You're listening to Redefining Energy. Your co hosts from Berlin Gerard Read and from
London Laurent Segalam. Today on Realefending LG Job, we're going to talk about
Yill goes and a little bit about what's called MLPs. Yeah, He'll go
is a generic term for listed infrastructure funds and those funds are owners of vulnerable
energy as sets, wind farms, solar box Yeah, and an MLP is
a US creation. It's called a master limited partnership and it's a company who
organizes a public traded partnership. The reason they do this is because you combine
the private partnerships tax advantages with the stocks liquidity, which you get to a
public market. And it's used in the US for really a little bit real
estate, but also for things like owning grids, cask grids and stuff like
that. But first of all, from a partner, this podcast is powered
by Expo, an international leader in providing sustainable energy solutions for the future.
So they're about thirty listed infrastructure funds on the London stockick Change and it's something
very particular. That's why we wanted to dive a bit into the operational and
financial performance of those funds because they've been biggest set owners. They are biggest
set owners. Their size is generally a bit less than a billion, but
generally more than five hundred, so you know, it's a bit of a
MidCap and they are managed by quite interesting teams're absolutely and they're they have been
very important for the renewable rollout, particularly the UK because they have been really
active buyers of everything from offshore into batteries. So we have decided to bring
a veteran of the industry because collect Odd with a director at dB Numis has
been tracking those vehicles for more than twenty years. She knows what she's talking
about, she sure does. It was great to have her on the show.
DBI Numiss, I mean, everybody knows Numis. It's a leading UK
focused investment bank in the mid market and now it's part of Toutcha Bank,
so it's called Deutscha Numiss and nobody knows Doutchia Bank. No Doutcha Bank are
really a bad decade, but it seems that they're doing much better now.
On the way back. On the way back, and you know gave me
the idea to do this episode. It's your partner mister Bruce Buber. Oh
Bruce, did I tell you? Okay? And because he wrote a very
interesting piece in December last year, yield coo, bargain or zombie? Yeah,
very good, very good, very good. Yeah. I think we'll
put the link and finally, finally, job, we're going to talk fixed
income and equity. Finally, Well, let's bring it on. I'm looking
forward to this, colect welcome to the show. Thanks for having me.
Let's just jump straight into this. I mean, we're going to talk about
what we in the finance will know as yield CAUs. But I think a
lot of people probably don't know what they are, so maybe you could talk
about what they are and then where they're actually important for this whole renewables area.
Firstly, in terms of the parlance, yield cosee is a guesser term
which has greater use in the States coming out of things like the MLP structures.
I don't specifically refer to the London listed infrastructure companies as yield cos per
sale, though of course they do have income as a major component of their
total returns. Depending on the infrastructure strategy, it's between fifty and eighty percent
of the return targets come from income, and in the context of renewable energy
specifically generators, they're sort of roughly around seventy percent income, so have some
sympathy with the parlance. But I think what a lot of investors also hope
to achieve in owning these kind of listed products is access to some capital growth
as well through active management of portfolios, which includes bringing through new assets.
And so from a transition perspective, they've been very important for delivering growth and
delivering the assets that we need to meet the transition targets. And in the
UK specifically, there have been a large number of funds. There are twelve
renewable generators. There's seventeen that focus on the energy transition more generally, but
of those twelve, renewable generators have been around since twenty thirteen. That was
the first listed renewable generator company and that was Greencoat UK Wind, followed shortly
by a number of others that year, including blue Field Solar. The first
so a focus business and they've been around really to facilitate the transition. So
when the UK was a primary market, when new projects needed to be funded,
this was a route for investors to participate in that journey, and so
it's been quite a key part of allowing the UK in particular initially to build
out its renewable energy asset base, and the listed companies that we follow they
own and operate a meaningful portion of the UK's renewable energy capacity. It started
off with the UK focus, but as investors became more familiar with the nature
of returns, as we said, income being a key component of that,
then we've seen other investment companies listed which are investing in other jurisdictions, again
with a view to giving investors access to the energy transition and the income and
capital growth that can come from that. So we've got European focused portfolios,
some US focused portfolios which perhaps haven't offerred as well in growth terms. So
we've got a broad mix of it, international ass sets, different technologies,
all part of the energy transition. Can I ask you a little bit about
the background of how they came into being, because if you look at these,
you can call them investment companies or whatever you want, but for me,
they're funds, right, They're not like an independent power producer that we
see sort of across the rest of the world. It's a very specialized vehicle,
if you'd like to say, for investing. The structure of the investment
companies is there's an independent board who's there to really look at ensuring that the
target returns and the risks and diversification requirements of a listed company are being delivered,
and they are managing. External managers are in charge of sourcing the assets
and operating the assets, and they are the sort of the entrepreneurs and the
experts in the asset class. It's a number of engineers and financial and technical
experts who have put together portfolios which can deliver dynamics or investment characteristics which are
attractive to a broad range of buyers. But these are investment companies. These
are listed companies, so a bit different to MLPs in their structure slightly.
They are owned by a wide range of investors from pension funds, institutional investors,
retail investors, wealth investors. So the benefit of the structure is that
it gives access to a broad range of investor types to the asset class,
particularly where they're interested in participating in the energy transition and growth. But again
it's not unique to renewable energy, unlike MLPs, which are specific to certain
asset types. Investment companies actually invest in a broad range of asset classes,
and the renewable energy peer group that we look at, so whether it's the
twelve generators or the broader energy transition peers are part of actually a much bigger
infrastructure peer group of thirty with a thirty billion aggregate market cap. Slightly different
strategies, but designed to give a broad range of investors exposure to some large
ticket assets delivering some economic and social environmental good I guess, Please correct me
if I'm wrong. The general thesis was those yield companies will deliver or yield
which is almost government back through existing support scheme, and the yield would be
much higher than government bonds. So have those companies delivered the yield they were
supposed to? And as that this is evolved over time, they all have
stated total return targets and they give quite clear guidance on the level of dividends
that they seek to pay to shareholders over certain periods of time, and that
will be based, of course, as you say, on the level of
earnings visibility that the companies have. Now if some of them have a high
proportion of subsidies or regulated income clearly the visibility around those income levels is greater
than if it was all merchant power price exposure, where obviously variability of power
price will be a feature. They've all delivered their target dividends in each every
year to investors. They have typically grown their dividends in most years. There
are one or two examples where that's not been the case, but most funds
have grown their dividends. There are some companies that have a stated policy to
grow dividends in line with inflation, and so again investors, they've certainly looked
at the sector because of the level of earnings and dividend visibility that they can
achieve. Importantly, with the exception of the very weak power price backdrop that
we saw going into the pandemic, most companies have consistently covered their dividends from
cash flow generated from the portfolio net of paying back debt, although management costs
and roughly speaking, there's been as a bias in the UK portfolios towards subsidy
based cash flows. It's between fifty and sixty percent of revenues come from subsidies,
so that gives you the visibility. The remainder comes from merchant power pricing.
And what the managers are there to do is, of course, manage
that volatility through time. And what we've seen is some pretty good successes,
some standout companies who've been able to hedge sufficiently well to mitigate the lows as
well as maximize the highs. And that has given a healthy level of earnings
growth and dividend growth, and that has supported total returns over time and by
and large the target returns that were set at IPO. If we look back
to the IPO targets, the majority of the companies that are fully invested have
met or exceeded their target returns. So that we would say is a validation
of the strategy and the thesis. How the market views that at any point
in time, of course as a function of when everything else is doing in
the market, but the sector has delivered on its thesis to date. I
can hear that in theory, But when I look at the share prices,
I think all of them are trading with as in value. And maybe you
could talk a little bit about that, because again most of us are realized
that when we put money in a business, you look at earnings. But
actually in this case I talked about NOV so maybe talk about that and why
you think these companies are training when all love And also i'd ask just in
relation to that, well, you know, we've seen last year, we've
seen takeovers of one of the listed businesses, and there's obviously been a huge
amount of rumors in the market about other takeovers. And this says, I'm
sure we're going to see more mergers in that, but that only happens when
there's undervalued. So then I would argue, well, well, why are
they undervalued? It's a good question. Net asset values are the key metrics
that investors use in this segment of the market to price the shares, and
you're correct, the last eighteen months or so I've been a difficult period for
share prices for renewable energy companies, but I would say that that is the
case for all infrastructure businesses, and indeed that extends beyond the infrastructure segment.
And part of that, as you'll be familiar with, is is of course
the volatile macro backdrop that we've seen and the rapid rise in rates that we've
seen interest rates across the different geographies. And how the net asset values work
is they're based on DCF discounter cash flow valuations provided by the directors of the
business and they look at the cash flows that they expect to receive based on
the subsidies and the inflation escalations and their view of merchant pricing or more specifically
a third party independent view on power pricing, and those individual assets are aggregated,
and so the NEST asset value is a function of a DCF based on
the cash flows they expect to receive over the life of the projects, and
of course the asset life and how long you expect to receive those cash flows
is also a feature of the net asset value. Discounts appear usually in the
listed markets when the market is uncertain around the valuation of the assets the NESTS
asset value. Generally, discounts exist because either they think the valuation or the
assets are wrong. The balance sheets are higher risk, i e. There
might be some refinancing exposure, and of course we've been through this higher rate
environment, or whether cash flows aren't deliverable or dividends can't be supported. And
what I would say generally about the companies that we follow in the context of
infrastructure more generally and the renewables, is that asset values have been relatively robust,
so notwithstanding lower power price forecasts compared to peak levels that we've seen,
Notwithstanding obviously inflation and rising rates, inflation has been a general positive tailwind for
net asset values of these companies because of the subsidies tending to have the annual
escalation with inflation we've seen. Generally, the majority of companies have long term
fixed cost debt, so there aren't any refinancing cliffs, as it were.
There is in the capital structure a slight nuance. There is a mixture of
long term strategic debt at the portfolio of company level, and there's also an
element of shorter term bridge financing which is bearing higher interest rates, but that
to be a relatively small portion of the capital structure. So generally, the
reasons why discounts exist to asset values are because valuations aren't stable or are expected
to come down. They have been generally stable modest declines between minus one and
a half to plus one and a half percent each quarter. They are quarterly
valuations, so we get a good level of visibility and at semi annual points.
Sore annual results and the interim results management teams provide a lot of granularity
around the sensitivities to valuation. They tell us the position that they have over
their hedging, so we can see earnings visibility. So again, notwithstanding the
power prices coming down from the lows, the net usset values haven't seen a
major fall as a result of that phenomenon alone because of the high level of
short term hedging positions that have been employed. Actually, the longer term outlook
for power prices as published by the Independent Power Price Forecasters, has been generally
stable, but speaking, the balance sheets have been stable. Fixed costs so
limitedary financing. Asset values have benefited from a positive tailwind from inflation, which
is offset higher discount rates discount rate being the key metric in discount cash flow
and to reflect the rising rate back draw where often investors look at achieving a
premium over risk free rates so relevant bond yields in relevant markets. What we've
seen is that managements, when they're valuing the future cash flows, they have
started to reflect that higher rate environment into their DCF so increase their discount rates,
which we think is giving currently at the moment over a four hundred plus
basis point premium over risk free rates. So we think that's a reasonable risk
premium for the kind of cash flows that you get in these specific companies,
whereas I say there is a reasonable element of earning visibility. Wow, that
was a long explanation. I'm trying to make it a bit shorter for the
non specialists. Can I summarize by saying, Look, government bonds used to
be at one percent or two percent, so everybody was happy with a six
or seven percent return, and now government's bonds are five or six so we
expect almost double digit from those guys. So the validation has to readjust to
meet those new expectations or is it probably more complex than that. It is
slightly more complex than that. I mean, there isn't a one for one
move. If on deeals rise by three hundred basis points, that does not
normally equate to a discount rate increase of three hundred basis point because, as
a reminder, the valuation of the listed companies that we look at didn't track
the bon yealds going to record lows in the valuation, so they didn't move
discourates down to the same degree, so they won't move up to match one
for one the same degree. So it's definitely an input into the discount rate
assumption. But what you also have, of course is third party transaction evidence,
which gives investors again another sense for what other parties are willing to pay
for these assets. And in terms of the listed companies, what we've seen
to date is examples of them selling assets, a range of assets in a
range of geographies with different characteristics, selling them above where the net asset value
has valued them at the last reported date. So we're seeing a combination of
managers have increased discount rates to reflect a rise and bond yields, and we're
also seeing third party transaction evidence showing us that valuations in the listed funds are
robust because people are buying at levels that are higher than the valuation. Applies
back to the question about discounts and why the discounts are there, whether net
asset values can be trusted or relied upon. I think we have to look
at those two things as a starting point before overlaying individual company specifics, which
is where does the discount rate value the cash flows relative to respected bonds.
And we think, as I say, there's a comfortable buffer and all their
buyers out there for these assets at prices which the listed companies are applying in
the netosset values. Those two points have been proven in recent times in recent
months in the sector. Can I also ask you a little bit about how
you see the future. And I just want to make a point that,
certainly from the renewables point of view, these zeal coals are incredibly important,
especially in the UK, and the reason why because they were the best buyers
in the market. They were the lowest cost of capital for owning renewables.
But if I look going forward, it's going to be very difficult for these
companies to raise money. So correct me if I'm wrong, and it's to
just talk about how you see that. Then another important piece of the puzzle
when we're looking at companies as well as current valuation statistics is how sustainable are
these returns over the long term. Can companies continue to grow and enhance returns
over time? What are the sources of the capital to allow them to do
that? And of course raising equity in the listed markets, as you say,
is incredibly important in that growth story. But you know, even if
if we look at some recent newsflow across the sector, we can see that
companies and boards and again the independent boards are important here, but managers and
boards have been looking across the portfolios and businesses to see what they can do
to continue to work their existing asset base to raise capital from other forms.
And we've seen the introduction of strategic partnerships a recent one with some local pension
funds and a very large, well known solar business which provides a number of
options for the business to continue to generate returns over time. So we've just
seen what the listed format on the board structure of the companies allows them to
do is explore all options. Selling assets has been a way to raise capital
to reinvest into new developments. So selling on assets that have been held for
period of time, operational assets generating good levels of earnings. You selling on
to additional holders using that cash to pay down debt facilities, which which allows
the funds to free up capital options to fund their pipeline. And it's about
looking at who's got access to proprietary pipeline as well as sources and uses of
funding it. At the moment, strategic options have been undertaken, so selling
assets, recycling capital, using excess cash to fund the pipeline. You know,
a lot of these companies, as I've already said, have not just
met their dividend targets, that they exceed their dividend targets and they've got excess
capital beyond that, and so they are able to use that access capital to
fund growth. So it might be sources of capital coming from a broader space.
And when the market that sentiment returns to the sector, as we believe
it will, then that will be another opportunity to fund growth. But not
all businesses will have access to proprietary pipelines. And then is those businesses that
we think will have more options around finding additional sources. It's time to be
a bit provocative. Was it just a moment? And I don't want to
make the ballel with SPACs in the US because SPACs that's upon this scheme mostly.
Now, if you look at the sophistication of the big fund managers,
the KKR, the black Rock, the Macquarie of this world, who somehow
creates similar vehicirls. Maybe if you're a big pension fund, you're going to
ask yourself or should I put my money in a yield core or with those
very larger non listed supermarket of finance. If I may say, so,
do you have an opinion on this? I do so. Look it's a
valid point, and we'll remind ourselves that some of the recent news flows is
showing you that some of those pension fund investors who might also choose to invest
their money with the larger asset managers in private funds, which different fees for
different investors. I think the benefit of an investment company structure is that the
fees are quite clear the return targets that you're looking to achieve a net of
those fees. So you've got liquidity in listed funds which perhaps you don't have
the same access to in other structures. You know, different structures will work
for different kinds of investors, of course, but again we would say that
there are examples and recent examples if we look at the announcements say from blue
Field Solar Income and the strategic partnership announced with Glen Infrastructure, whereby you've got
groups of pension funds so long term investors in the energy transition partnering up with
a well established listed company operator that has a track record of developing assets at
an opportune point in time in the market and has built a proprietary pipeline.
So I would say different things work for different investors. But a key benefit
of the investment companies is that the liquidity and the visibility over fees. And
as I say, they are companies with active managers who have been busy building
portfolios of opportunities which the shareholders can benefit from. How they fund them is
becoming more innovative through strategic partnerships or selling older assets to recycle. But that's
the benefit of the sector is it gives the investors the choice to invest when
it works for them and to exit when it works for them. And that
is a big difference between the listed investment company structure and other forms of investment.
You're reliant on drawdown and access to deals with which are perhaps slightly less
out of your control, versus a listed company that will typically look to be
fully invested at all times. So draw down is a big positive factor for
listed funds. Collect Now, first of all, thank you very much for
this. As I'm listening to you, I'm just reflecting, and I suppose
if you look at an alternative for these businesses. Alternative for these businesses that
they become independent power producers and then move in that direction and The reason I
say that is because if you look at the future. You said earlier on
that a lot of these vehicles what they had was they had government back revenues.
I if I look in the future, it's not government back revenues,
it's our purchase agreement. You might have a CFD that gives you some form
of risk reduction, which you know, monetization of your portfolio through trading and
all this typics becomes much more important. And that sort of sounds to me
like an independent power producer. And also, then as you just said,
I think the pipeline is really really really important. Rather than just being a
I say, a dumb buyer of assets, what you need to be is
the intelligent manager of assets and whatever. And that's going to be more complicated.
So is that not the direction we go? That's what I'm asking,
whether you call it an independent power producer or a renewable generator fund. I
mean, we think that you've got some of the same characteristics that you would
perhaps be more familiar with in an operating company business. You have got management
teams that build pipelines, are not sort of just financial owners of the assets.
These are very well ingrained experts in their respective fields and things like GPAs
and accessing having internal resources. You know, listed companies very much through the
management of these vehicles. You know, if we look at some of the
European names, particularly where PPAs are certainly a bigger part of the market,
managers are adapting to that. They are very much growing their internal merchant markets
teams. Some already have some of the biggest merchant market teams out there.
So we definitely when we're assessing the peer group, look to the manager's expertise
and skill set to ensure that they have exactly what you would expect a toolkit
if you like, across the value chain to run these businesses over time,
and we look at sourcing origination, we look at how they manage power,
price exposure, and risk capital structure. So we look to those managers that
have that broad suite of expertise already in house to take a view on whether
the list of companies can continue to deliver value for shareholders. So the name
that's on the tein asn't wear is less important to me. The analysis is
still the same companies and managers and boards got the added benefit of the boards
in the sector which are independent and therefore there to protect all shareholders' interests.
We do that analysis, So whatever you call them, it's okay for me.
I just want to know that you've got as a manager that skill set
in house which is going to help me take confidence or not on whether you
can deliver the returns you've said you can for investors. Well, thank you
very very much for coming on the podcast. Greatly interesting. Thank you,
yeah, super interesting. Thank you call it sol What did you think of
that? Number? One? It works? Does infrastructure funds delivery yield?
Which was what they were supposed to do? And of course there's a lot
of question around the future because the performance into twenty three was not very good.
But I like the vehicle provides liquidity. It requires much more discipline than
the funds you will have under those big asset manager where they're not as liquid
and I don't know how granular the calculation of nav is and here the fact
that it's industry kickshite provides really the very good understanding of what's going on in
the portfolio. So yeah, I like those vehicles. What I really like
about them is the fact that they give the retail investor and the small institutional
investor, the opportunity to invest directly into renewable assets, because to be clear,
if I try to do this, say where I'm living in Germany,
it's very difficult. I have to go to a private fund and the other
thing and whatever. So I think that's number one. And number two is,
especially in the UK market, they have been the best buyers for renewable
assets for the last seven eight years, and that's really important because what I
mean by the best buyer, what I mean is they are the people who
pay the highest prices. That's a very good thing because what that is actually
doing is it is just increasing the efficiencies in and around the role that are
renewables. We need guys like this that have low costs of capital behind them,
So I think they're very important. I'd love to see changes in tax
legislation and other countries to allow more of these vehicles to go onto the list
of markets. I also really like your comments at the end where you said
that they would progressively morph into ipp independent power producers, because let's be clear,
the thesis when they were created ten years ago was you're going to get
some flat government back revenues, so which really positioned themselves very well into the
core infrastructure, and now their revenues are going to be much more merchant which
means that those you'll go will need to bring in house the expertise of trading,
aging and so on. The way. They're already doing this. Guys
like the Green Coasts are doing this already and it's great because they're adapting to
the changing world renewables. Renewables is not about subsidies anymore. It's about commercializing
renewables and that's two PPAs and that's also true an element of power trading and
risk management and all that type of stuff. So yeah, it's good to
see the leading gel cos becoming an investment companies. That's really what they're becoming,
renewable investment companies. As I said, I'd love to see more of
these coming to being. One of the thought I have is it's going to
be difficult to replicate that model for let's say, pure place storage, because
the results of the storage business is so all over the place. You know,
they might deliver twenty percent one year and they might deliver five percent the
other year. There's too much better. The alpha is great, but there's
too much better. And I think that investors who go into yield cos they
like the low better better means the volatility of the result, the alpha being
the absolute result. I go along with you and we just add that store.
It is going to be a critical part of any of these renewable asset
owners going forward because it enables them to manage the risks in and around negative
pricing, zero pricing, low pricing, et cetera, et cetera. But
just standalone storage, I hear you on that. It's it's just too volatile
for the average customer. Or you don't do it as a yel code.
Maybe you do it as something else. It's a it's a storage fund,
but it's not a yield. You're not there to do yield, right,
yeah, yeah, yeah, yeah yeah. You're a trader, that's what
you are, Isn't it really right? You're going and saying, listen,
we're gon, we're gonna have a great year. We're going to go to
the UK market, then we're going to go to the Textan market. You're
up and down, up and down, and you're managing this portfolio of assets.
But ultimately what you're doing is trading and optimizing. Okay, So it
was a technical, but nevertheless very pleasant conversation. We like it very financial,
so we kind of understand what's going on. Sometimes we get engineers on
the shore and we have no clue what they're talking about. Well, you
understood collect we spoke our language. Yeah exactly. We thank AXPU for the
support, and two weeks time we'll have Aquilla coming back. So I'll talk
to you next week for our minutes and in two weeks time another big interview
look forward to. Thank you for listening to Redefining Energy. Don't forget to
read the show and subscribe on Apple Podcast, Spotify, or the platform of
your choice.