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Hi Zac.
1. The articles on the free Motley Fool blog are just superficial click bait intended to attract you to their paid subscription service (which I do subscribe to at the moment).
2. I can't see the point of worrying about one year total returns. They are meaningless if you are an investor rather than a trader, especially for dividend stocks. As long as UKW can continue increasing its dividend in line with RPI indefinitely, I don't care about the share price. That said, a fall in the share price could indicate investors' doubts about the long term sustainability of the dividend. But I think it has little to do with that and is almost entirely a reaction to high interest rates.
Personally, I would like to see my investments go down, as I have a lot of cash (well, short term bonds) that I'm hoping to invest at lower prices!
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%.
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?
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.
"Debt also gets inflated away which wasn't the norm in 2009 -2021."
Yes, real interest rates are very low or even negative. I think most savers are well aware that they are receiving a negative real interest rate or (even if they don't think in those terms) that their savings are not keeping up with inflation. But borrowers just seem to focus on nominal interest rates.
Providing a business can survive the short term cash flow pain of high nominal rates, it will benefit in the longer run from the low real rates. While it's possible that inflation could come down with nominal interest rates remaining high, I can't see that happening for long. I'm expecting inflation to remain elevated.
@joseywales
"there are so many you can mention right now at multi year lows"
IMO a large part of that is because shares have been overpriced for a long time due to ZIRP and now they're coming back down to earth.
"the crutches keeping the uk standing are the pensioners they gave a 10% pay increase to"
I always thought the triple lock was unrealistic in the long term. Pensions should be increased in line with wages, so pensioners share in the fortunes of workers, for better or worse. And I say that as someone who is within a year of state retirement age. (I can't believe I'm that old!)
I've been consulting Mr Google on the subject of the true cost of renewable energy. I came across this paper which makes for uncomfortable reading:
https://www.ref.org.uk/ref-blog/365-wind-power-economics-rhetoric-and-reality
It's not just Mobico. The stock exchange is having a fire sale today. I just bought some SMDS down over 4% on the day and more over the last few days, despite having a good report a couple of days ago, and only 1.2x debt/EBITDA (IIRC). It's probably just because recession fears are up and cardboard box makers are considered very cyclical.
REITs are also being hammered. Personally I think those were overpriced, and I'm hoping to buy some cheaper.
Thanks, Monkshood. I hadn't seen any figure for expected dividend cover. I'd be happy with 2×.
In the Annual Report they said the plan was to pay off the revolving credit debt with longer term debt or by raising equity. They also said that they like buying assets on leverage because the cost of debt was less than the yield on the assets. But maybe that was when interest rates were lower, and they might change their minds now.
I see the share price is well down again today. Looks like I was too impatient, buying at 140p, as usual! Fortunately I still have some dry powder. ;-)
Correction... I understated the amount of short term debt. From the Annual Report...
"As at 31 December 2022, Aggregate Group Debt was £1,780 million, equating to 31 per cent of GAV (limit 40 per cent). Debt outstanding comprised £900 million of fixed rate term debt at Company level, £200 million drawn under the Company’s revolving credit facility and £680 million being the Group’s share of limited recourse debt in Hornsea 1."
When I said that 1/3 of debt was maturing within 2 years, that was 1/3 of the £900m. The £200m borrowed on the revolving credit facility also needs to be refinanced. I haven't been able to find out anything about the terms of the £680m debt for Hornsea 1.
This is a little disappointing, though as I said, I'm not too worried about higher nominal interest rates, as long as real interest rates are low.
I have two main concerns about the long term future for intermittent renewables, like wind:
1. I suspect that the true cost of electricity from intermittent renewables is much higher than most people realise. I often hear about how cheap renewable energy now is, but I don't think this takes into account the extra costs that are incurred by the system in coping with the intermittency. These extra costs include: electricity from wind being wasted when there's too much of it (I believe the generating company gets paid for the wasted electricity, at the consumer's expense); the cost of batteries that are used to store intermittent electricity for short periods (I think these are mainly used with solar energy); the unit cost of gas-fired electricity being increased because power stations are running at reduced capacity just to fill in when there's not enough wind (so the building and running costs of the power station are spread over fewer units of electricity produced); the grid needing to be expanded to accommodate new wind farms, which tend to be much further from consumers than power stations are. These extra costs fall on the consumer and taxpayer. Over time perhaps the generating companies will be made to shoulder more of the cost. (Consultations are already in progress over a new electricity pricing system, "REMA".)
2. New or improved non-intermittent technologies may replace intermittent ones. I'm thinking mainly of nuclear and geothermal.
On the other hand, the development of cost-effective longer-term energy storage technologies would be good for intermittent renewables, as would cost- effective conversion of surplus electricity to hydrogen.
All in all, I think there a lot of uncertainty about the long term future for intermittent renewables, and that's the one thing that stops me buying more of them.
All good points, Monkshood.
From a personal point of view, I wouldn't invest in long term fixed income bonds, because I'm afraid that we're entering a long period of higher inflation. I'm already semi-retired, and part of my income is from a fixed annuity, which is really hurt by inflation, so I want to hedge by making sure my investment income is well protected from inflation.
For pension funds/companies with fixed liabilities (such as the one paying my annuity) it makes sense to invest in fixed income bonds. But I wonder whether some pension funds are exposing themselves to excessive inflation risk by holding too much fixed income.
Anyway, getting back to the subject of UKW, I had a look at their last annual report the other day, and one of the things I particularly looked out for was how exposed they are to increasing interest rates. One good point is that their gearing is only about 30%, which is lower than other renewables companies I've looked at. It's also good that they have some pretty long maturity debt at low interest rates. Not so good is that about a third of their debt is due to mature within the next 2 years. If they roll over that debt, it will presumably have to be at a much higher rate than they are currently paying. But perhaps they will be able to pay down some of that debt out of whatever remains from last year's windfall or next year's profits.
Anyway, I'm not too worried about interest on debts, because I expect_real_ interest rates to remain low. The short term cost of higher nominal rates is offset by the fact that the real value of the debt is being slashed by inflation.
In my opinion, it's mainly interest rates. We saw a similar drop (even lower) last year after the Truss mini-budget. There may also be a significant contribution from lower gas/electricity prices. It will be interesting to say what happens if we have a much colder winter this year.
I try not to worry about a falling share price, as I'm holding for the dividends over the long term. A lower price can even be a good thing if you want to buy more. Of course, it's another matter if the falling share price reflects an actual worsening of the company's prospects. I don't think that's the case here (or I wouldn't have just bought some more).
2. Low gas prices are probably having some effect too
Thanks for the replies to my question. I've only just noticed them. (Is there a way to get email notifications when there are a new posts to a chat board here?)
I'm still holding off on buying SUPR (and most other shares) for now. I'm hoping for a bigger margin of safety.
Hi. First time posting here under CSN. I only bought CSN a few months ago, after having it on my watchlist for a while. I was wary of it, as I didn't know how it would be affected by interest rate hikes. But the share price has been remarkably stable for the last 3 years, despite the interest rate chaos and market swings.
My main concern now is whether the dividend will be able to keep up with inflation over the long run. But, given the high current yield, I can live with some fall in the real value. I don't really expect my investments to give a real return of 8.3%. (It would be nice though.)
Well, after looking at NESF and BSIF (and having looked at other renewables companies recently), I still like UKW best. And even though I know I should diversify, I can't bring myself to buy second best! So I bought some more UKW, at 140p.
I'm still half-expecting a significant market correction from here, and holding back some cash and equivalents to take advantage of any bargains. LGEN is on my watchlist, but I'm wary of financials at the moment and waiting for a bigger margin of safety. I already own CSN, a smaller pensions company, with similar yield to LGEN, but seems less volatile.)
Prices still falling, so I'm in no rush to buy. Other renewables are looking good too, so I may diversify a bit. NESF has a forward yield over 8.2%, based on its target dividend of 8.35p. I'll take a closer look at it.
That said, I'm still concerned about the long term future for renewables investments, so a bit reluctant to buy more.