Bluefield Solar Income Fund Limited (DRX) Earnings Call Transcript

Good morning, everyone, and thank you for joining the annual results presentation for the Bluefield Solar Income Fund for the period ending June '24. As a colleague said to me, it is timely to presenting Bluefield Solar's results on the day the last coal-fired power station in the U.K. is closed down. As usual, it's James Armstrong and Neil Wood from Bluefield Partners Investment Advisers to the Bluefield Solar Income Fund. And this presentation should take circa 30 minutes. So we'll go straight to Page 6 of the presentation. When we look back over the year in question, we have executed or are executing most of what we wanted to achieve, having consulted our shareholders about capital deployment priorities in what has been a closed market for now for over 12 months. The priorities were: one, to create liquidity through the existing portfolio. This has been achieved by the strategic partnership with GLIL, which has delivered the sale of 50% of the portfolio of assets, which was 100% owned by BSIF at NAV, so underpinning the valuation of the company and also releasing circa GBP 70 million back to the company. Two, we were very focused on capital allocation. This means lowering the revolving credit facility, the RCF and to start the share buyback program. Now the share buyback program was started in February and is ongoing, and the Board have indicated will continue to be ongoing while we remain the discount -- share price remains at discount to NAV and -- which is a post-event period that we've got receive funds from the sale of those aforementioned assets to GLIL, which -- and just over GBP 50 million is going into paying down the RCF. And third, it was -- the priority was to create future value through the management of our very unique large proprietary pipeline, which including Yelvertoft today has over 400 megawatts of CfDs. And we'll talk about that as we go through the presentation. So if we go on to the next page which is Page 7 on the key financial highlights. I think the highlights emphasize solid year, another spectacular as last year, but still very solid in absolute and in relative terms. And if we take it from the top row, gross asset value is shy of GBP 1.4 billion. The NAV has dropped around about 10p, but that's what happens when you combine the fact we're not buying any assets and that we have a falling power market in terms of power sales, the power prices. Operational cash flow is down from a record year last year, but still very solid and very healthy at circa GBP 95 million. Going to the middle of the debt side, prudent levels of overall gearing remain and the 3.4% all-in cost of debt has actually gone down from last year, which is probably down to the cost of the Lyceum debt, which was the debt which came with the deal we did with Lightsource -- the acquisition of the Lightsource bp assets. And we've got an average duration of that debt of about 12 years. And so this has delivered what is a very attractive dividend cover. So pre-debt amortization of about 1.8x and 1.4x post, which is very comfortable and attractive, and we expect that to increase to near to 2x in the coming years. Dividend yield is now a remarkable 8.3% compared to just highly attractive 7.3% last year. We've increased -- we're obviously very pleased to have announced and paid the dividend of 8.8p, and we've increased that to 8.9p for the coming year to June '25. So moving on to Page 8. So this chart through the combination of the performance of the past decade, very high progressive dividend, on the highest in the infra space, not just renewable space on a pence per share basis, and that's underpinned by one of the lowest risk portfolios in the segment. So we've got very high levels of visibility on revenues, defensive asset base, very high levels of regulated revenues and power fixes. NAV total, if you look at the top right, NAV total return, very pleasing, 104%, and we paid out over GBP 300 million in dividends. As I've mentioned, good dividend cover at the moment. But as we said, we're looking at -- it's likely or expected to rise in the coming years to sort of 1.7x, 1.8x cover due to better performance and better, well, radiation moving back to its average. So we move on to Page 9. So a familiar chart to those that have seen this before. We've constructed a very highly diversified and very defensive portfolio, all U.K., which is likely to be -- if you're thinking about public policy and government initiatives, it's likely to be one of the most, if not the most, attractive area to invest in renewables and batteries in the world in the coming years, which we'll talk about later on. We have -- it looks quite static chart, but we have actually sold some ROC assets, as mentioned, part of the GLIL relationship. We've added some brand-new assets, Yelvertoft and Mauxhall, which add some CfDs to the portfolio the first time. And we were a minority share in the acquisition of the Lightsource bp assets, which actually takes going back and forwards to today, actually takes the capacity to 883 megawatts. High levels of ROC revenues, you can see on the right-hand side of the top right, which is 1.5 ROCs per megawatt, and we've got one of the highest levels of regulated revenues in that in the renewable space. And if you look bottom right, overwhelmingly, we've got some very nice solar assets, but also that we -- our top 10 assets cover only 40% of our asset base. So again, really very nice levels of diversification. Okay. So on to Page 10. So this gives a site of the portfolio revenue mix that goes out to 2034, which is a decade out and would be actually our 21st anniversary of the company in that year. Neil will talk more about the power strategy as we go through, and I'll talk about the power markets as well. But looking at the bar chart, it shows the average annual composition of revenues from a regulated merchant and PPA basis. And so looking at the merchant figure, although you've got, that's the green. If you look at that level, that's actually just so people understand, that's the forecast there of -- which makes up the total revenues is taking -- you take obviously the regulated revenues that you know and then you add on what is a blend of the 3 leading power forecasters that we use and including the adoption of the solar capture curves, which if you take it over the life of the forecast at, let's say, a 25% discount to the base forecast, which is quite important to note. So we always focus, as you know, for those who know the business on the fixed power -- at the short end of the power curve because that enables us to have very high levels of contracted revenues alongside the regulated revenues and so if you look at the bar chart on the left-hand side, you'll see that there is this combination in 2024 of light blue and dark blue revenues overwhelmingly, which make up 94%, that's the combination of fixes, which is the light blue matched to regulated revenues, and then that sort of drops off a bit next year in '25. And because we're constantly restriking our PPAs, there is always contracted revenue. So those light blue figures will start to move to the right as you go through because we're always contracting and depending on the circumstances, we will decide to contract the PPAs for longer or shorter. But it gives you an idea of the visibility and certainty of the revenues that we have from a very stable and defensive asset base. And if you look at just that straight line in front because it's not theoretical that, but we have added in the impact of adding CfDs to the portfolio. That's in the case that we bought them, but it shows how much regulated revenue that we will add into the portfolio if we did go through that. Okay. On to Page 11, my last page before I hand over to Neil. On Page 11, we've said this before, we have a very simple business model. We convert -- well, what we're doing is we're converting our radiation into electricity and then that gets converted into revenues and then net of debt service, it drives earnings and dividends to shareholders. There's a very high level of visibility that you can see. Good performance in terms of the -- across the board, even though obviously power markets have been slightly down and also our performance in the radiation. We had -- if you like, we've had sort of the combination of all factors coming in, it's still a very strong performance. It's worth noting actually that we've had the worst radiation figures relative to a P50 number. So that's your average number 11 years. So this -- and this sort of the annual variance from your average with your P50 is typically in solar is something like 3% to 4%, and this is borne out by the solar generation over the past 11 years. In fact, the radiation for the year was down 4.3% against forecast, so outside of standard deviation. So really what would be viewed as a kind of 1 in 10-year event, maybe in our case, a 1 in 11-year event, it does still compare very favorably with other renewables. That same comparison if you do it with wind is set to sort of 15% to 20%. So there's much lower volatility. And this is because solar and -- well, radiation is not a weather phenomenon. It's a daylight hours driven strategy and you get -- the power source comes on the morning and goes off at night. Now notwithstanding this and combined with lower overall expected energy production due to specific outage in the portfolio, we still have a gross cover of 1.8x dividend cover and 1.4x, if you look on the bottom right there this year, which we're expecting to see grow to circa 1.8x in the next couple of years, which is very encouraging. So with that, I'll hand over to Neil.

On to the capital structure slide, and thank you, James. So since its IPO in 2013, the company is focused on a simple and deliberate debt strategy of ensuring leverage levels are maintained prudently below company's overall limit of 50%. And then outside of the company's revolving credit facility, long-term debt within the portfolio is secured against portfolios of assets at conservative levels with fixed interest rates on fully amortizing terms. Deliberately structuring debt across portfolios of assets rather than borrowing against individual projects delivers 3 crucial advantages. Firstly, it drives out lower debt costs than those of single projects as the all-in cost of debt of 3.4% evidences. Secondly, it materially reduces the risk of financial ratios being breached. And thirdly, perhaps most crucially, it provides the company with the operational flexibility 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. Turn over to valuation factors. Now following the significant increases in inflation and interest rates over the past 2 years, the 12-month period to June '24 brought some welcome relief as interest rates and inflation first plateaued and then finally began to decline with inflation falling from 7.3% in June '23 to close to 3%, in fact, 2.8% to be precise, as at the 30th of June '24. This precipitated the Bank of England to make a 0.25 basis point rate cut post period end in August '24. That's the first cut since initiating an unprecedented series of rate increases from 0.25% in December '21 to a high watermark of 5.25% in September '23. Now despite signals from the central banks that further interest rate cuts will be forthcoming, the directors do not believe there is yet sufficient evidence as at the period end of a lower rate environment influencing changes to discount rates and the implied premium of the company's discount rate to the 15-year U.K. Gilt. As a result, the directors have continued to apply a discount rate of 8% and inflation assumptions of 3% to 2029 and 2.25% thereafter. Ultimately, though, the valuation of the portfolio is premised on a willing buyer, willing seller methodology. And so beyond individual assumptions, precedent market transactions form the critical benchmark in the determination of the director's valuation. And there's no better validation of the company's approach than the sale, as James has referenced and as part of its strategic partnership with GLIL of a 50% stake in a portfolio of 112 megawatts of operational PV assets in line with the latest NAV of the company. Turning over the page to the NAV bridge. Now demand for U.K.-based renewable assets with attractive levels of regulated revenues remained high over the period. And with inflation and interest rates falling instead of rising, there has been limited movement in headline assumptions over the period. That said, there have still been a number of changes underpinning the movement of the company's NAV over the 12-month period to the 30th of June '24. So starting on the left of the chart, positive movements to cover high inflation across the first half of -- or the second half, I should say, of 2022 and the first half of 2023 resulted in ROC's increasing in price by 9.8% from April '24. This added 1.9p per share with a further benefit in the period coming from recognition that Renewable Energy Guarantees of Origin, or REGOs as they're commonly known, are expected to provide a small source of additional revenue for the period to 2030, and that's 0.9p per share in value terms. Continued success of the company's development program resulted in a further 300 megawatts of solar and storage achieving planning commission, adding 1.1p per share to the NAV with the company's share buyback program adding a further 0.4p per share. Now these increases have been offset by small negative movements of 2p per share from lower-than-forecast performance with radiation and operational performance, both circa 5% below expectations and prudent amendments to predicted future operational costs and 1.3p per share from tax and working capital changes. And rounding off the reductions bars relating to power price estimates from the company's forecast is, for the period to 2030, having been lowered and resulting in an impact of 2p per share, with the final reduction being dividends paid over the period of 8.8p per share. But stepping back and 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 '24 is squarely placed within the universe of values seen across transactions over the past year for portfolios of comparable size and technology mix. Turning over to the active management slide. 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 over 110 individuals within the Bluefield Group, covering development, construction, operations and maintenance, technical asset management, finance investment and ESG with over 70 different core responsibilities. And these specialist units have been created over the past decade, enabling a series of asset enhancing programs such as life extensions and cost-saving initiatives and core OpEx items like insurance, operations, maintenance and business wins. And specifically, in the past 2 years, these teams have combined to drive a GBP 20 million innovative repowering investment program on 17 small-scale wind turbines in Northern Ireland, secured CfDs on 431 megawatts. That's close to 70% of the company's consented solar pipeline and committed over GBP 65 million of investment into 2 new solar projects, which with a combined capacity of 93 megawatts will increase the company's generating base by circa 11% in the period to June '25. And there are further details on our construction work streams in the appendices of this presentation. So turning over to operational performance. Our operational performance across the portfolio for the period to June '24 has been slightly below expectations, as James has outlined. The company's solar portfolio was impacted by a combination of lower-than-forecast radiation, circa 4% below and operational underperformance of circa 5%. And that was as a result of maintenance by the grid network operator in one of the company's 50-megawatt plants and a targeted investment -- sorry, inverter replacement program reaching GBP 4 million in the period with the aim of securing operational performance for the decade ahead. The company's wind portfolio performed in line with expectations for the period, but exceeded generation compared to the prior year by 21%, and that's a consequence of wind speeds simply having greater levels of year-on-year variance than solar. However, the deviation in levels of irradiation and wind speeds against forecast expectations really highlights the benefit of carefully layering a minority of wind to a majority base of solar as highly forecastable daylight hours driven solar generation is complemented with the additionality provided by wind generation across any given 24-hour period. And if you're stepping back from the most recent 12-month period, what's clear is the company owns and operates a well-performing portfolio with cumulative generation over the decade of its existence being in line with expectations. And that's something that is only really possible from the combination of carefully-tailored preventative maintenance programs, targeting activity during periods when lower generation is expected and a rolling capital investment program evidenced this year by the GBP 4 million spend on inverter replacements in order to continually optimize the long-term operational performance of the portfolio. Turning over to the PPA strategy side. So Bluefield Solar focuses on fixing power price agreement contracts at the short end of the power curve, so that's 6 to 30 months with contract renewals spread evenly across periods through competitive tenders with a number of counterparties. 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 providing significant insulation from periods of declining pricing. And no greater evidence of that is the last year. And whilst day-ahead pricing has continued a downward trend from GBP 86 per megawatt hour in June '23 to GBP 71 per megawatt hour in June '24 as a consequence of high gas storage following a milder-than-expected 2023 winter, the BSIF average seasonal weighted power price actually rose to GBP 148 per megawatt hour, marginally up from GBP 141 per megawatt hour in June '23 as a result of fixes the company secured during 2022. And of course, as the chart shows, materially above the day-ahead market. Now the success of the company's PPA strategy means that on a blended basis, over 60% of the portfolio has power fixed at circa GBP 130 per megawatt hour for the 12 months to June '25, so close to 2x the latest forecast of predictions for spot prices. It also underpins expectations of growth in the company's dividend cover from 1.4x in June '24 to circa 1.8x in June '25, as James was referencing, and that's net of debt amortization and EGL. So in conclusion, the result is the Investment Adviser believes its PPA policy is the best strategy for shareholders who are looking for stable revenue and forecastable sustainable dividends with high visibility of revenues on a rolling multiyear basis. Turning over to the last slide from me before I hand over to James, and that's development and construction. So in 2019, the company made the strategic decision to begin to develop projects wholly for the benefit of the business. This pivot in strategy was designed to enable the business to organically support growth in its asset base alongside that with a successful third-party acquisition. Five years on, the success enjoyed by the company has been extraordinary as a pipeline of over 1.5 gigawatts has been created across 954 megawatts of solar and over 603 megawatts of batteries with the circa 93 megawatts in construction, the epitome of this strategy, organic growth of the company's asset base. However, creation of the proprietary pipeline goes beyond providing the company with future investment opportunities as it also offers huge potential for capital recycling. With the Board having consistently stated their intention to crystallize value on up to 1/3 of the development pipeline, the successful receipt of CfDs on 70% of the consented PV pipeline of 614 megawatts puts the company in a unique position for future disposals as projects with regulated revenue characteristics are highly sought after. And finally, as the company's valuation policy is only to recognize value at the point developments receive planning permission and move from the development stage to consented, there is also the prospect of a material valuation uplift being created as the pipeline of 690 megawatts that is currently in planning and development reach consented stage. And with that, I will hand back over to James.

Thank you, Neil. To finish up, I'm going to talk about ESG public policy and power markets. So if we go to Page 23 on ESG. And as has been said before, you could have a whole presentation on ESG activities in the company. So in terms of trying to distill down a few highlights, there's been very important work in terms of the human rights DD, which seeks to mitigate social and environmental impacts across Bluefield Solar's operations and where possible, and this is an ongoing bit of work, the supply chain across our over 400 suppliers. Biodiversity continues to be a real area of focus for both Bluefield Solar, but also the shareholders. It's something which is of great interest and of great value to the Bluefield Solar shareholders. And we continue to build our biodiversity data sets through ecological surveys and our biodiversity net gain assessments across the operational portfolio. Indeed, West Raynham, which is our 50-megawatt site in Norfolk was the first solar farm in the U.K. to be awarded a gold certification from Wild Power for its biodiversity impact, which the team is rightly proud of that progress. And there continues to be focused this year to obtain a better understanding of how climate change may potentially impact the portfolio. A solar fund is likely to benefit from certain elements of a change in climate. Indeed, work with one of our consultants, just to put it into sort of context is one of the consultants is talking about a theoretical scenario where you have, which is an extreme scenario, but it's worth exploring, which is of a 4 degrees centigrade increase in temperatures by 2050 and where it was -- is modeled that the U.K. could experience over 200 hours per annum of temperatures in excess of 33 degrees C, which sounds great if you're a solar fund or a wine maker, but it mirrors temperatures today, which are being seen in southern parts of Europe and North Africa, which is sanitary when you think about what the temperature -- if we're getting those sorts of temperatures, what the temperatures in those countries will be in North Africa or in Spain in 2050. Moving on to maybe more immediate opportunities and challenges, but it's public policy. And in all my time in renewable energy, which is now 18 years, I've never experienced such a positive intention from any government, and there have been a few, as we know, in the last 18 years. We've already had site visits. You can see on the -- on Page 24, that is a discussion we're having on the right-hand side there with Michael Shanks, who's visiting one of our solar farms, which we co-own with GLIL. Michael Shanks is the minister responsible for GB Energy, and there are further meetings with various ministers planned in the very near future. And the government's intention is to accelerate net zero to 2030. So it's accelerating. And this leaves companies like Bluefield Solar incredibly well placed in the event that the equity markets open up because we should be a major part of the solution. As Neil has just said, we've got this incredible position that we've developed, particularly with our development pipeline. And we think it is conceivable that the government will probably look to incentivize renewable and decarbonization activities further. They're definitely going to focus on increasing planning commissions for solar and also they will look to speed up the process of getting those approvals. And they even seem to have sorted out the double counting of fees for investment companies, which one would think should be useful in the long term, particularly with retail investors. But the thing to sort of counterweight to that is what will hinder their ambition is whether they are able to genuinely unlock the issues around grid capacity, which will then supercharge the market. If they can do that, then there will be a bull market in primaries. And I should reiterate that we have -- as Neil has just highlighted, we have a strategically dominant position in this area. It's a 5-year program we worked on and having grid offers 1.5 gigawatts of solar and battery, 800 megawatts of approvals and over 400 megawatts of assets within that group that have CfDs, it is a uniquely strong position to be in and one that I hope will be reflected in our stock rating at some point in the near future. Okay. So on to the final sort of analysis before the conclusion. On Page 25, there has been a lot of talk about falling power prices, and I thought it would be helpful to contextualize this. If you look at the chart, we've obviously had the extraordinary pricing. If you look at the blue box there, you've got extraordinary pricing driven in large part by the Ukraine war, which saw companies like Bluefield Solar fix power contracts in excess of GBP 600 per megawatt hour, where 12 years -- sorry, 12 months before, 18 months before, we were striking circa of GBP 50. So that was an incredible position. But what I thought would be interesting is what's the future forecast? What are we looking at outwards compared to the sort of the pre-2020 numbers that we were relying on the power numbers we were relying on, which was pre-Ukraine, pre-COVID, pre-globalization, pre-major decarbonization, which are all inflationary. And what you look at there on the left-hand side of that chart is that the average price that was achieved was GBP 43 per megawatt hour. So that was an environment where Bluefield was delivering one of the highest dividend -- covered dividends in the renewables and infrastructure space at an average of 43. And in fact, just as a note, we outperformed this by about 10%. So looking forward over the next few years, the average price is forecast, if you look at the right-hand side of the chart, is forecast to be by the sort of leading forecast of circa GBP 70 per megawatt hour, so 60% higher. So first of all, this should give confidence about the ability to deliver the dividend going forward. But moreover, we think -- and we've said this repeatedly, we think that there is more chance of prices being higher than lower than the forecasters are predicting. And this is because of the aforementioned war, decarbonization, deglobalization, they're all inflationary. But the biggest long-term driver for energy and electricity is going to be AI and data centers, and they're going to drive unprecedented demand for electricity. I think forecasters are only just catching up on this. And we think this has, again, when you're thinking about a sort of higher or lower scenario in terms of the risk to the model and to dividends, there is a reasonable, very coherent expectation of higher prices that are being forecast and are in this model. Okay. So just going on to the final sort of conclusion, which are the -- on Page 27, which are the priorities for the coming financial year. And I mean I think we go back in terms of conclusion, we come back to the beginning, which is that there are increasingly positive tailwinds to the strategy, whether it be political, whether it be on the demand side, I've just mentioned. And we've also got -- we've laid the foundations for an incredibly strong platform for the company going forward, not least this unique situation we have and capability we have within the development pipeline. So what are we going to do? So it's going to be more of the same that we spoke about at the beginning. So one is to reduce the RCF. It's currently at GBP 134 million. We want to see this reduced further. So that's a very clear objective. Two, we've spoken about the highly valuable pipeline. It's valuable in the future, very valuable for the company if the markets recover. It's also highly valuable for sale, as Neil referenced. And as such, we're looking to sell over 300 megawatts in the current financial year, which will be highly accretive for the business. And then last but not least, is the continuation of the strategic partnership with GLIL, which continues to grow and support both -- the interest of both groups long-term interest. And so with that, we do think that there is both, as I say, the macro position is improving. The political conditions are very favorable, and we have a very unique position at the moment in the market to be able to take advantage of that, and we look forward to the coming year with great optimism. And that concludes the presentation. Thank you for listening.