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To invest mostly in operating UK wind farms with the aim to provide investors with an annual dividend that increases in line with RPI inflation while preserving the capital value of its investment portfolio.
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At what cost to your capital, though?
Https://uk.finance.yahoo.com/news/d-buy-11-650-shares-070044762.html
Well surprise surprise, the mentioned "Climate Lobby Group" netzerowatch.com, that seems to oppose all kinds of green energy including recommendations to dismantle the entire wind energy sector, has some dubious sponsors.
IMO of course those rules on ever decreasing strike prices should be rewritten. If this government caves in to the these shortsighted, oil loving, profiteering climate-change deniers, then fortunately it will only be temporary until a government that's pledged support to green energy steps in.
https://www.opendemocracy.net/en/dark-money-investigations/global-warming-policy-foundation-net-zero-watch-koch-brothers/
"An influential Tory-linked lobby group leading the backlash against the UK government’s net-zero policy has received hundreds of thousands of dollars from an oil-rich foundation with huge investments in energy firms, openDemocracy can reveal.
The Global Warming Policy Foundation (GWPF), which also campaigns as Net Zero Watch, has also received more than half a million dollars through a fund linked to the controversial billionaire Koch brothers.
The GWPF has long refused to disclose its donors and claims it will not take money from anyone with an interest in an energy company.
But tax documents filed with US authorities and uncovered by this website reveal the network of dark money behind it for the first time – including the $30m shares in 22 companies working in coal, oil and gas that are held by one of its donors."
Https://www.zerohedge.com/political/wind-industry-blackmails-uk-demanding-huge-ramp-subsidies
Hello tichtich,
You raise some important issues that I have been puzzling over.
First, I agree with your understanding of how the unlevered discount rate to used to calculate NAV. As you say, the nominal outstanding debt is deducted from the discounted revenues.
Second, I believe the levered discount rate is that which gives the same NAV as the above when the debt cashlows are projected and discounted. This is higher than the unleveraged discount rate because the company can borrow at a lower rate than 8% per annum. The unleveraged discount rate should be a more accurate estimate of the projected return on ukw shares.
Third, I cannot understanding why the 10% leveraged discount rate only gives a 9% return to the shareholders.
Is the company allowing for higher borrowing costs when it re-finances its existing loans?
Fourth, I agree that the projected real return is more useful than the nominal return. Your 9% minus 2.5% calculation is a slight overestimate because short term inflation rates are assumed to be higher than 2.5%.
Lastly, the calculation above assumes the investor buys the share for its NAV rather than market price. If the market price is lower than NAV, the projected return on buying the share is higher than implied by the leveraged discount rate. I have tried to construct a spreadsheet model that allows for this effect.
Hi Actuary63. I was planning to be an actuary at one time, but gave up the training after a year. Decided to go into software development instead. Well done for sticking with it!
Regarding the rate of return, the annual report says:
"As at 31 December 2022, the blended portfolio discount rate was 8.0 per cent. This is an unlevered discount rate and is therefore different to the discount rates quoted by peers. The equivalent levered discount rate (assuming 30 per cent gearing) is approximately 10 per cent, which delivers a net return to investors of approximately 9 per cent."
As I understand it, 8% is the discount rate used in the DCF calculation. I don't understand how they get the 10% and 9% rates, or how those are relevant.
The way I would look at it (perhaps too simplistically) is that the NAV is based on a DCF calculation with a discount rate of 8%. So if you buy at NAV and the DCF assumptions are realised in practice, you would earn a return of 8%. That said, the NAV does not evaluate debt repayments and interest as discounted cash flows. The current debt is simply deducted from the GAV to get the NAV. So maybe the other rates cited are intended to adjust for this.
If the rate of return is 9% as stated, what does that mean from an investor's point of view? Does it mean I will earn that rate of return if I buy at NAV (and the assumptions are realised) ?
Finally, I believe this is a nominal rate of return. I prefer to think in real terms. Since the DCF assumes a long term inflation rate of 2.5%, I reckon this would be equivalent to a real rate of return of 6.5%.
Hello tichtich,
Thanks for your comments about the discounted cash-flow method, which we actuaries are compelled to study in the professional exams!
What you said about the calculation being based entirely on the projected cash-flows from existing assets is correct and has important implications. If the DCF calculation predicts an internal rate of return of 9% per annum, it means enough cash is being generated by existing assets to give the shareholders an annual return of 9% plus the return of their capital. So if no new investments were made, the company would accumulate enough cash to make regular capital repayments as well as paying the dividend.
Lastly, although depreciation is not a cash-flow, it is allowed for implicitly in a DCF calculation because the term of the cash-flow stream is reducing over time, hence the DCF value of a wind farm will shrink to zero at the end of its useful life.
Hi Tichtich, thank you for sharing your thoughts and the calculations, found your take very useful,
May it be a good long term investment for all, I'm finding it rather amusing that the risk free rate is now 5% albeit it won't stay there for ever
May's wind speed data was 24% below the long term average, Aprils was also below, combined the two months come in at 15% below the long term average. The early part of June is unlikely to have been any better. I can see generation being well down this quarter although prices are still well above long term averages which should help to compensate.
The jet stream has now moved back to a more typical position so we are now back in a more 'settled' period of Southwesterly winds which should help generation.
Sold some shares to buy more of this dip. I've been waiting for 137p-140p to buy back those I sold at 157p
GLA!
I've managed to find my old calculation, so I'll quote it here. Note that the 5.3% mentioned below was the dividend yield at the time, and the dividend cover at that time was 1.5x.
'It seems to me that, for the business model to be sustainable, we should be treating part of the reinvestment of surpluses as providing for the eventual replacement of exhausted assets, at the end of their 30 year life. Based on a very rough calculation, it seems to me that about 1.6% of capital should be reinvested per annum to cover this replacement. (An asset life of 30 years would simplistically suggest replacement of 1/30 of capital per year, or 3.33%. But these replacement assets will be earning reinvestable surpluses over their lifetime; assuming a real return of 5.3% compounded, I reckon that reduces the required 3.33% to about 1.6%.) If we take market capitalization to be roughly representative of capital, that means reinvesting 1.6% of share price to cover replacement. At present the surplus cover (over dividend) is about 0.5 x 5.3% = 2.65% of share price. But if we say that 1.6% out of that 2.65% must be spent on replacement, and is therefore not "real" cover, then the real cover (after making provision for replacement) is only about 1.2x instead of 1.5x.'
Based on this, I should have said that the cover needed to pay for asset replacement is 1.3x, not the 1.2x that I wrote in my previous comment here. Obviously that figure should be treated as a very, very rough idea.
The '5.3
The NAV (as calculated and quoted by UKW and similar companies) is based on a discounted cash flow analysis over the life time of the assets. Unless I'm mistaken, depreciation doesn't come into it, as that's not a cash flow. The NAV calculation makes some assumption about the life of the turbines. If that assumption turns out to have been too high, then the will NAV have been overestimated. If I've understood correctly, the NAV does not consider possible replacement of the turbines at the end of their lives. It is the NAV of existing assets, not potential future assets.
If we forget about the NAV and just consider the sustainability of the dividend, then the dividend needs to be covered with enough surplus left over to pay for replacement of the assets. I think I once calculated (very roughly) that they needed a dividend coverage of 1.2x just to pay for replacement, assuming no real terms increase in the replacement costs, and I think I assumed a life time of 30 years. That first 0.2x surplus over dividend coverage (or whatever the correct figure is) should IMO be considered a kind of maintenance capex, and not a true surplus.
If replacing the assets turns out to be not economical, they could instead pay out surpluses as an extra dividend, which shareholders could reinvest in something else to make up for the eventual loss of dividend income from UKW.
I don't think it would be appropriate to say that UKW doesn't need to pay for asset replacement out of earnings, on the basis that it could instead rely on new equity raises to pay for asset replacement. If it did that, it would be expecting new shareholders to subsidise existing shareholders, and why would they do that?
Hi Actuary thanks for your reply that's useful thanks. I'm thinking i was confusing myself earlier on the re investment in relation to depreciation wear and tear. However i think i had my numbers wrong, looks like (surplus profit as % of NAV after dividends being paid) 1% in 2020 (too low) 4% in 2021 (fine) and 10% (very high) in 2022
if i have these second figures right the reinvestment should cover the depreciation. 2022 in fact was a fantastic profit result and investment figure -- although we know we cant expect that every year...
i'm thinking a good diversifier for the portfolio and yields higher than BP..
Hello dadean,
The depreciation of existing wind farms is offset by the reinvestment of retained profits in new wind farms. This is why UKW believes its NAV per share will grow broadly in line with inflation. On this basis, I would estimate the long-term return on UKW shares as 6% per annum above the rate of inflation (whatever that turns out to be).
Hi, i bought into this as been watching it for a year or so, i do wonder if we are eating our own tale when it comes to NAV.... scant few details on depreciation in the accounts, if a wind farm has a life of 25 years crudely we could expect 4% depreciation on the asset anually... when looking at the accounts i could infer 1% from the investment managers report.. which would suggest underfunding organically paid reinvestment..... which could mean that the existing assets eventually get to the end of their life with underfunding organic replacements.... (additions aside) could this be the case? or do we think NAV will be maintained?
I also looked at the accounts of a private windfarm business -- community wind farm ltd, and jeez they are bags more profitable than this albeit a smaller firm...... im quite happy with my 6% div, but so long as we are not getting it at expence of a 2% NAV Burn which is under reported
Why the rise? I think that's just because the market has fallen so quickly that it's due for at least a short snap back!
Perhaps we should have a 'Why the rise' thread today - the 'alt 'trusts are leading the FTSE 250 , many with 4-5 % gains.
Hi Tichtich.
"Too many of those new windfarms appear to be planned on Nimby land"
As below, I'm pretty sure they'll sort out the strike price problem with lobbying, and the next government if Labour have already openly supported a vast amount of projects and subsidy so should be fine.
My only concern is when the wider market drops, we drop faster, and our dividend hikes must keep pace with inflation, which as we all know is easier said than done.
Next dividend is in August. Chart did show a cycle between last few dividends which is why I recently went top heavy in the mid 140s, looking to trade my holding larger. We''ll see.
Agree tichtich,
Wind energy is now too big a part of energy generation to be replaced. Electricity prices are main source of risk (rather than running costs or even wind resource). Hopefully, the gradual shift to electric cars will be beneficial for the industry.
One way to reduce costs would be for the government to stop blocking new onshore wind farms.
Personally, I'm not so concerned about the rising cost of new wind farms, as long as UKW's existing wind farms continue performing well. In fact, a barrier to building new wind farms could help reduce competition for existing ones. I'd be quite happy if UKW stopped raising new equity for expansion.
If I'm going to worry, I'll worry about the electricity prices that UKW will be able to earn over the longer term.
Hi Actuary. I see, is that not part of the blunt mallet argument ?
Or simply to do with narrowing margins, electricity price vs costs (interest rates/staff/materials etc etc).
I seem to have opened a can of google worms, as more and more are crying out for new government rules to allow strike price flexibility.
https://dailybusinessgroup.co.uk/2023/03/offshore-wind-farm-at-risk-without-tax-breaks/
Which highlights that certain wind farms have no chance of being built without more subsidies.
https://www.pv-tech.org/how-will-the-uk-cfd-scheme-fare-against-the-rising-cost-of-capital/
And the same including other renewables like solar, on similar schemes.
Interesting twitter thread which though favouring one side of an argument is posting some interesting links.
https://twitter.com/LoftusSteve/status/1669760302672478233
The point I was making is that similar price falls (over the past 6 weeks) have occured outside the renewables sector, which suggests the cause is not particular to the renewables sector.
Https://watt-logic.com/2023/06/14/wind-farm-costs/
Another article arguing that a change in strike price rules is needed.
IMO This is the kind of thing that sends a blunt mallet to a whole sector regardless of the details of how individual companies business is actually going.
----
Time to accept that wind farm costs are not falling
Falling subsidy prices at the same time as massive manufacturing losses makes no sense and is clearly not sustainable. Of all of the projects that secured Contracts for Difference (“CfD”) agreements in the most recent subsidy round, known as AR4, only two have actually taken their Final Investment Decision (“FID”) – ScottishPower’s East Anglia 3 project, and Moray West which is a joint venture between EDP Renewables and ENGIE. Ørsted has warned that Hornsea 3 could be at risk without Government action “to maintain the attractiveness of the investment environment”. It has said it will make its final investment decision later this year.
The Government has said that the CfD is structured to take inflation into account, but other than introducing 100% capital allowances for a limited period in a bid to stimulate business investments in the Spring Budget, it has offered little additional help to renewable developers. “Long-life assets” only benefit from 50% relief, with many commentators believing that wind turbines will be considered to be “long-life assets” – these are typically assets with a life of at least 25 years, which tends to be the upper limit of the life of a wind turbine.
With the pot of money available for AR5 being lower than for AR4 there are now real questions about the sustainability of the trend of ever lower strike prices, and whether the AR4 projects will ever see the light of day.
Senior participants at last year’s WindEurope 2022 conference said that the trend of turbine manufacturers selling at a loss will (self-evidently) threaten renewable generation targets.
“The state of the supply chain is ultimately unhealthy right now. It is unhealthy because we have an inflationary market that is beyond what anybody anticipated even last year. Steel is going up three times…It is really ridiculous to think how we can sustain a supply chain in a growing industry with these kind of pressures…Right now, different suppliers within the industry are reducing their footprint, they are reducing jobs in Europe. If the government thinks that on a dime, this supply chain is going to be able to turn around and meet two to three times the demand, it is not reasonable,”
– Sheri Hickok, Chief Executive for onshore wind, GE Renewable Energy
On the upside... We know how corrupt the current government is, so it's a rolling eyebrow guess that new strike price rules will be announced in the summer, and just like that, the sector goes back up.