Renewables can have a bond-like income with upside value potential – Whitney Voûte

by | Jul 15, 2022

By Whitney Voûte, head of investor relations at US Solar Fund

In any market, but particularly a volatile one, steady stable income – often generated by bonds – is core to an investment portfolio.

Renewable investment companies like US Solar Fund (USF) have similar income features to a long-term bond, particularly where the power generated isn’t sold at variable, and sometimes volatile, market prices, but effectively pre-sold under long-term contracts known as Power Purchase Agreements (PPAs).

In that case, the yield on the initial investment is generated by long-term contracted cashflows from investment grade offtakers, reinforcing reliability of that income. Ideally, a portfolio will include a combination of fixed and escalating PPA prices (growing at a set percentage) providing some growth for the cashflows. For example, USF’s 2021 dividend of 5.5 cents per share at the current share price ($0.88 as of 18 May 2022), means it is currently yielding over 6%. That current yield is fully covered by income from contracts with a weighted average term remaining of 14.4 years and individual PPA expiries ranging from six to 24 years.

While solar cashflows are strong and steady, reflecting bond-like income characteristics, solar investing has several additional benefits that increases its attractiveness from an income perspective.

Solar assets in the US have useful lives that exceed the average PPA term; with most new assets having a useful life of 35 to 40 years compared with PPA lengths generally from ten to 25 years. As PPAs expire, a solar asset owner can recontract the electricity generated at current PPA market prices. If the trend in short-term US power prices continues, driven by higher gas pricing, changing supply dynamics, and the geopolitical environment, the project may be able to contract at higher rates when its initial PPA expires.

In an inflationary environment this also means that increases in forecast long-term electricity prices driven by higher interest rates will increase the value of post-PPA cashflows from the project, partially offsetting the valuation impact of higher discount rates. And while interest rates are a key driver of valuations for solar assets, other factors influence demand for the assets, which can make valuations more resilient to rising rates than fixed-income products like bonds.

Owning renewable energy assets in the world’s second largest economy as it undergoes a major energy transition also offers wider benefits with long-term government support. Democrat and Republican administrations alike have enthusiastically backed clean, cheap and job-supporting solar energy.

After the disappointing stall of President Biden’s Build Back Better (BBB) agenda in late 2021, lawmakers (including Senator Manchin who refused to support the full BBB package) are crafting a bipartisan package that would take key provisions from the BBB climate agenda.1

With solar the most cost-competitive source of new electricity generation in many parts of the US, the US Department of Energy sees it as a critical component of the country’s clean energy shift – with estimates suggesting solar could reach 40% of US electricity generation by 2035. Political and cultural shifts are driving demand from corporates as well, especially in the US, further supporting the growth of solar. In 2021, corporations bought a record 31.1 gigawatts of clean energy, up nearly 24% from the 2020, with 65% of the PPAs coming from the US.

Finally, in supporting the world’s most energy-hungry nation to move to clean energy, investing in solar power in the US clearly meets investor demand for reliable returns that support global climate change commitments.

Recently, Blackrock CEO Larry Fink said that he predicts “a significant long-term opportunity for investors in infrastructure, renewables and clean technology”. Despite recent market volatility, investors continue to prioritise stable income-generating opportunities, particularly those which are more sustainable.

According to Morningstar, Q1 2022 capital flows into sustainable fixed income funds climbed by 9% to $3.2 billion, while outflows in sustainable equities remained more resilient than the wider market, reinforcing recent trends that sustainable investments tend to resist a ‘flight to quality’ more than the wider market. Our view is that quality and sustainability go hand in hand, and where income is sought, solar offers the perfect solution.

Solar power has the steady stable cashflows of a bond and the growth potential from being in an industry set for strong tailwinds from cultural and geopolitical shifts we expect to dominate for decades to come.

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