Renewables ITs hit by climate levy change

In the days following the Budget on 8 July these trusts' share prices fell and their average premium to net asset value (NAV) fell from 6.4 per cent on the day before the Budget to 4.7 per cent at the time of writing on Friday 17 July.

However, selling levy exemption certificates accounts for less than 6 per cent of these trusts' revenue, according to broker Winterflood, with most derived from subsidies such as renewables obligation certificates (Rocs) and electricity sales. The ending of the Climate Change Levy exemption will also be partially offset by the reduction in corporation tax to 19 per cent in 2017 and 18 per cent in 2020, from the current level of 20 per cent.

The trusts are generally confident that they will be able to pay their targeted dividends this year, but Iain Scouller, head of the funds research team at Stifel, says: "Some funds may reduce their dividends by 5 per cent or less in 2016. However, even if there is some modest reduction in 2016 dividends, the prospective dividend yields on the funds would still be relatively attractive at close to 6 per cent. We estimate that this change will reduce some of the renewable funds' revenue receivable accounts by around 3 to 4 per cent, although this may be higher in cases where the portfolio is leveraged. This will reduce dividend cover."

However Kieran Drake, analyst at Winterflood, says most of these trusts have a good level of dividend cover and were factoring in the end of the exemption from this levy in 2022, so he expects most of them to continue with their dividend policies.

Analysts at Numis think there are a number of positive valuation drivers which will mitigate the impact on portfolio values, "including increasingly favourable transaction pricing as the market moves from a primary (new build) to secondary (operational) phase".

Effects on individual trusts

The trust most affected by the ending of the exemption is The Renewables Infrastructure Group (TRIG). It expects a drop in its NAV of about 4p after the reductions in corporation tax are taken into account. Its NAV was 101.9p at the end of May and had fallen to about 98.6p at the end of June.

Renewables Infrastructure Group says there is no change to its interim dividend of 3.08p, and no change to its aim of increasing dividends progressively in line with inflation over the medium term.

Expected dividend cover over the next five years will fall from 1.3 times to 1.2 times, although over the longer term the average is expected to increase back to 1.3 times as the cash position improves due to debt amortising. The trust continues to target an internal rate of return of between 8 per cent and 9 per cent.

Between the Budget and 17 July the trust's share price fell by about 5p and the shares are now trading on a premium to NAV of 2.9 per cent, down from 4 per cent, although that fall is also partly due to a recent share issue.

Bluefield Solar Income (BSIF) says that levy exemption certificates account for 3-4 per cent of its revenues, but Mr Drake estimates that the impact on the NAV is likely to be less than 3-4 per cent as this will be partially offset by the fall in corporation tax.

Mr Scouller adds: "Given Bluefield aims to pay out all revenue received in the portfolio and not retain revenue, this fund may be more exposed to any fall in revenues received, with a consequent impact on dividend paying ability."

The trust's share price was 108.6p on 8 July and, after hitting a low of 105p on 13 July, had recovered to 107.4p on 17 July. It now trades on a premium to NAV of 5.6 per cent, compared with 7.6 per cent the day before the Budget.

Foresight Solar Fund (FSFL) estimates that the removal of the levy will result in a 3 per cent reduction in its portfolio valuation. "The fund has gearing of around 20 per cent so the impact on the NAV is likely to be slightly higher than 3 per cent," says Mr Drake.

But Foresight Solar is maintaining its 6.08p dividend target for 2015 and Ricardo Pineiro, head of UK Solar at Foresight Group, adds: "We don't expect the recent Budget announcement to impact our ability to continue to pay our target dividends moving forward."

GCP Infrastructure (GCP) expects the end of the exemption to have no impact on its cash flows. The fund invests in the debt rather than equity of renewable infrastructure projects, and while there may be a modest reduction in projects' forecast net cash flows this is not expected to affect their ability to pay back the debt.

Impact of end of climate change levy exemption

Source: Winterflood, as at 10 July & **Renewables Infrastructure Group

*Winterflood estimate

What should you do?

Mick Gilligan, head of research at broker Killik, thinks there is still an investment case for renewable energy infrastructure investment trusts as they will still generate an attractive income and don't rely on equity markets for their returns, making them a good way to diversify your income sources. He does not advocate that existing investors sell.

"The withdrawal of the exemption has had a limited impact on NAVs, and the medium- to long-term prospects for these existing vehicles remain attractive given their partial revenue indexation, stability and cash-generation capability," adds Ian Barrass, director, multi-assets at Henderson Global Investors. "And most of their assets are based in the UK, which despite the recent Budget, generally provides a known, stable and transparent regulatory and fiscal backdrop."

The sector is still supported by investors: John Laing Environmental Assets (JLEN) conducted a share issue after the Budget which was significantly oversubscribed. Renewables Infrastructure Group pushed back a share issue due to close on 9 July to 16 July, and reduced the price from 105p to 101p a share. But the trust still issued more than 126m shares out of a possible 142.5m available, raising about £127.75m.

Mr Gilligan thinks Greencoat UK Wind (UKW), John Laing Environmental Assets and Bluefield Solar Income are good options providing there are not serious falls in wholesale electricity prices, as these trusts do not have high levels of debt.

However, as the share price falls following the levy exemption announcement have not been significant, analysts generally don't think they offer a value opportunity, with all the trusts still on premiums to NAV.

"Why pay a premium now if a future share issue and new investment of the cash raised will give a chance to buy at a smaller premium later?" says Nick Sketch, senior investment director, Investec Wealth & Investment. "If rising interest rates in the next couple of years see share prices underperform, long-term investors may see that as a buying opportunity."

And there are risks with investing in these trusts. Mr Barrass says these include "significant increases in real interest rates which may erode the relative attractiveness of these vehicles against other asset classes, and long-term European power prices falling significantly".

Government subsidies are always at risk of change and these funds derive around half their revenue from these, typically Rocs, but any changes are unlikely to be retrospective so their existing investments would not be affected.

The broader infrastructure investment trusts, which put their money into assets such as private finance initiative (PFI) and private public partnership (PPP) schemes, also offer attractive yields, but trade at high premiums to NAV. "We think that the listed Infrastructure funds, including (IC Top 100 Fund) HICL Infrastructure (HICL) and John Laing Infrastructure (JLIF), also have good quality underlying assets, but felt that their premiums become rather elevated a while ago," says Mr Barrass. "We therefore switched much of our exposure into the renewable energy sector, which we believed to be better value."

Mr Gilligan says the broader infrastructure investment trusts are lower risk as their cash flows are less variable, but this is reflected in their higher premiums to NAV. These also tend to have higher debt levels than the renewable energy infrastructure trusts, although Mr Drake says their more secure revenue streams may be able support this.

Renewable energy infrastructure investment trusts: yield and performance

Source: Winterflood as at 17 July, *AIC