FGEN DIVIDEND LOOKS SUSTAINABLE - 02/12/24

Aside from my long term and continued focus on the small-micro-cap space, I also hold a number of Investment Trusts, primarily for income, but also, with the hope of some longer-term growth appreciation.

For clarity, those that I hold in this spot include AEI, BIPS, HFEL, HHI, BRLA and most recently FGEN.

The latter, Foresight Environmental Infrastructure Fund has recently seen its share price in a southerly retreat, having slumped from 95p in mid-September to a current 74.5p, which shows the company now sporting a near 10% yield.

On a personal note, I bought in around the low 80p range, but have subsequently added to my position, after following the stock for some time now.

Thus far, despite it being early days, it hasn’t been an easy ride on the share performance front for me and other Investors or watchers are seemingly divided on this one at present.

The old adage of a falling knife certainly springs to mind given the recent trend and that is clearly something that nobody wishes to be catching.

However, in order to hear more on the structure and prospects for the business in the context of the mid-longer-term outlook along with those all-important dividends, I have been fortunate enough to catch up with management.

Both Edward Mountney and Charlie Wright were on hand to talk me through the various mechanics of the business, which sees Mountney, who was previously at John Laing Capital Management, having now been on the management team of FGEN for coming up to three years.

Prior to that, he was head of valuations at Foresight Group for not only the FGEN fund, but other Infrastructure assets under management too.

Wright, is also an investment Director at Foresight Group and has been since 2017, having also previously spent time at John Laing a few years prior to that.

With impressive enough backgrounds, both appear pretty well versed in all things FGEN, as they went on to fill me in on the nuts and bolts of the operations.

Mountney, pointed out that Foresight Group is the Investment manager, whilst FGEN, which fairly recently rebranded from John Laing Infrastructure is the actual Investment company.

“That company doesn’t actually have any employees, as it outsources the management to Foresight, which is where Charlie and myself are employed. So, Foresight Group now has over £12bn of assets under management, which are split over three distinct sectors.

There is an Infrastructure team, which is where we are and that is where the bulk of the asset management sits, but there is also a private equity team, along with a capital management team which are very distinct from where we sit.”

Mountney said that typically, they refer to FGEN as a diversified Environmental Infrastructure Fund, which sees it placed as what is described as a first-generation fund, having listed around ten years ago alongside a number of other funds that emerged around the same time.

Diversification on a balanced focused portfolio has very much underpinned the strategy, with lots of differing aspects, which means that they are less exposed to the unpredictability of weather patterns that would impact a more singularly focused fund.  

“If the sun doesn’t shine, it is very unlikely that the wind isn’t blowing and that applies to the others too, where we have forty-two assets across wind, solar, anaerobic digestion, biomass, waste management and controlled agriculture environments.”

There is, within the mix, a glasshouse facility along with a small exposure to Hydro, which complement the wider asset allocation, providing for an increasing diversity.

“What that means for us” added Mountney, “is a really balanced portfolio with an equal allocation in different sectors, where we try not be too overweight in any particular one, so that we can maintain a good spread of risk.”

Having recently delivered its Interim Results to the market, this saw the NAV decrease from the £1.13p recorded at the end of June to £1.09.8p, following the full write down of a Hydrogen asset play, (HH2E) which accounted for 2.2p of the total value.  

The Hydrogen aspect clearly spooked some investors and has no doubt played a leading part in the recent downward trend of the share price, although given where the shares now sit, this arguably looks significantly overdone.

Particularly in light of the wider portfolio performance, which minus the HH2E element would have amounted to a positive total performance.

To emphasise, Mountney said that the six-month period was actually the best that FGEN had seen coming off of its investments, with this amounting to £46m, which is higher than any other six-month period since its IPO.

Going further he added, “the underlying asset base continues to perform really well and we are very pleased with that and every year we have managed to grow the cash coming off the portfolio since IPO.

As a result, that gives us a good dividend cover of 1.2x-1.3x and we are confident of reaffirming the dividend target of 7.8p per share for this year, which yields 10% at the current share price.”

He also added that this is clearly an attractive yield, which will hopefully see investors sticking with them, despite the recent share price performance which as a point of note, has also been mirrored by other players across the sector.

On this front, he cites various headwinds that have afflicted the space, not least the high-rate environment, along with movements across gilts that have conspired to contribute to the downward trend.

“I think what we are trying to do, is to position ourselves and to make the fund as attractive as possible to both shareholders coming in along with the existing shareholders, so that when the market does re-rate, which we are confident in, it will see us in one of the best positions of the funds to come out of this quickly.”

Wright also commented on this aspect, “there are various macro conditions that are making life difficult and obviously HH2E didn’t help that either and it is a difficult market for listed companies at the moment anyway.”

Wright was also keen to point out though, that he felt the Hydrogen impairment has been something of an exaggeration regarding the share price performance, but does accept that it is obviously indicative of what is something of a delicate market at present.

He was also keen to stress that he understands investors will be less familiar with some of the relatively new areas of investment within the assets, that include the previously mentioned glasshouse project along with a fish farming operation in Norway.

Whilst these may sound to some investors as a diversification too far, both Mountney and Wright are notably positive on the prospects for upside and delivery on a risk-return profile, particularly across the portfolio as a whole.

To reassure investors on this front, Wright stressed that these other projects have a completely different risk profile to that of the Hydrogen venture which was the only development stage asset within the fund.

That should, provide for some welcome reassurance for holders of the shares going forwards, suggesting that the higher risk-higher reward aspects are in a very much more comfortable place.

Wright speaks positively on the prospects of a number of the emerging assets and stresses that they have been and are keen to explain the financial dynamics and the potential regarding the risk-return profile to investors.

He was also keen to point out that these are very real, being at, or beyond the construction stage, where importantly the Glasshouse project is already operational.

These assets, which also include CMG a clean transport platform, are I was told, now getting very close to operational ramp up and to building up revenues, which Wright says provides a really good opportunity for capital appreciation as they move from construction through to operations. “When that happens” he said, “the value of those will increase and as they become de-risked the value grows, so that is the strategy for the short term.”

Longer term, in a year or two when the current macro conditions have improved along with the interest rate environment, Wright sees FGEN as being very well placed to exploit the massive opportunity that environmental infrastructure offers.

Despite the current difficult backdrop, Mountney is hopeful that the noises currently coming out of Government regarding support for the sector and an acknowledgment that some areas do require its support, should prove a positive for the likes of FGEN.

He is also is keen to point out the benefits of the CFD programme, which is The Government's primary mechanism for supporting new low carbon power infrastructure.

This had seen the previous Conservative administration setting ambitious goals, which have subsequently been increased further by the Labour Government and that has resulted in an increasing of the total CFD pot.

This is effectively the subsidy mechanism for wind and solar which is a clear tangible sign and provides for a stronger direction of travel for those operating across the space.

Taking a brief look at a couple of the emerging assets as previously mentioned, it is worth firstly looking at the Glasshouse project.

This is a 2.1 Hectare project where construction was completed in September of last year. Close to an anaerobic digestion plant already owned by FGEN, this project is initially focused on growing cannabis for medical purposes.

That concentration will be on the very heavily regulated tetrahydrocannabinol flower, which will be used to supply UK-based pharmaceutical manufacturers and would appear to provide for a significant opportunity to FGEN in what is a growing space across medicine.

In relation to the fish farm agriculture facility in Norway, which has to some degree split investors opinions and expectations, Mountney was keen to provide some welcome colour.

He said that whilst it is under construction at present, it is actually partially operational given the modular nature, which has seen the building commence at one end of the operation, before rolling on further, which commences with fish eggs being placed in the first tank.

As the fish grow, so the process moves on and continues, which led Mountney to tell me that they expect the facility to become fully operational by the end of next year.  

His personal view is that this is both an interesting and exciting facility where having obviously visited, he describes the location which is next to a Norwegian Fjord as being fantastic, with clean water and the right temperature along with extremely good sustainability credentials.

Importantly, it scores very positively and highly against the alternative coastal pens, which are degradational to the local environment and are associated with the very high use of antibiotics.

“We don’t need to use antibiotics” added Mountney, “as we do not have those kind of pathogens coming in, so it is very good from a sustainability perspective and also on a risk adjusted return one as well.”

When they first became interested in this particular agriculture project, a very close look was taken at the deep level of the market for selling trout and the price that could ultimately be achieved.

The result was, that the lowest price of return was factored in, thus then charging management with the task of delivering on one that is higher.

The view as we stand is that this is a premium product that Mountney believes can be sold for a premium price.

At present, he is confident that construction is progressing positively, with the all-important hitting of operations next year, so that when fish are actually sold to market, he believes the price achieved will be significantly above that which has been modelled.

Once up and running it should produce around 8000 tonnes of trout per annum as it is what is described as a pretty large facility, where from a personal investment perspective, I warm to this aspect within the asset base.

With Salmon having for sometime been a firm favourite now with consumers, trout is also enjoying growing popularity, being a winner on the Omega 3 aspect, which resulted in the market for trout reaching 988 thousand metric tons last year.

Mountney did add, that they feel on this particular investment they have been fairly transparent in that they don’t see themselves as being long term owners of multiple fish farm.

“For us, as part of our diversification approach, is a core of operational assets that are responsible for providing the yields which we need as an income paying fund.

Making sure first and foremost that we are able to pay that dividend to our shareholders, although we do also have an allowance for construction assets which is up to 25% of NAV.”

This, I was told, should provide for future yielding assets as they move from the development stage into revenue generation and appreciation in value which then provides for further exit opportunities.

One point that I felt was important to raise was that of share buy-backs, a process which is currently being implemented and one that again divides investor opinion on the merits.

Mountney was keen to address this, where he said that firstly, they  have a very clear and visible approach to capital allocation.

This includes sales, such as those that have already been achieved and the allocation of that money generated, which firstly goes towards paying down debt, which sees gearing now down to a sector low of below 30%. Additionally, cash is available to execute on the share buy back programme, where FGEN had already announced a £20m facility.

By September, £5m had been spent on the programme, which has subsequently increased to £10m.

Commenting further, Mountney said, “we have a large shareholder base and they will have different views on what we should be doing, there is no single strategy that will keep everybody happy.

However, we have found that whilst the discount is where it is, it is a very compelling story to buy our own shares at that price, compared to the return that would be required to investing in something else.”

Although it is compelling for us to do that, it isn’t really there to change the share price, because at that sort of scale it is unlikely to achieve that and we have seen that not just with us, but right across the sector.

It is a good investment opportunity for us to buy shares at that level though, although we are mindful of not shrinking the fund, as that is something we believe investors don’t want to see either, as we believe they actually want us to be bigger, not smaller.”

Mountney concluded that the programme has a place in the broader capital allocation strategy and therefore has an integral part to play.

The other absolute key aspect regarding an investment in FGEN is the dividend, which is currently as previously mentioned sporting a thumping yield.  

On this, Mountney was happy to reassure investors, where he commented, “one of the attractions of investing in infrastructure and infrastructure like assets is that typically you have pretty good visibility over the long-term cash flow.

That means that when we make decisions about increasing dividends or where else to put the money, we have got a very good understanding of how much cash we need in order to be able to grow that dividend.”

Going further he said that the dividend had been increased by about 15% over the last three years and that they are comfortable with the level of where the dividend currently is.

Importantly, Mountney stated that they have that good visibility over the cash flow and have low exposure to the likes of changes to power prices.  They also have a high level of fixed revenues compared to peers which is in part down to the price fixes that FGEN enters into which provides for increased visibility and continuity.

Additionally, because they are not reliant on just wind and solar and have other contributors, the percentages are increased on the revenue and cash flow front.

In terms of the life its assets, Mountney said that they currently have a weighted average of around 16-17 years remaining across the portfolio, although he was happy to say that they believe this to be pretty conservative.

“We expect to be able to run these assets for longer, although that is the basis on what we value it at the moment, so one, two, three years out we certainly have no concerns on the dividend cover within that period, even in some pretty downward scenarios on power pricing.”

Regarding the longer term, he added that in time, they would  hope to have concluded on further investment opportunities which in turn, should ensure the pushing out of assets held within the portfolio.

Pleasingly, there is certainly a frank and underlying confidence on maintaining and growing the dividend with good visibility on yields, which should provide for some comfort for income seeking investors at a time when the shares are decidedly unloved.  

Returning once more to the Hydrogen aspect though, I was keen to hear a little more on the reassurance that there is nothing else on the horizon that could mirror such downside as has been seen.

Mountney reiterated that it was the only investment at that kind of stage, where they have an allowance for 5% of NAV to go into such investments.

That particular venture was 2.6% and the reason they have the cap is a recognition of the higher risk profile of such an investment. Although there are, as previously mentioned here, some assets under development these I was told are completely different on a number of fronts, with some already partially operational and generating revenues.

To conclude, Mountney stressed again for investors that the profiles are in no way like that of the HH2E and therefore the concerns from that should not be applied to these.

In its recent HY note, broker Peel Hunt added, “across the portfolio FGEN sold a 51% interest in its anaerobic digestion assets for £68m, with proceeds primarily used to reduce gearing. This was partially offset by follow-on investments totalling c.£16m.

The company remains engaged in further sales processes to recycle capital and enhance portfolio value; investment into new projects are not expected in the short to medium term in light of the wider market situation and ongoing focus on capital allocation.

The portfolio was 92% operational at period end, split 90% UK and 10% rest of Europe, by sector: 28% wind, 26% waste & bioenergy, 13% AD, 15% solar, 8% low carbon & sustainable solutions, 9% controlled environment, and 1% hydro.”

On a personal note, it has been extremely helpful to speak with both Edward and Charlie in order to gain some further insight into the current picture and the future prospects.

To that end, despite the current share price weakness, I am happy to hold for what is an extremely attractive dividend that looks adequately covered.