The transition to cleaner energy is a long-term trend which will involve significant investment in areas like renewables. UK Greencoat Wind (UKW) is a good way to play this transition while offering a stream of income from dividends which are rising in line with inflation.

The trust generates strong cash flow from its portfolio of onshore and offshore wind farms, reinforced more recently by strong power prices. Often trading at a premium to net asset value, it is currently at a modest discount of 3.3%.

Revenue from operating wind farms in the UK is made of up of several components. The main one is the sale of power produced under long-term agreements to utilities who are obliged by law to purchase a certain percentage of power from green sources.

Since its launch in 2013 Greencoat UK Wind has paid an RPI-linked dividend and it reaffirmed these inflation-busting income credentials in January as it confirmed a 2023 target to increase dividends by 13.4% to 8.76p. That puts the stock on a 5.4% prospective yield.

Dividend cover in 2022 was 3.2 times which leaves surplus cash of £395 million, according to estimates by research group Kepler, which can be reinvested in the portfolio, helping to lay the foundations for further growth in the dividend.

Greencoat has a committed pipeline of acquisitions and the growth opportunity is highlighted by the estimated total value of UK assets in operation, construction or with planning consent of around £90 billion.

Because the dividend is well covered by earnings, the trust can withstand significant downside in wind volumes and power prices in any individual year.

Analysts at Kepler note the managers’ observation that they ‘fixed the roof when the sun was shining’ in 2022. ‘When electricity prices were rising at their fastest rate, they built plenty of conservatism into the net asset value by assuming very significant haircuts to the wholesale electricity prices at which they would sell their energy output. As interest rates started to increase, they raised the discount rate at which they value assets.’

Rising interest rates have led to higher discount rates on long duration assets like renewables infrastructure. Two key elements make up the discount rate – the risk-free rate which is typically taken as the yield on government bonds and the risk premium which is the part which reflects the risk associated with investing your money. The risk-free rate has moved materially higher.

This has already had an impact on the valuation of trusts in this space and we now think it is fully factored in by the market.

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