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

Good morning, and welcome to the annual results for the Bluefield Solar Income Fund for the period ending June 2023, and thank you, everyone, for joining James Armstrong and Neil Wood from Bluefield Partners presenting Investment Adviser to the Bluefield Solar Income Fund. The presentation should take no more than about 30 minutes. We are delighted to announce record results of Bluefield Solar, which are the best in the company's 10-year history and have highlighted the core strengths of the business. To counter these results the company's share price is at a significant discount to NAV. However, we hope that we can demonstrate during this presentation and obviously through the detailed analysis of the results, how durable these returns are and how fundamentally robust the company is going forward. For the purpose of this presentation, we're going to skip over the introduction slides and go straight to Page #6. So from my introductory remarks, there are 5 key areas that have driven outperformance. And crucially, there are areas that have been implemented often an IPO or certainly many years ago that will be highly beneficial to the company in years to come. In short, they are very difficult to recreate. And I'll highlight each of these as we go -- we will highlight each of these we go through the presentation, but the summary is, one, a very defensive capital structure. We've got prudent levels of debt, which is overwhelmingly fixed and amortizing and therefore not exposed to interest rate increases. Thus, with our index-linked revenues, inflation for the company is beneficial. We have a power strategy that's delivered earnings in excess of 2x dividend cover. So that's net -- just to emphasize, net of debt amortization and the EGL so the energy generators levy. And it's been delivered through a very specific and optimized approach to power sales, and Neil will talk about this in just a few moments. We have active management of the assets from a dedicated team now of 114 people addressing all aspects of the value chain and the life cycle of the assets. The fourth area is our proprietary pipeline, the continued advancement of this which also now has the -- is beneficial, obviously, in terms of the ability for us to control and create value for shareholders, but also going up to the point about the 2x dividend cover, we've now got the opportunity to use some of that. Those surplus earnings for reinvestment which will create value for shareholders or indeed, we've got the opportunity with our large pipeline, which we'll talk about through the presentation to be able to sell to third-party acquirers. And last but not least, number five, the demonstration over the past 10 years of very disciplined capital deployment and capital discipline, which has combined, if you look at all these factors put together, have delivered work towards the delivery of these results today and driven a high level of visibility of high performance in future years. So if we go on to Page 7 with the business model. John Scott, Chair of Bluefield Solar says in his statement that we have a very simple business model than we do. We convert a radiation or wind from onshore wind turbines into electricity. We convert these into revenue, which net of debt service drives earnings and dividends to our shareholders, which you can see at the bottom comes down for that distributable earnings of about GBP 90 million and then surplus of about GBP 58 million and giving that 2x -- over 2x dividend cover. It should be noted that not only it is a simple business model, but with our focus on solar and with our prudent debt and power strategy, we have the lowest risk portfolio in the sector, which again is very comforting in terms of the high-level results we've delivered thus far. On Page 8, I suppose this is a way of summarizing all of those elements coming together with the financial highlights and it emphasizes [ one of the ] incredibly strong period that we've had. If you take the top row, the financial overview, we've got gross asset value of just shy of GBP 1.5 billion and NAV, which at just shy of 140p has been very resilient through the past 12 months, even though the discount rates has increased materially. So it's gone up from 6.75% in to 8%, which is to reflect an increase really in the risk-free rates that we've seen during this period. But this has been offset. The reason the NAV has remained so strong. It's been offset because we've got these fixed levels of debt, which means that we benefit from inflation with our inflation-linked revenues and also we benefit from the very high power prices that we've locked in, and we'll talk more of that in a few moments. And this can be seen in the very significant amounts of the operational cash flow, which has close to doubled from the previous financial period. In the middle row there, defensive debt strategy, which I've touched on a prudent level of -- gearing just over 40% to growth assets. 3.5% average cost of debt with almost 13 years as an average date of maturity that's really important because we've got -- it's something we've really focused on since we started putting debt into the company in 2016. And of the 400 -- circa GBP 460 million of debt that we have ex the revolving credit facility around about GBP 430 million of that is fixed and amortizing. And then on the bottom row, we've got the dividend cover, which is over 2 times cover, again. So just to emphasize that, it's net of debt amortization and EGL and we're also delighted to announce today -- the Board is delighted to announce that we've got an increase in the target dividend for the full year, which was -- target was 8.4p per share, and it's been increased up to 8.6p per share, and they've also announced that the dividend target for the financial period ending June '24 is 8.8p per share, not less than 8.8p per share, which again, I think that makes us the highest payer in our sector, I believe. The level of earnings we've got, I think, obviously, if you put all that together, the earnings is not only the highest -- one of the highest dividend payers in the sector, but it's also a very highly sustainable one. And the dividend yield now is circa 8.3%, 8.4%. One point about the earnings and the dividend and the debt amortization. We've obviously created significant headroom to be able to reinvest into assets, create infinite IRRs for our shareholders, which we believe in certain selective situations will be a good use of those earnings whilst also obviously keeping a sensible buffer and it's a very nice position to be in as we make this announcement. Okay. On to Page 9, the portfolio overview. So as you can see on the top left of the page, we've got a very diversified portfolio, which is spread across most of England, and some in Wales going up to some elements of assets in Scotland and in Northern Ireland. Average life is 27 years, which is very cautious if you're thinking about an asset such as solar, which makes up the vast majority of our assets. That's fairly cautious in terms of -- we'd expect to be able to outperform that. So we think there could be some upside there going forward. Going across to the right-hand side -- the top right-hand side of the page, high levels of regulated revenues you see there, that 1.55 ROCs per megawatt hour. That's a very high level of ROCs with long duration and there that makes Bluefield Solar with one of the highest levels of regulated revenues in the sector. And you can see again on the -- just that mix that I spoke about, where you've got over 90% of the technology mix is in solar, which for those keen sector watches over the last decade, that was noted that solar is the most consistent predictable technology you can use. And if you're looking for stable defensive income, there is no technology that gets near -- in our sector gets near solar. The bottom right, just to finish on this page is, again, in terms of risk mitigants. We have across our top 10 assets by capacity, which starts with Bradenstoke, which is the 70 megawatts solar farm, which is the largest solar farm in England at the time we acquired it. It makes up only 40% of the [ type of ] portfolio. So we have a great deal of mitigation in terms of diversity of portfolio and obviously, no risk around concentration. So moving over to the revenue -- portfolio revenue mix, which is on Page 10. We've done the portfolio revenues out to 2033. So taking it to a decade out, so there, obviously, the company then will be -- its 20th anniversary of the company. And obviously, this what you're looking at on the top half of the page is a static view. So you've got the dark blue at the bottom is the other regulated revenues or fixed contracts and then the green is the merchant element. And then within that, you've got this striped line, which is the CfD assets, which we've just recently been involved with at auction and also from the previous AR4 allocation. So what you can see there in terms of the next decade is that there is very high levels of index-linked revenues and a very, very sort of good sense, I hope, of the sustainability of the revenues that we've got within the portfolio. And a key thing to note in terms of that green -- the green assumption around power forecast. The way that we present this as you have -- initially, you've got your short-term contracts, which are taken into account. And then what we do is we apply the long-term assumptions of a blend of the 3 leading power forecasters. But because of the adoption that we have -- excuse me, of the solar capture curves we're actually looking at a 16% discount to the base forecast over the life of those forecasts. So not only is it very comforting in terms of the forecastability of the regulated revenues, but there's also a very cautious power assumption. The final thing to say here is that the middle bit, which I mentioned, I touched on, which was the CfD approvals. We wanted just to show the impact of the fact that if you see that striped line, you can see that if we were to including Yelvertoft, which is being built at the moment, which is a CfD asset. We've also recently had a series of assets that were successful in the AR5 CfD auction. And there's a very interesting dynamic developing at the moment in the safety auctions, which is going to be potentially very, very valuable and attractive to Bluefield Solar. So the background is the offshore wind market is really struggling due to increased costs. There is a sort of the fine line of economic justification for building assets in the middle of the sea has closed because of higher costs. And what that means is that at the moment, there is a lack of appetite to build new offshore wind because participants don't feel they can be compensated for the risks they are taking and obviously, relative to where risk-free rates are today. And so that's a whole separate topic. But in relation to Bluefield Solar, this is creating a material opportunity for solar generally in the CfD market. And when we participated in AR5 we were granted CfDs for all the assets that went into the auction at the highest clearing price available, which was actually GBP 47 per megawatt hour in 2012 prices. So it equates to circa GBP 65, GBP 66 per megawatt hour today. So it's a very, very attractive sort of market, and that's developing. And I think that's one area where because of our proprietary pipeline, we've got the opportunity to be able to create some very interesting regulated revenues and push the duration of those out for beyond that sort of 2033 point. Okay. So the final page for me discussion before I hand over to Neil is on the dividend track record. And what you can see here is just -- I mean, it's a great sort of -- accumulation of the financial performance of the past decade on Page 11. And you've got the NAV total return, which is very pleasing on the top left, 90% since we IPO-ed. We've paid GBP 273 million in dividends, which is excluding the announcement of the dividend today, so it's all those which have been paid and the aforementioned 2.1x dividend cover and then you've got this growth, the declaration today of an 8.6p dividend, which was in excess, obviously, of the target or the not less than 8.4p, which the Board has stated for the period ending June. And then we've got the announcement of 8.8p so there's a very -- it's a really strong picture, incredibly strong picture for the company in terms of both a consistent performance over the last 10 years, but also a very, very strong basis upon which to grow the company going forward. But with that, I will hand over to Neil, who will talk about valuation and capital structure.

Thank you, James. Since its IPO in 2013, the company has focused on a simple and deliberate debt strategy of ensuring leverage levels are maintained prudently below the company's overall limit at 50%. And then outside of the company's revolving credit facility, all debt within the structure is secured with fixed interest rates on fully amortizing terms. Deliberately structuring the company's long-term debt across portfolios of assets rather than borrowing against individual projects, not only enables highly attractive debt costs, as evidenced by the current average cost of long-term debt of circa 3.5%, but also ensures cash flow cover on debt ratio sits materially above lender levels, resulting in a reduction in risk of equity distributions being impacted. Crucially, it provides the company with the 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. This insulates the company from periods where prices dropped dramatically has happened during the COVID-19 pandemic as well as enabling it to capture attractive fixes in a rising market. And finally, by consistently aiming to maintain overall leverage between 35% to 45% on a steady-state basis. The company ensures crucial headroom is available for the fund to maximize the use of its revolving credit facility should attractive investment opportunities arise where funding needs are immediate. Turning over the page to Slide 14, inflation and discount rate. Over the course of the past period, 2 significant push and pull forces relevant to the company have been at play, inflation and interest rates. As inflation across both CPI and RPI hit 30-year highs driven by confluence of factors, Central Bank stepped up their respective efforts to tackle continued increases by initiating an unprecedented series in recent times, at least of interest rate rises with the Bank of England, moving its base rate up from 1.25% in June 2022 to 5% by June '23. Now whilst base rates have a bearing on discount rates, the better measure for the assets held by the company is the movement in underlying long-dated gilt yields, which also rose during the period, albeit more modestly compared to base rates. The directors have reflected this sentiment within valuations during the period by increasing the portfolio discount rate from 6.75% in June 2022 and to 8% in June 2023. And in fact, since December 2021, a cumulative rise of 2% has been applied by the directors. A movement that correctly bears greater comparison to those in underlying gilt yields over the same period rather than base rate. However, as the company has circa 60% of its revenues to 2037, directly linked to inflation through government-backed support mechanism. The company is a net beneficiary in an inflationary environment. And the result of this, as the sensitivity on the slide shows is that increases to inflation assumptions have a positive impact on value and provide a significant counter to the effect of rising discount rates. If we turn over the page to Slide 15 and the NAV bridge. The valuation of the portfolio is premised on a willing buyer/willing seller methodology with precedent market transactions forming a critical benchmark in the determination of the director's valuation. With demand for U.K.-based renewable assets remaining high there has been limited movement in the headline valuations of assets. But this relatively steady holistic position masks a number of updates and underlying assumptions over the period. And key changes outlined in the NAV movement chart cover the effects of: number one, changes in power price forecast over the period to 30th of June 2023 and the corresponding impact of the electricity generator levy, and this is a 45% tax on power revenues greater than GBP 75 per megawatt hour, which was announced late in 2022, and in place from the first of January 2023 until 31st of March 2028. Secondly, increasing near-term inflation assumptions, reflecting expectations that U.K. inflation will remain higher for longer as well as an increase in the portfolio discount rate to 8%, following rises over the period in the Bank of England base rate and 15-year gilt yields. Thirdly, inclusion of operational acquisitions made during the period. In this case, the 46-megawatt 1.4 ROCs subsidized solar portfolio purchased by the company in December 2022 as well as increases in value with respect to [ base rates ] development and construction portfolio as a number of sites moved to fully consented status and further investment into construction projects was made. And finally, the combined impacts of increases in working capital, which has grown substantially during the period to June '23, reflecting higher power prices being captured from the company's successful PPA strategy have been offset by increased debt balances within the company from addition of further long-term debt and drawings under the company's revolving credit facility. 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 June '23 is squarely placed within the universe of values seen across transactions over the past year for portfolios of comparable size and technology mix. So if we move on to the next section of the presentation and portfolio operational performance. Starting with Slide 17, active management. Now active management can often be used to cover a myriad of generalized activities in the investment space. However, for Bluefield Solar the purpose is clear. It means deploying the specialist knowledge of a dedicated workforce of 114-and-growing individuals within Bluefield Partners and Bluefield Services. Split across specialist teams covering investment, development, ESG, engineering and construction management, monitoring and reporting, technical asset management, finance, operation and maintenance, and commercial with 74 different core responsibilities. These specialist units have been created over the past decade, enabling a series of assets enhancing programs, which have consistently added value to the company's portfolio, both on a capital basis, such as work initiated over 5 years ago that has led to life extensions being secured on greater than 65% of the portfolio. And on an earnings basis, cost saving initiatives on core OpEx items like insurance, operations and maintenance, and business rates are constantly run. Teams have also combined to drive innovative repowering investment programs on 17 small-scale wind turbines in Northern Ireland as well as securing CfDs and extension projects to 2 of the company's existing Solar plants. Dedicated teams within Bluefield Services provide around-the-clock monitoring, ensuring operational issues are highlighted in real time to the company's operations and maintenance providers in order to minimize downtime from any given incident. And finally, commercial teams design and execute power fixing strategies, sourcing offers for the sale of electricity from rolling competitive tenders that have provided shareholders with revenues from power markets that have helped deliver a decade of sector-leading dividends. Moving on to Slide 18 and operational performance. Operational performance across the portfolio for the period to June '23 has been in line with expectations. During the period, solar radiation was circa 6% ahead of forecast, whilst wind speeds were 16% below. This deviation in performance of the 2 key feedstocks for the company's operating assets highlights the benefit of not only carefully layering a minority of wind generation to a majority base of solar generation. But crucially, it broadens the company's ability to benefit from selling power across multiple time periods as highly forecastable daylight-hours-driven solar generation is complemented with the additionality provided by wind for generation across any 24-hour period. The result is a widening opportunity in both power price fixes from off-takers. Indeed, the total average units of revenue for the period was circa 20% ahead of expectations and the number of counter parties the company is able to contract with. This diversifies both the timing of revenue generation but also crucially counter party risk. Looking beyond the success of the most recent 12-month period, a key operational measure for the company is delivery of cumulative outperformance on generation on a year-on-year basis. Because as the chart shows, this really highlights how effective multiyear operational management strategies have been. Indeed, supporting the sustained period of solid operational performance is the combination of carefully tailored preventative maintenance programs, targeting activity during periods when lower generation is expected and a rolling capital investment program which focuses on replacement of key components in order to continually optimize the long-term operational performance of the portfolio. Turning over to Slide 19 and PPA strategy. So Bluefield Solar focus is on fixing power price agreement contracts at the short end of the power curve, so between 6 to 30 months. and it actively monitors power market conditions to ensure that contract renewals are spread evenly across periods. A crucial tenant of the company's PPA strategy is flexibility within the company's capital structure that enables PPA counterparties to be selected on a competitive basis, not influenced by lenders requiring long-term contracts with one offtake. Now by rolling PPA fixes during the year and targeting the most liquid area of the power market, the company is able to take advantage of rising power prices as well as insulate against points where markets [ score. ] Over the course of the past 12 months, the strategy has enabled fixes to be secured during periods when wholesale power prices were close to their peak. Evidence of this is reflected in the BCF average seasonal weighted power price, which for the 12 months ending 30th of June 2023, increased by 147% from GBP 57 per megawatt hour in June '22 to GBP 141 per megawatt hour in June '23, driving record earnings for the period. And as mentioned previously, over 2x dividend cover, net of debt amortization and the electricity generators levy. Equally importantly, though, is that revenue certainty has been secured on 94% of the portfolio in 2023 and 82% of the portfolio in 2024 and the majority of the portfolio to 2025 at power prices that are, on average, over GBP 50 per megawatt higher than the current forecast of power curves over the same period. And this gives confidence that earnings in the period to June 2024 and June 2025, and will maintain cumulative dividend cover of in excess of 2x. The result is the investment adviser believes its PPA policy is the best strategy for shareholders who are looking for stable revenues and forecastable sustainable dividends with high visibility of revenues on a rolling multiyear basis. James?

Thank you, Neil. I'm going to talk about capital allocation future pipeline and ESG before my concluding remarks. So on Page 21, looking back over the 10 years that we've been in business, the shareholders can track the journey we've done and the value that's been created. And if you look at the -- some of the numbers there in the middle of Page 21. We've -- the equity deployed a GBP 665 million, which is now valued at a pleasing GBP 854 million of net asset value, which goes to that aforementioned capital discipline point. We made further investments using short- and long-term debt, which delivers alongside working capital, gives you the gross asset value of just shy GBP 1.5 billion. And we paid out, as mentioned, over GBP 270 million of dividends to date. And how this has been delivered is partly down to that capital discipline point, which you can see on the chart on the bottom half of the page, where there is periods where we are going to be very active which is in the period of 2013 to 2016 and then through 2020 onwards. But in the period 2017 through to the middle of 2020 we made very few investments and we didn't go and raise capital from the market once because the conditions weren't right for us. In addition to that, we have a focus and an ability to be able to look at the primary market where we will take assets through construction and create value in that way. And if you combine those 2 elements of discipline and being able to enter the market at the right point at the right time, combined to a sensible debt strategy, combined, they have contributed to delivering the outperformance for our fund. And if we move on to Page 22. We can talk a little bit about that development and construction strategy that we've got. So being able to create value for shareholders has come down historically in large part to being able to access the market at the right time. And one of those areas is having the capability to create new capacity through the primary market, delivering tailor-made assets at a certain price, giving visibility over deployment. And you can't do this. You can't create this sort of model overnight and nor should you try to. We started looking at developments years ago. We've built up a dedicated development team that deals with self-developed and third-party developed assets. We have planning experts, land experts, an engineering team and a construction management team. And combined, they are creating. If you look on the right-hand side of the page, and that sort of column, combined, they are creating huge value for the company and also visibility of future growth potential or indeed sale potential. So getting construction on that donut chart, that's covering Yelvertoft and Mauxhall Farm. And then if you look down to the bottom half of the right-hand side, you've got this progress that's been made in terms of consented sites that we had almost 370 megawatts of sites, which were consented in the period under review, which then gets us to this sort of circa 600 megawatts, which are all valued -- I should just add at the moment at the development purchase price. So there's no additional value there. And then coming behind that is, again, almost in excess of 700 megawatts of assets, which are the pre consented stage. So combined, it's going to be an incredibly exciting bit of progress for the company, and it gives options. So over the next 5 to 7 years, we have the option to be able to build out the company should we wish or indeed if strategically we think it's preferable then we can look at selling some of these assets to third parties. And it's a very -- it's a very attractive position to be in and one that is very much central to the sort of the growth and strategic view of the company going forward. So on to Page 23, which is the ESG highlights. And we could have a whole presentation just on the ESG activities of the company alone. There's 3 full-time members of staff working at Bluefield Partners and our focused on this. And the difficulty is trying to condense down what the highlights could be in the period. A key focus of just trying to do the key focus has been to try and obtain a better understanding of how climate change can potentially impact the portfolio. So as the renewable energy fund, we're very well placed to benefit from the opportunities arising from the energy transition but we're also conscious that climate change will present the physical risk of the portfolio. So this year, for example, we've been looking at what's the impact of extreme heat could have on solar assets and the generation and how this may impact revenues over different time periods and over different temperature scenarios. And looking forward, the next stage is to look at that but looking at the potential impact of changing wind patterns, which is where you look at that on the left-hand side, that sort of physical and transitional scenario analysis. We further embedded ESG policies within Bluefield Solar's corporate governance, including the adoption of the suite of policies, which are in the middle there, middle column, including human rights policy, supplier code of conduct and helping us communicate our ESG expectations to business partners and ultimately cascade best practice across the whole supply chain. And finally, we've got biodiversity continues to be a real area of focus for Bluefield Solar. We're in a unique position having circa 3,000 acres of solar farms in the U.K. alone. And so we have the ability over a prolonged period to make a real impact, and we continue to build our biodiversity data sets through ecological surveys, and biodiversity net gain assessments, which is something I know is very important to a lot of the shareholders and looking at how that impacts the operational portfolio. And for the upcoming year, we're going to pull together all this data into an overarching nature strategy aligned with the recommendations of TNFD, which is the task force on nature-related financial disclosures. And clearly, this is an area which is of huge interest and also a consequence for shareholders. So to conclude on Page 25, we'll sort of come back to the beginning, which is that we've developed some really -- a really powerful platform, which has been built up over the course of the last decade, the debt strategy, the power sales strategy the opportunity for reinvestment through our proprietary pipeline, the end-to-end management that we've mentioned with 114 people dedicated to the fund and a consistently disciplined capital allocation. And all those areas have coalesced to create record earnings for the company in the period and have laid the foundations for an incredibly strong platform for the company going forward. And as I echo the words of John Scott, the Chairman, that -- and we look forward to the future with great confidence and are delighted to be able to present these results to the market today.