Cheap power: US Solar Fund at an attractive discount

Developments in recent days – namely Russia’s closure of Nord Stream 1 and Opec’s reversal of planned oil supply increases – suggest this period of plenty could go on for some time. But what if you’re looking for a set-and-forget stock that is neither likely to be at the top of the cycle now or in the coming months? 

Owners of renewable energy assets, by contrast, swap the upside that comes with surging volatility with stable asset values and solid growth prospects, as money lands in the sector through government stimulus. According to organisations such as the International Energy Agency, it is precisely investment in renewables that will help prevent a repeat of the past year’s energy market dramas. 

While the US races ahead on solar, European governments are working out how to reorganise power systems and end some of the huge profits being made by energy generators, including from renewable sources. These low-cost operations in many cases get paid the same wholesale electricity prices as fossil-fuel-fired plants because of the way markets work, ramping up earnings. 

In response to the crisis conditions, investors have already bid up the share prices of funds that own renewable energy generation capacity on this side of the Atlantic. But with potentially significant regulatory changes coming down the line here and in continental Europe, the US holds more promise. Additionally, renewables operators are unlikely to have full exposure to high power prices. This is because much of the market runs on contracts for difference (CFDs), especially newer projects. 

“We think investors know reform is coming [in the UK power sector] and corporates are unlikely to argue against low-carbon CFDs if implemented carefully,” wrote analysts at RBC Capital Markets this month, adding that “decoupling renewables and nuclear from gas over the longer term is also sensible”. The chancellor, Kwasi Kwarteng, has said voluntary long-term contracts for renewable generators could come in, although why they would accept these lower prices is unclear. 

Lower exposure to the spot power market does not mean UK and Europe-focused asset owners are completely in the cold, as signalled by the rising net asset value (NAV) of funds in the sector. “Today's reported NAV is the highest that NESF has ever released and it is encouraging to see that [its] share price has started to strengthen in line with peers,” said NextEnergy Solar Fund (NESF) chair Kevin Lyon a fortnight ago. Bluefield Solar Income Fund (BSIF) also announced a 10 per cent jump in its NAV between 31 March and 30 June. Both funds are trading in line with NAV. 

For a growth option, investors might consider US Solar Fund (USF), which has the bonus of trading at a 12 per cent discount (73.6p, against March’s unaudited NAV of 96.7¢ per share). It is also coming into a heady time for solar businesses in the US thanks to the new Inflation Reduction Act. This has been passed by the Senate and should spur a rush of new spending on solar capacity and opportunities for the fund to grow, a goal of the board despite a recently announced asset sale. 

The major help for solar-exposed entities is an expanded tax credit scheme for new projects. The other is added tax credits for projects built with locally made solar panels. This is stimulus-as-geopolitics, given China’s dominant position in the global supply chain. At the same time, the Biden administration has dropped a tariff on solar parts coming from other Asian countries.  

Sun states

USF listed in 2019 as a vehicle for – you guessed it – US solar assets. This was initially a mix of in-development and completed solar farms across North Carolina, Oregon, Utah and California. Just under a third of the assets are in North Carolina, with 168 megawatts (MW) out of 543MW in total. In terms of generation capacity, this is as ome way below Bluefield’s 766MW and NextEnergy’s 865MW, although it’s worth noting USF is much younger than both its peers. The fund saw significant expansion in 2021, when NAV grew from $194mn to $324mn and electricity generation rocketed from 374 gigawatt hours (GWh) to 851GWh as new projects came online. 

Growing scale has brought with it a growing profile among institutional investors, and the fund’s manager, New Energy Solar Manager (NESM), has successfully added a shareholder base that includes Liontrust, Sarasin & Partners and Baillie Gifford. One result of this has been fairly limited liquidity for retail investors, but expansion plans for the near future could improve this. 

Beyond the initial capital raise in 2019, the fund has gone back to the market just once, raising $132mn in April last year. This largely went into refinancing ($92mn) as well as $21mn for an option to take a greater stake in the 100-MW-MS2 project in February. It has since agreed a deal to sell off the 50 per cent stake in the project to a Goldman Sachs offshoot for $53mn, saying this would “monetise a significant existing asset at its current carrying value”. 

If MN8 Energy (as Goldman’s renewable power arm is now known) decides not to buy the project, US Solar holds on to a $1mn option payment. But completion will mean expansion is on the cards: “Should the sale proceed, USF will use the proceeds for new investments, working capital, and/or future capital management”, the fund said. 

For capital management, it’s probably not a stretch for potential investors to read ‘share buybacks’, all on top of a well-covered dividend of 5.58c a share for 2022.

A similar hat-tip in the first-quarter outlook came a few months before the MN8 divestment announcement, when the board and NESM said they were “evaluating a range of strategic options to deliver shareholder value from USF’s high-quality portfolio”.

The ruthless approach of NESM is evident in its recent decision to sell off the assets of its Australian Stock Exchange-listed solar fund to MN8. It is also in the process of delisting from the ASX and returning the cash to investors, after sitting at a hefty discount for some years. 

A trading update for USF later this month will give further insight into what is coming next. What is already clear is that the US has had favourable conditions for solar generation this summer. The ‘heat dome’ from 2021 didn’t reappear in the Pacific north-west, but Oregon had much more consistent hot weather, according to local reports. It was “lower than expected irradiance”, to use the jargon, that contributed to the fund's overall generation missing forecasts by 3.9 per cent last year, so this will be welcome. 

A matter of capital 

The long-term picture for the fund (or rather its projects) improved this year, even as power price forecasts hit NAV. Last year brought asset life extensions for around 70 per cent of the portfolio, pushing the average use to 40 years. This is a lengthy horizon given solar technology evolves quickly, so the key number for investors is the average length of power purchasing agreements (PPA) – 14 years (see table). This has also shifted upwards. The downside is locking in prices – although PPAs do have increases built in – so that the NAV is impacted by electricity price forecasts over a decade into the future. 

The longest PPA currently is 24 years, at the fund’s largest asset, Milford in Utah, and the shortest is just under six years, for a smaller plant in North Carolina. Milford is double the size of the second-largest plant, at 128MW – providing enough power for around 30,000 homes in the area. 

The European equivalents do certainly have some appeal given extremely high prices aren’t going away anytime soon. But with USF at a discount and generating its income entirely in US dollars, we take its long-term stability and short-term growth prospects as a buy signal.

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