NextEnergy Solar Fund Limited (NESF) Earnings Call Transcript & Summary

Now, Ross, we've had you on the show before, but thanks very much for doing this again. And maybe you could do, as usual, just talk a little bit about the fund and what they are trying to do and then we get some questions, please.

Yes, that sounds good. Thank you for having me this morning. And so we can move on to the first slide. I thought it would be helpful just to revisit the NextEnergy Group. So what we've built within the NextEnergy Group is a mission-driven organization that is driving towards a more sustainable future through the adoption of renewable energy. And we've built various different verticals within the business to allow us to have more than 300 specialists focused on each aspect of the value chain that allows us to drive significant value for our investors across all of the assets that we look after. So first vertical, which you'll be most familiar with, is the NextEnergy Capital, and I look after the U.K. business, and I'm COO of the wider global business. And we look after various different funds throughout the world, all focused on solar PV and ancillary technologies. And we run around 400 operating physical assets across the globe. 100 of those are in the U.K. And we've got around $4 billion worth of assets under management in that vehicle. We've got a sister company, which is called WiseEnergy. It's the world's largest solar-focused asset manager. So it looks after assets in every stage of their operational life, from the initial concept right the way through to their decommissioning. And we're able to use that intelligence and build it back into the way in which we think about the assets that we buy, build and operate in order, again, to drive that incremental returns for our investors. We also recently launched a development platform called Starlight, and that allows us early access to pipeline, again, across the globe. We've got around 10 gigawatts under management, significant pipeline in the U.K. and other OECD markets, and it contributes nicely to the incremental growth story that we have as a business. Now if we can move on to the next slide, I'll talk a little bit more about NextEnergy Solar Fund. So I've been with NextEnergy now for 11 years. And what's really nice is the NextEnergy Solar Fund has been a really important part of that journey. So NextEnergy Solar Fund now enters its 10th year of operation, and it's really nice to reflect on how successful that journey's been. So the NextEnergy Solar Fund focuses predominantly on U.K. solar. So we've got 100 operating assets, and more than 90 of those are in the U.K. And those are predominantly subsidized by the government through the ROC, so the Renewable Obligation Certificate, and the feed-in tariff regime. But we also have new build assets in there that have long-term corporate power purchase agreements, so selling power to energy users. And we're also bringing online some battery storage technology, which we'll talk about in a few slides' time. And we also have international assets in there as well on the solar side that bring a little bit of diversification to the revenue stream. What's really important from my perspective is the platform has the significant number of really well-diversified operating physical assets that have really long-term predictable revenue streams. We've then got a really uniquely designed capital structure, which allows us to continue to pay a well-covered dividend. And we've, year-on-year, increased that dividend in line with RPI and continue to look at a very attractive future for the platform in terms of its growth opportunities and in terms of how it's going to continue to service that type of return for its investors. If we can move forward again. So talking to the dividend itself, we currently have an outstanding 8.35p dividend target for the current financial year. And that's an 11% year-on-year increase. And as I've said, every other year, we've either achieved or beaten RPI since the company's inception. We've paid more than GBP 318 million of dividends out since IPO. So that gives us an exceptional dividend track record and also has been an incredible total return for the investors who have supported the platform to date. What's nice from my perspective is where we are in terms of cash coverage. So we're 1.3x cash covered for this current year. And we're able to, through the predictability of the revenue streams that we've got, forecast that we are covered by cash for the future period as well, which in the context of things like that battery storage conversation that you've had earlier on, really does set this type of a trust away from other peers in the group. So we're very comfortable with how the underlying assets are operating and how we are selling the power from those assets in order to continue to drive forward that dividend cover. If we can move on again. Very briefly, the assets, I talked about it already, but that 100 operating assets delivers around 930 megawatts of capacity. It's split across various jurisdictions, but very heavily concentrated in the U.K. These listed trusts have been a really important driver of the steps we've taken so far to net zero. As a business, we have built around 14% of the U.K.'s solar PV -- utility-scale PV, and we're very proud of that, and we look forward to continuing to contribute to that journey as we drive for more growth in the future. Now on to the next, and I'll just jump through this slide and move on to the next one, in fact. Thank you. So I talked about revenue certainty, and that's really derived by the way in which we've acquired assets and how we think about monetizing them. So around 50% of the revenue that we generate as a platform comes from those government subsidies that I mentioned. So they're long-term inflation-linked subsidies provided by the government for the generation of renewable energy. The remainder of revenue that we generate comes from the way in which we sell the power. And what we don't do is generate that power and leak it into the grid and take a spot price. Instead, we forward sell that power using our in-house energy sales desk. So we were able to forward hedge, as they call it, so sell a pip of power that we anticipate generating in the future and lock a price point into one of those available forward seasons. And we're able to do that up to around 36 months ahead. So we generally run the next financial year, all but fully hedged. And you can see from this slide that we're around 97% visibility in terms of that total revenue stack for 2023/2024. And then we have around 72% for the following year and around 60% for the year after. That gives us really good forward visibility of how we're going to service that dividend. And the other reason it's beneficial is it serves to derisk the platform as well. So if we see any exogenous events that drive power pricing down significantly, well, those hedges remain in place. A good example of this I always mention is COVID when everybody abandoned their offices and went to work from home. We saw a significant demand shift, which drove power price down the way. We were fully hedged throughout that period. We generated more than GBP 5 million of additional revenue relative to forecast. So we know the strategy is robust in that downside environment. And what Paul in the energy power sales desk in our business does is continue to look forward at opportunities to increase the hedge in the future markets and to increase the power price that we achieve on a weighted average basis for those future years as well. So as you can see from the bottom of this slide, we've got strong power prices already locked in and expected for future years. Let's talk a little bit about growth of the platform. If we can go on to the next slide. Thank you. So the existing strong asset base as we've said, we see incredible opportunities for the renewable space in the current market and over the next decade. And what's nice from a NextEnergy Solar Funds perspective is we've been positioning for that growth over the last few years. And how we've done that is securing options owned by the fund itself for that future growth. So we already have significant volumes of solar and battery storage assets, which total to more than GBP 500 million of spend, which we intend to deploy over the coming years. That creates a whole heap of optionality for the fund because we're either able to construct and operate those and add them to the portfolio, or we're able to think about recycling those out of the platform and look at recycling that capital back in and doing again accretive acquisitions with that asset base as well. We talked a little bit around battery storage earlier in this session. It's an important part of the energy mix, right? So from my perspective, batteries are needed on the system. They will be an important part of how we achieve net zero. We've built a small proportion of the batteries that are required at net zero scale to date. But we always have had this as a small proportion of our revenue stack and a small proportion of our overall asset base as well. So we currently have a 10% of gross asset value limitation on energy storage as part of the mix. So the very vast majority of our assets will always be from the generation side. However, we do see there being opportunities in the midterm, which are really attractive around battery storage on a colocation basis, so located alongside our existing solar assets, and also on a stand-alone basis as well. So we do also anticipate that normalization of revenues that you spoke about earlier. So the short-term pain that is being experienced by peers in the sector who are very battery-focused, we are insulated from by the very nature of our diversified portfolio, but we also do see the attractive opportunities in the revenue stack for the future. On again for Ken, James, I mentioned active management a little bit earlier in the call. And over the last 12 months or so, the listed space has been an interesting journey where we've all been experiencing share prices that have operated at a discount to the net asset value of the portfolio. That obviously provides a capital constraint for us. So when we're looking at that attractive pipeline, we are contemplating how we are looking to fund that growth. And one of the things we decided to do, and we were a very early mover in this space, is to recycle some of those existing assets out of the platform and then to use those proceeds to fund accretive growth or maybe share buybacks if the time is right, considering total shareholder return at the time. We've taken the first steps on that journey. We sold an asset called Hatherden, great development asset that we managed to move actually into one of our private funds in the NextEnergy Group, but we achieved a 2x multiple on invested capital for that project, so an incredible return for the NextEnergy Solar Fund investors. And we are currently in a competitive process around a chunk of other assets, which I can't talk a lot about, but it remains a competitive process, and we are delivering the right transaction, which will bring again significant value into the platform and allow us to think about future growth prospects throughout 2024 and beyond. A little word on capital structure, if we can move on one more. I mentioned this earlier. It's an important part, again, of how we look at NextEnergy Solar Fund as a valuable tool for investors. We've been very disciplined around the way in which we've designed our capital structure. So we have various different components of debt within the structure. We have a conservative 50% debt-to-GAV limit, which we operate under at the moment at around 46% geared. Within that bucket, we not only include our long-term amortizing debt of around GBP 170 million, but we also include our preference shares as well, which we have GBP 200 million of in the vehicle. Both of those present real long-term, interest rate-hedged certainty in the capital structure. And that, again, derisks it, allows us to benefit from those higher interest rate environments where we are seeing inflation drive. Power price is higher, and we're also seeing opportunities in the market to bolster their portfolio as well. So a really well-thought-out capital structure. We have a small proportion of our debt, which is unhedged in our revolving credit facilities like peers. And one of the reasons for running that capital recycling program that I just spoke about is to down pay that revolving credit facility in the short term. It's a minor pain point for us. It doesn't create any issues in terms of the ongoing operations of the platform. But tactically, from our perspective, makes sense that we down pay that revolving credit facility, leave the optionality to recall it in due course for accretive growth. And that leaves us with our entire debt stack fully interest rate-hedged, which I think is a really great place for the platform to look at incremental growth perspectives in the future. We've got around GBP 50 million of available proceeds to fund that significant pipeline of opportunity that I've spoken to. So we're really excited about the future, and we're looking at ways in which we can continue to drive that growth further forward. Final one on ESG, then I'll open up for questions. The ESG is working through everything we do at NextEnergy. It's in the very DNA of the organization. The NESF platform is Article 9 fund. We drive forward our transparency and our auditability at all times across all financial aspects of our fund but also across ESG. We've been a very early adopter of things like biodiversity within our portfolios. We're looking forward to joining the TNFD reporting cycles as well as TCFD and all of the other kind of ESG compliance pieces that we do. But at a very high level, NESF not only delivers significant amounts of clean green energy, but it also has social and environmental benefits as well to the local communities in which we operate. And we're very proud of the upsides that we've brought to communities. So just to sum up, really excited around the platform. I think we have a really well-curated set of assets that continue to do what we want operationally, drive forward that revenue certainty, give us good cash coverage of a very attractive dividend, good revenue stability into the future. And we've got a significant pipeline of exciting things to do in the future. So I think NESF is really well positioned to narrow that discount back to NAV in due course and to continue on the exciting journey it's had for the last decade. Thanks, James.

Great. Thank you very much, Ross. Questions are kicking in, but by no means, put more in the box. I suppose is sort of the big picture, if we sort of start from there. Your yield at the moment is like 9.5%, which is ridiculous. And especially as Andrew was saying earlier, there are people running around, they're looking for where they can get more income from. Why do you think the yield -- I mean, the yield is that high because the share price is low. Why do you think that is?

It's the perpetual question I've been asked for the last 12 months. I think the honest way to approach that question is to say that I think the discount is entirely unjustified for a number of key reasons. So the underlying physical asset-based nature of the portfolio that we run is really predictable, right? We understand this technology. We understand how it generates revenue. We have long-term assumptions around things like inflation and power price forecasts that give us good visibility of how these things should be valued on a discounted cash flow basis. So from my perspective, we spend a huge amount of time and effort delivering quarterly NAV updates that really do demonstrate what we believe this platform is worth on a reasonable basis. And therefore, looking at the discount that's applied, it really is very much unjustified. What we've also seen over the last 12 months is a significant increase in the discount rate that we apply to the platform. We now run a weighted average of 8% across the portfolio. That is in line with what we see in the private markets as well. So we know that, that is the right kind of discount rate to be applied. It doesn't move one-for-one with gilt, which is always a particular challenge in these conversations. There are other market drivers around inflowing capital into the space and attractiveness of projects as well as inherent upsides in the projects as well like repowering and the terminal value of grid connections and so on that do place tension in that kind of one-to-one transition with gilt. But as we see rates softening and forward market sentiment being positive, combined with what I've taken you through this morning around the growth prospects and the underlying robustness of the portfolio, we can only see that discount narrowing and then putting NESF back on really good fitting for growth in the future.

I suppose that one of the things that would be going through any investor's mind is, if it's 9.5%, is it sustainable? Well, you've talked quite a lot about the visibility you've got on the dividend. I suppose one element of that is where power prices go. So obviously, you've been locking in pretty high power prices for '25/'26 and when power prices were high. Where do you think the general direction of power price is going? Do you think it will decouple from the gas price? What's the sort of views on those sort of things?

So we see a relatively stable long-term power price these days. It's changed a lot over the last decade, as you would imagine. But what we see is kind of stable power pricing out into the mid and the long term. The fundamental drivers of change there are what's going to happen in terms of generation over the coming decade. So what we had seen in those forward forecasts is the expectation of new nuclear capacity being realized, continued growth in renewables on and offshore and stability in the gas supply space as well. So that gives us that kind of long-term stable forecast. We think there's plenty of reasons to be positive relative to those current expectations because we are seeing faster adoption of things like electric vehicles and electrification of heat. We are pretty bad at delivering things like nuclear and offshore wind to time and budget. And there are significant challenges in realizing new connection capacity, so new grid connection capacity, which are well publicized. That plays well for generators because it means those forecasts are going to be overforecasting the amount of available generation at any point in time. So I think there's reasons to be very positive about the future. We obviously sell power forward, as we've said, so we have good visibility of how we're going to continue to service that dividend. And we're also, importantly, recycling old assets out and replacing them with new as part of continuing the strategy to drive revenue forward and to continue to service dividend in the future. Interesting question around decoupling from gas. I think what we've seen over the past 12 to 18 months is a very slow process from government, and the regulators looking at what's called REMA, so to how the energy market itself operates and a general desire to evolve the market so that it is more designed to a distributed energy system from the historic thermal energy production that we had historically. Government has kind of committed to continue to run that exercise. What we've been lobbying hard for is to ensure that government understands the existing assets that they have on the network and how to protect investors and grandfather them through any changes that take the -- that take us on, then drive a market that's more signals-based so we're delivering new renewable capacity where it's needed on the grid as opposed to where you can get grid connections and so on. So we expect to see that continue. We'd like to see that process towards certainty speed up. I think in this kind of year of political change, it's unlikely we see any rapid evolution there. So from our perspective, current expectations of long-term power price remain in line with what we've assumed and what we expect to be able to deliver from a sustainable dividend perspective.

Great. On the sort of debt side, obviously, with interest rates relatively high now that doing revolving credit facility is relatively expensive, it makes sense to pay it down. What sort of level would you start taking -- or actually, it makes sense to use this now? Or to look at a different way maybe, what kind of margin over that risk-free rate do you need for a project to be attractive?

We look at it relatively holistically, as you would imagine. So we see things like solar in the U.K. delivering a consistent kind of 7% to 8% return, depending on how it's been developed and where it is. We see and have always assumed battery storage giving us something like low -- or sorry, high single-digit returns. And we're still seeing that type of a return over the midterm for assets of that nature. The other thing we consider as part of our accretive growth is things like share buyback, for example. So there's price points where that makes sense, provided there are other momentum drivers in the market as well. So we look at it, in the round, in terms of total shareholder return and anything that we do will be accretive, and we're obviously doing that on a very tactical basis as well.

Great. Obviously, the very strong bias of the portfolio is to the U.K. Would you go elsewhere with it? I mean I know you've got some interaction exposure through the NextEnergy -- NextPower III. Would you actually dip a toe into some of those markets directly?

So we do have some direct investments internationally. So we've got a portfolio of Italian assets. We have direct investment in Spain and Portugal alongside that international fund. From our perspective, this fund was predominantly set up to do U.K. renewables, and therefore, that has always and will always be the key focus of the platform. But we do see attractive international opportunities. They are part of that growth matrix that I showed in the slides earlier. So again, in terms of that accretive growth, we do look at all opportunities on their merits. What you wouldn't expect from us and what you won't see is us going to super racy jurisdictions to unlock very risky but high-yielding assets. That's not in the interest of the platform. So where it's the right kind of OECD territory and it's the right type of asset to bring on board, then absolutely, over time, we can see more growth in those spaces. But yes, we remain U.K.-focused as we currently stand.

You are obviously recycling some of the assets as you talked about here. But generally, is it a buy-and-hold type of strategy? And what's the kind of life cycle, how long do these assets last? And what do you need to do in terms of maintenance capital, I suppose?

So it's definitely a long-term hold strategy. Our expectation when we are looking at new assets that are going through the build process is that we own them for the entirety of their operational life, which is 40 to 50 years in current technology sets. We have a maintenance reserve account, as you would expect, that's built into the annual budgets of our assets. They are relatively steady-state things to operate, but they are ultimately full of computers and electrical components. So you do see failures in components, you do see operational work that's required, but it's a small predictable spread. Everything about solar and why we like it is it's all predictable. You can predict the revenues, you can generally predict OpEx, and you can predict how assets are going to perform at a portfolio scale on a consistent basis over the very long term as well. So I think that combined measures means you're in a very good position to continue to run a very profitable platform for the future.

And some of these projects that you've got there that you actually sort of sold power through the government's auction round for Contracts for Difference. And is that an attractive mechanism for you going forward? Is that something you'd do more projects if you were building more solar in the U.K?

Yes. So I sit on the government's solar task force, and one of the key ways in which the government is looking at driving more renewables on to the grid is what we call these Contracts for Difference. So over recent years, the government moved to annual CfD auctions from a previously less frequent auction run that allows us for new projects to achieve planning and grid connection to enter into an auction process. And the good thing about the CfD, of course, is it's super bankable from the government offtake perspective and that it's inflation-linked as well. So yes, it's an important part of how we consider growth. But there's multiple different avenues for growth these days and for bringing revenue certainty as well. One of the other key things we have in the platform are some corporate PPAs. So those are contracts to sell power to energy users over a long term, so they're 10- to 15-year in duration. With bankable offtakers, that's also an important part of the revenue mix, is an important part of how we drive more renewables onto the system over time as well. So yes, we see CfD as important. We see those PPAs as valuable, and we also continue to sell power to those utility offtakers as we've talked about earlier as well.

Yes. Great. In terms of battery storage, is what's going on in the market making you think we want to sort of pause our development now? Or are you sort of thinking no work is going to plow on because we know it's going to come good? And we're...

It's definitely not -- so I think a couple of different ways to approach that. One is the headline I gave earlier, which I think Andrew also gave as well, which is we do need battery storage, right? It's an important part of the energy mix in the future. So I still believe batteries are a valuable tool for platforms like ourselves, albeit I've always said, I prefer that it is part of a larger portfolio of more predictable entities. Cash flows from batteries are super volatile. They will always be super volatile. From our perspective, we've always assumed some contracted revenue from the capacity market and arbitrage as the way in which our batteries operate. So we've not really seen a massive step change in the anticipated revenue profile of the batteries that we have currently in construction or in the pipeline. So we've got 150 megawatts, which will go live in the first half of this year. And we have a further exciting kind of 250-megawatt battery, which is deliverable through kind of 2025/2026 when those revenues look stronger again for batteries. So yes, look, I mean, in terms of a really long-term play like the NextEnergy Solar Fund, small steps to bring batteries on as part of the portfolio remains the right thing for us to do. What we're definitely not doing is pulling the handbrake and suddenly becoming a battery fund. You'll see incremental growth in battery and incremental growth in storage from us over time as the portfolio continues to succeed. The reason we have secured those assets, though, for the future is what we've mentioned earlier. So the availability of grid connection means finding the right asset in the right location, has value for the platform, and we really wanted to make sure that NESF was in the driving seat in terms of how it's going to continue to drive its growth in the future.

Yes. And you're going to maintain the focus on solar and storage. I mean there's no other kind of technologies you think or maybe that would be interesting to do.

For now, we are solar and storage focused, right? We've built a business that is very much solar expertise through and through. We've got more than 300 professionals that focus on solar and batteries. So that's really how we continue to drive value for the platform, albeit we always look to what the right thing from an investor's long-haul perspective is in this platform. So we are always looking at other technology sets and how they might fit within the existing asset base. But vast majority of what we do will always be that solar PV, and it's core because of the predictability and reliability of that underlying technology.

Yes. And then one more question just to finish up. So in terms of the management team and the Board, what's kind of ownership do you have in the trust itself?

So we have a significant amount of shares owned by the Board and the manager. The number eludes to me right now, but multiple millions owned by the team and also the Board itself. So we believe in this platform as much as we ask our investors to. I think it's around 2.5 million we've got across those different internal parties. So yes, we're very much a believer in this platform as well.

Brilliant. Thank you very much, Ross. That's really good, very interesting. And we'll catch up to you again soon.

Sounds good.

So we will be back next week. For those of you who might have been watching it through the Facebook live stream, we're not going to continue with that. We're going to stream it live on YouTube from next week. That's something I've been asked to let you know. Just a simple, I think today, but I think most people use the Zoom link. It's totally up to you. Next week, we'll be talking to Kartik from Artemis Alpha. We've got HydrogenOne coming on -- obviously, that was delayed from a couple of weeks ago, on the 16th, and we've got a full lineup all the way through now, actually until the middle of May, I think. But a reminder again, I keep saying, I think probably next week, we'll give you a bit more information on what this quarterly panel thing is going to be on the 22nd of March. But it started to look quite interesting, I think. So I will let you know then. In the meantime, have a good week, and I will see you next Friday.