Solar power investments - 2nd thoughts

Solar power has been a phenomenal success. It's increasing adoption is driving down costs, and generating increasingly cheap electricity. Here is an article that spells this out in convincing detail.

This article from the IEA is suggestive of something similar, although from the point of view of auctions. And this from Irena, suggesting the costs from Solar have been reducing by around 13% per year.

I think the greatest impediment to further adoption of renewables over fossil fuel has been economics. It seems clear that in the case of solar this argument has been won. Solar provides increasingly cheap, cost effective electricity.

Solar investments
I have two investments in solar power in my portfolio, Next Energy Solar Fund (NESF) and Foresight Solar Fund (FSFL). In both cases I assumed these would offer relatively little in the way of capital growth, but that the pedestrian growth will be augmented by a steady flow of dividends. And since the power that these businesses generate gradually increases in price over time, the dividends will more or less keep pace with that level of price inflation.

However, as noted above, solar energy price inflation may not be forthcoming. Quite the opposite. Next Energy Solar recently published their annual report so I was intrigued to read about how they intend to manage a product reducing in price.

Next Energy Solar Fund (NESF)

I bought shares in Next Energy Solar Fund (NESF) in November 2019, essentially buying into their investment objective as outlined in their 2019 annual report:

I expected it would reduce the volatility of my portfolio, as it should have steady revenue streams, most of which were backed by Government subsidy. And one reason I like dividends is that they too help reduce portfolio volatility. So it was a typical risk/ reward trade off - lower growth and lower volatility. The KIID implied as much.

At the time 35% - 40% of NESF revenue was not covered by some form of subsidy, and more subsidy free solar development was underway. So this chunk of subsidy free electricity would be subject to the movement of prices on the wider wholesale energy market.

The annual report describes the fund's NAV increasing over 2019 for various reasons, including "...upwards revisions in the forecasts for long-term power prices...". Happy days, unless those power prices go the other way...

Next Energy 2020
I like reading annual reports - it is the chance for the business to put itself in the shop window, and tell the best version of it's story. It is also a more rounded story, with a little more meat than the simple results briefing. It should be convincing, so when it isn't I find it worrisome.

The NESF results weren't great, but not disastrous. NAV down a bit, dividends up a bit. Operationally there were more assets generating more electricity, and a higher capacity. But the Chairman's statement contained the following:

"...power prices and inflation levels have become less correlated..." - which rather matches some of the analysis from the articles linked above. And as a result RPI linked dividends are out of the window, the resulting change to NESF's investment objective has since become "regular dividends":

Subsidy free risk
The top "Operational and Strategic Risk" highlighted in the annual report relates to the risk of falling electricity prices: "The acquisition of subsidy-free assets will increase this risk as currently most of their revenues are derived from the wholesale energy market with only a part benefiting from short-term PPAs."

The Chairman acknowledges that 39% of their revenues are without subsidy, and require locking in prices using PPAs:

And that they continue to pursue a subsidy free investment programme, aiming for 150MW by the end of 2020, at a cost of £55m - £80m. Preference shares worth £100m were issued during the year, which I guess is the source of the majority of this cash.

Discount rate
The final bit of irritation was found in their financial KPIs, 

Each year since 2017, the discount rate has been reduced. Since this sits in the denominator of the discounted cash flow they will be using to calculate the NAV, it has the effect of increasing the NAV. Which is mentioned in the discussion of NAV in the annual report:

Unfortunately NESF don't state how they determine the discount rate.

Conclusion

It feels to me as if the business has backed itself into a corner. It's only route to growth being the purchase and development of assets that are generating a product being sold for an ever decreasing profit. Continuing to increase the proportion of subsidy free assets in their portfolio surely can't be sensible, as indicated by their own risk assessment.

Changes to the discount rate have been made without explanation, and since doing this cushions the impact of the falling price of their product, it's not a good look.

I should have identified some of this in my research before purchase. Lesson learnt.

August 2020 portfolio update

August proved to be a fairly uneventful month in the markets, UK markets going sideways and most others chugging North. US tech continues to eat the world and now a small handful of these companies are worth more than all European listed companies. I wonder what will happen when the tech giants' share prices fall over?

At least the drip feed of hopeful news on COVID-19 treatments continues, as does the search for a vaccine. Hopefully the mask will be to COVID-19 what the condom was to HIV, my ventures into public spaces recently have been filled with a mask wearing public. I even saw a TV advert for the fashion conscious mask wearer the other day.

I've been having a ponder about the portfolio, and there are a couple of changes I think I'd like to make over the next few months. Following some more research, and release of info from a couple of holdings, I'm less keen on keeping hold of them, so potentially a couple of sales required. On the buying front, I'm curious to see what will sell off during the next drop - will the shares already hurt go much lower, or will it be those that have held up well that are in the firing line? 

Portfolio performance
The portfolio was up +1.2% in August, behind my chosen benchmark (Vanguard FTSE All Share Accumulation) which was up +2.4% over the same period.

Best performers this month:
Dignity +65%

Compass +16%

Elco +13%

Worst performers this month:
Somero Enterprises -12%

Saga -10%

Network International -7%

August share purchase: REL

RELX (REL) was added to the portfolio in August. I'm rather pleased about this as it's a company I've been following for a while, but the price never seemed to fall too far when the market wobbled. So I thought I should take the opportunity when the price dropped earlier in the month.

RELX has it's roots in publishing, in particular, scientific, technical and medical material, and legal textbooks. It was formed from a merger of two publishers, one British: Reed International, and one Dutch: Elsevier. It has been listed on the London Stock Exchange in some form since 1948, and over the past few decades has grown to a market cap of around £33bn.

RELX now make relatively little from paper publishing, only around 9% of revenue is from print. Today the company, in their own words: "...is a global provider of information-based analytics and decision tools for professional and business customers". They have 4 segments in the business: Scientific/Technical/Medical, Risk/Business Analytics, Legal, Exhibitions. The first 3 segments provide data and analytics technologies to a range of industries, from life sciences, fraud detection, and case law. The 4th segment - Exhibitions - is a bit of an awkward fit with the rest of the business, and the reason that I think the price tumbled. More on this below.

The interim results announced at the end of July told of the 3 data and analytics segments of the business holding up well under the pressures of COVID-19, and even growing. However the Exhibitions have been whacked by the virus - getting large groups of people together to try to sell each other stuff isn't a great idea at present. This part of the business generated around 16% of revenues last year, which was roughly the discount on the price from the start of the year at which I managed to pick up the shares. Face to face business clearly isn't going to happen for a while, so this part of the business is likely to continue to struggle, but so long as the other segments hold up RELX shouldn't be in an too much bother.

According to their annual report RELX are in the top 1 or 2 position in the various markets in which they operate. Their "moat" has been built over many years, RELX has developed sophisticated databases and decision-making tools that many industries and professions now heavily rely on to carry out their daily activities. The majority of their revenues are subscriptions, which is preferable in my view - they tend to be sticky and give visibility of future earnings. Their Return on Capital has averaged over 15% and net margins over 17% over the past 10 years, which combined with relatively light capital requirements have led to healthy cash flows. These have covered the dividend more than 2x over the past few years. 

It's not all silver linings of course, on the cloud front, they have more debt than I would like. Should the data that RELX provides become more accessible in the public domain, or author/reader payment models change, this could give them a headache.