Renewable energy real estate investment trusts (REITs) have had a pretty rough time over the last couple of years. Despite soaring demand for green electricity, these shares have been thrown into the gutter on the back of rising interest rates.
It’s not difficult to understand why this has happened. The bulk of net profits are being redistributed to shareholders as dividends. As such, management teams are forced to rely extensively on external financing to expand their asset portfolios. And now that the cost of debt has increased substantially, the fair value of renewable energy assets has been dropping, dragging valuations in the wrong direction.
However, for long-term investors, this could be a rare buying opportunity to lock in chunky dividends.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
The problem with REITs
Let’s start by looking at one of the UK’s leading wind farm REITs – Greencoat UK Wind (LSE:UKW). Over the last 12 months, the share price has tumbled almost 20% on the back of higher interest rates, wiping out almost £100m of net asset value (NAV).
Yet on a per-share basis, NAV suggests the stock should be trading close to 164p versus today’s valuation of 135p. That’s an 18% discount, suggesting that investor confidence surrounding this business continues to be shot. And there may be a good reason for it.
For starters, it seems interest rate cuts are going to take longer than expected now that the Bank of England intends to maintain higher rates for longer. In the meantime, government windfall taxes on the renewable energy sector have placed even more pressure on margins.
So, it’s easy to see why not everyone is eager to invest in this business right now. And there are plenty of others within the green energy sector in a similar situation. But is this pessimism a mistake?
Cash is king
While Greencoat’s share price has left much to be desired, the same can’t be said for its dividends. Even with macroeconomic pressures, the group remains a cash flow generating machine, enabling management to sustain a 7.4% dividend yield. Management has just hiked shareholder payouts for the 9th consecutive year at an average growth rate of 8%, too!
Providing the firm can keep this up, investors may be looking at the start of a new FTSE dividend aristocrat. As such, the already impressive yield today could get substantially higher later down the line.
This strategy is precisely how Warren Buffett is now earning more than a 50% annual yield on his original investment into Coca-Cola. There’s no guarantee Greencoat can replicate such chunky payouts. But, providing management continues to prudently manage its debt load, I believe the firm has this same potential, especially considering the ever-increasing demand for renewable energy.
That’s why I’ve already added this REIT to my income portfolio and am currently considering buying more at today’s price.
