ Fund ]. And as part of the presentation this morning will highlight 3 themes, key themes that are developing or continuing to develop, all of which have positive implications for the company over the medium to long term, namely future earnings, future public policy and future growth opportunities. And so with that, we'll go into the presentation on Page 1. By way of introduction, first, earnings, you'll see the expectation of very high earnings in the coming years due to locking in power fixes over the past 6 months, particularly record earnings for the first half of the year and forecast earnings of over 2x dividend cover for the full financial year. And then on a cumulative basis, we're seeing earnings grow up to over 3x dividend covered by the end of June 2025. Net, I should add, of debt amortization and the Electricity Generator Levy, the EGL. Second, the strong results for the period are set against the backdrop of what was the most challenging time for the company in its history, and it's almost its 10-year history due to political uncertainty around the time of the trust government and the mini budget, and we'll discuss the impact of public policy and the EGL as we go through. But the direction public policy is taking today is 1 which remains very positive in respect of renewables, but also again shows how robust the model is for Bluefield Solar. And I was looking at my notes from a year ago where we described the company is anti-fragile and that has certainly proven to be the case over the past 12 months and particularly the last 6 months. And then finally, on Page 1, we have continued to see really good progress on the work we started over 4 years ago with our development partners and also our in-house developer. And we've had a very successful period with over 200 megawatts of new solar sites being granted to plan permissions on top of the existing portfolio of assets which we are -- which are ready to build, which we'll come back to. So all in all, very, very positive period for the company and 1 which if you take the first point around earnings, where we've got the increased level of earnings and the development we, as mentioned before, it gives us the opportunity to be -- to have the opportunity to be able to invest potentially into our self-developed assets. Okay. Moving on to Page 2 with the period highlights. What we've got is on the financials on the top left there, we've got increase -- further increase to the discount rate, which reflects the movement in gilt yields during the period. Neil will talk about this in more detail, but we've seen discount rate move to 7.25%, which looks prudent when looking at the assets and also the geography of the company being U.K.-based. NAV has remained very solid. So the counterweight to the increase in the discount rate is that we've captured very high power prices on our power sales. Power forecasts have been very positive and inflation has remained inflated, which were all benefits to the company. So we see the strongest NAV that we presented previously. We've also had very good asset activity on the top right there. So we made an acquisition of just shy of 50 megawatts, which is an operational plant just before Christmas. And we've also, as I mentioned, we've had 215 megawatts of new sites, which have been given planning permissions in the period between July and December. And bottom left, mentioned very, very strong earnings for the period where we're expecting over 2x dividend covered for the full year. And just finishing up on that development pipeline, which I mentioned, we've grown the development pipeline to over 1.3 gigawatts in development or being developed and that is almost 1 gigawatt of solar and the balance is made up of battery investments. Okay. So just a quick summary on Page 3 of the current portfolio. So on the right-hand side, you can see the company has grown to around about GBP 1.4 billion. Market cap is as at the end of the period was in excess of GBP 100 million. And so we've got that vast majority being solar assets and then we've got a growing portfolio of wind assets are all geographically based in the U.K., and you can see the bottom right there, the vast majority of that is within England. On the left-hand side, just the overview really good performance, very strong operating performance by the portfolio, above expectations on the solar portfolio actually again. And we've got an average revenue was captured as GBP 190 per megawatt hour, which is 1/3 higher, as we've mentioned, over 1/3 higher than in the period June '22, and it should be -- it's worth referencing, it's actually 4x higher than the average revenue that was captured in December '21, which I think gives you a sense of the -- obviously, the success we've had in capturing those prices, but also what has happened in the past 12 months. Revenues, which are split pretty equally now between regulated revenues and also the power sales, partly because of the high levels of revenues that we've achieved with the power sales has made that balance more like 50-50 historically, it's always been pretty 60-40 in favor of the regulated revenues. If we go on to Page 4, a key chart in terms of the forecast that we have in terms of going out. And as you're aware, Neil will actually talk about the power strategy in a few moments in a little bit of detail. But historically, we've always delivered the earnings and dividend through in-year earnings for the past almost decade. If you look on the right-hand side there, we can see the outlook has never ever been stronger in terms of our earnings potential. And so you can see in the June '23, we've got the full year target dividend of 8.4p per share, and we're seeing that over 2x cover there, which was previously mentioned, which is net of debt amortization and the EGL. But then on a cumulative basis, you can see how that grows over June '24 and June '25. Now that includes we have very high visibility of that because of the power fixes that we have undertaken, where we've looked to strike for as long a contract as we can in the past 6 to 12 months and investors will see the benefit of that clearly over the next 2 to 3 years. And it also relies on some of the -- obviously, the power forecast that we're using at the moment. But you can see it's an incredibly strong position for the company over the, as I say, the next periods out to June 2025. On to Page 5 on the underlying earnings and showing you how we work through that. So if you look at that half year position, which is the column to the left, we've got total underlying earnings of 8.41p per share, which is nice because that is in excess of the full year target we have for our dividend, and we've achieved it in 6 months. So that's obviously a very pleasing position to be in. We've amortized more debt. We've had reserves brought forward, which means that where we end up is that we've got over 7.5p per share post the dividend in the period available for distribution, which is where we're starting to build that very significant surplus that I've just spoken about. And at the bottom there, the net asset value is just a couple of pence higher than it was at the end of the full financial year ending June '22. And then on final part from me before I hand over to Neil is on Page 6. We'd like to show you the bridge tart of what we -- how the -- from the accounts, how the earnings translate into dividends and cover dividends for the shareholders on a pence per share basis. And you can see that bridge chart. And I think the key thing to look at is if you look over to the right-hand side, you've got that 7.5p per share being carried forward, which clearly is a very strong position to start the second half of the financial year end. And with that, I will hand over to Neil to talk about the capital structure and the valuation.

Thank you, James. Now this slide outlines the company's capital structure and how it has enabled the fund to flourish since listing in 2013. Critical to this has been ensuring the structure offers the ability to maximize shareholder value through enhanced operational flexibility. Now to achieve this, Bluefield Solar has deliberately structured over 85% of the company's debt across portfolios of assets rather than borrowing against individual projects. And in doing so, enabling it to spend more time delivering value-enhancing portfolio initiatives such as life extensions, capital works programs and power price fixing. All 3 strands as delivering material value to both individual projects and the wider portfolio through improving revenue across near-, medium- and long-term horizons. Although this has especially been the case across the company's ability to apply a dynamic rolling power price strategy, securing terms from competitive tenders instead of being locked into periodic fixes under single long-term offtake agreements. It's why during the COVID-19 pandemic, the fixes the company has secured helped drive record earnings. And why as power markets have rallied since that the company has gone on to report even higher earnings. Turning over the page to debt strategy. Now connected to the benefits of the capital structure is the position of the company's debt arrangements and the strategy of maintaining leverage between 35% to 45%. This ensures cash flow cover on debt ratios sit materially above lender levels, resulting in limited risk of equity distributions being impacted. To facilitate this, the company has arranged at over 3 time horizons. Short term, this reflects [ redoable ] funds available under the company's RCF to support acquisitions. Medium term, it's a financing that has a limited tenor in order to secure favorable cost margins over longer-term debt, but delivery structure to include a long-term swap so that refinance risk is materially reduced and any impact from adverse interest rate movements are avoided. And finally, long term, this debt is sized to ensure it is fully amortizing within the life of the subsidies, completely insulating the company from interest or refinance risk over the life of the loan. Current overall leverage of 38% combined with only 10% of this not being fully hedged, means the company has very limited interest rate risk exposure in its current debt drawings. Turning over to power price movements. Now following on from the capital and debt structure slides, a key operational benefit enjoyed by the company from its gearing approach is the flexibility to adopt a rolling power fixing strategy. The result is that the company has delivered record earnings in falling and rising markets without exposing shareholders to the risk attached to daily power price volatility. The flexibility of this hedging approach has meant that during 2022, when power prices reached successive highs following the recovery of the global economy from COVID-19 and the impact of Russia's unprovoked invasion of Ukraine, the company was able to adjust its fixing schedule in order to implement competitive tenders across over 310 megawatts and in the process, securing elevated pricing out to 2025. This has also meant the company enters 2023 with 100% of its fixed power sales hedged until March '23, over 85% until March 2024 and 80% until June '24 with over 650 megawatts of the portfolio hedged at an average contract price of GBP 173 per megawatt hour for this period. Now when combined with average pricing of around GBP 150 per megawatt hour as at the 31st of December, '22, a rise of over GBP 100 per megawatt hour to the position in December '21, the results as the company has secured very attractive power prices over the next 18 months at levels that provide a high degree of visibility in respect of the company achieving over 2x dividend cover in the period to June '23 with the expectation of it rising further in the period to June '24 and June 2025 with the inclusion of carryforward surplus earnings. So turning to the Electricity Generator Levy. Now the consequence of the unprecedented rises empowered during 2022 and the pressure this added to households already struggling with rising living costs was that in November 2022, in response to demand for a windfall tax, the U.K. government announced the introduction of a temporary 45% tax, otherwise the levy on the extraordinary profits potentially being made by electricity generators. The levy will be in place from the 1 of January '23 until the 31st of March '28 with a benchmark price of GBP 75 per megawatt hour linked to U.K. consumer price inflation. Revenues earned from assets under feed and tariffs, renewable obligation certificates, or contracts for differences with the low-carbon contracts company are exempt. Now with around 53% of revenues out to the mid-2030s, the company has revenues that are exempt from the levy with the combination of the company's successful power fixing strategy and medium-term power forecast, mean the estimated value impact to the directors' valuation is still close to around GBP 90 million or 15p per share. However, the company is pleased to be playing its part in providing a solution to the energy crisis. Turning to valuation parameters. Now despite the political turmoil during the period from June '22 to December '22, demand for U.K.-based renewable assets remained high. Although under the surface, equal and opposite forces have been at play as record power prices and rising near-term inflation have been tempered by the introduction, the Electricity Generator Levy, as just discussed, and increasing interest rates. With CPI and RPI running at 30-year highs during 2022, the director's valuation has reflected this and applied RPI at 10.9%. Consensus on the extent of a fall in inflation remains split beyond 2022. And so 5.5% has been applied for 2023, an increase from 3.4% in the June '22 evaluation with 3% until 2029 before dropping to 2.25% thereafter as RPI is replaced by CPIH. As the company is a net beneficiary from inflation and even more so following recent highly regulated revenue acquisitions, increases to inflation have a positive impact on revenues and ultimately value. Inclusion of the latest power curves from the company's 3 leading forecasters as well as PPA fixes in the period have contributed around GBP 120 million of additional value compared to June '22. That's an astonishing figure and 1 that is principally a result of surging estimates of power prices for the period to 2025. Although the introduction of the Electricity Generator Levy means this figure is reduced by close to GBP 90 million of additional taxes. Looking beyond the mid-2020s, the forecast is continue to hold predictions around medium- and long-term power prices being in line to the curves released over the past 12 months. The Central Bank is continuing to increase interest rates between June '22 and December '22. In fact, as the Bank of England moved its base rate up from 1.25% to 3.5%. The directors felt it prudent to also adjust the weighted average discount rate to 7.25%, up from 6.75% in June '22 and 1.25% higher than in December 2021. So 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 December '22 is squarely placed within the universe of values seen across transactions over the past year for portfolios of comparable size and technology mix. James?

Thank you, Neil. Okay. On to Page 12 on ESG. So we've made very good progress in the period on our ambition to be at the front of the pack in respect to ESG standards and are setting a very high bar in terms of where we're looking to get to. And we've achieved 100% alignment on EU taxonomy in the period. We've moved forward with Level 2 SFTR disclosure requirements and also we've adopted a sustainable investment policy into our investment policy procedures. And we're also making which hasn't been mentioned on this slide, but we're also making very good progress with the biodiversity project we started across the several thousand acres of solar farms that we have across the U.K. and that we hope to see the -- obviously, the ecology on the land on the portfolio. We'll see the benefits of that work over the coming decades as we look to implement that very wide ranging program. It should be said on the right-hand side of Page 12 is that we are now -- we've moved from powering a city the size of Bristol, which is last year, I think we're now powering a city the size of Leeds with renewable energy each year. So that's, again, another good milestone for the company. Moving on to the Page 13, which is future growth. So we spoke about this at the beginning, and the -- 1 of the key elements that we've been working on over the past few years, and it's very much the DNA of Bluefield is this ready-to-build development capability that we have internally. And you can see on the right-hand side of the page where we have very significant development progress has been made by the team where we've -- where you can break it into 3 elements: one is the ready-to-build side. So we've got over 400 megawatts of ready-to-build assets, which are going through since both solar and storage assets and we've been breaking ground on some of those assets already. And we've got that program kicked off, and it will be going through until 2026. The second is that we have an additional over 200 megawatts of solar projects in planning. So what that means is the planning application has been put in and submitted, and we are awaiting determination by the local authority on whether we have been successfully granted the plan permission. And then in development, there is a further over 600, 650 of solar and battery projects which haven't yet had those planning applications put in place, but we're working towards that. So combined, we have a very significant and developed proprietary pipeline that we can control, and that gives us very good visibility on the future growth of the company, which we can control. And then if we go back to that, the earlier comments about the earnings surplus we have ahead of the dividend, obviously, that's something where we have the ability to very effectively use those potential surplus earnings into these proprietary deals that we're working on. Okay. So the penultimate slide here, so the public policy has been at the center of really the period under review. And I think that the last 6 months have shown that public policy is interlinked in terms of government have responsibility for creating firstly, financial stability. And then secondly, the ability to provide stable long-term energy policy measures to support investors like Bluefield. And as I said in my opening comments, the -- this period was the most challenging period we have experienced since we IPO-ed the company. And the epicenter of this challenge was the U.K. gilt markets where we saw very significant volatility, and we saw a doubling of the U.K. gilt rates pretty much overnight around the time of the mini budget with the trust government. And at 1 stage, it actually became quite difficult to value long-term assets during that period. And the first thing which we said is it's been very reassuring to see that there has been a real period of stability has returned. I mean, gilt rates are still inflated from -- certainly from 12 months ago but we're seeing stability has returned to the market. And what that then means is you then -- if you have some control over that area, we've then got the fact that renewables can then look -- renewables and storage then becomes the sort of the centerpiece for the U.K. government in terms of dealing with what we've termed the energy trilemma. So this is the challenge for governments of the cost of energy, energy security and also Net Zero. And obviously, the last 12 months have put this into a very sharp focus. And what is really encouraging in terms of the current government, but also just generally in terms of public policy is that for very hard economic reasons that the renewables and storage combined deal with the energy trilemma together. So it's the lowest cost, solar and wind are the lowest cost of energy today. They are also very quick to deploy. So that increases energy security. And then in doing so, it deals with the very important issue of climate change and our Net Zero targets. So we think that even though it's been a challenging period in terms of public policy, the end part has been fairly positive in terms of where the government has got to. Okay. So just to conclude, it's been a very positive end to what was a challenging period but 1 that again shows the robustness of the model that we have set up. And we've -- we end the period with record earnings for a half year and with very high visibility on future earnings, which could deliver 2 to 3x dividend cover over the next couple of years. And with the near-term pipeline growing so significantly and with public policies, as just said, having the stability that we need to see, we think that there is reasons to be very optimistic about the next period for Bluefield Solar and that we are in a very strong position to be able to take advantage of the market opportunities presented to us. Thank you for listening, and good morning.