NextEnergy Solar Fund: High-Yield Dividend Opportunity or Income Trap?NextEnergy Solar Fund: High-Yield Dividend Opportunity or Income Trap? The FTSE 250 company NextEnergy Solar Fund (NESF) boasts an impressive 10.2% dividend yield. However, investors may wonder if this return is sustainable or an indication of an income trap. Assessing Dividend Sustainability Free cash flow is crucial for dividend coverage. NextEnergy’s dividend coverage ratio stands at 1.3x, indicating sufficient cash flow to cover dividend payments. Management anticipates maintaining healthy coverage in the future, as evidenced by an 11% dividend increase following the full-year results. Risks to Consider Despite healthy dividend coverage, NextEnergy carries significant debt (29.3% of capital structure). Rising interest rates have increased debt servicing costs from 3.9% to 4.5%. Additionally, valuations of the group’s solar assets have declined. If the company needs to sell assets to pay off debt, shareholder value could be eroded. Potential Buying Opportunity However, the Bank of England is expected to cut interest rates later this year, potentially easing the negative pressures on NextEnergy. The company’s strong demand for electricity and ongoing share buybacks suggest that management believes in the company’s long-term prospects. Conclusion NextEnergy Solar Fund’s high dividend yield presents a potential buying opportunity for investors comfortable with the risks involved. The company’s free cash flow coverage and management’s confidence in dividend sustainability provide some reassurance. However, investors should be aware of the debt and interest rate risks associated with the business and conduct thorough research before investing.
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Despite being home to small and medium-sized businesses, FTSE 250‘ is filled with high-yield opportunities. And among the highest lies NextEnergy Solar Fund (LSE:NESF). The renewable energy company is currently offering shareholders a whopping 10.2% dividend yield!
In many cases, seeing double-digit returns is a clear sign to stay away. After all, these are rarely sustainable and are often caused by falling stock prices rather than dividend increases. So is NextEnergy an income trap to avoid? Or is it one of the few exceptions where investors can reap huge long-term income? Let’s investigate.
Testing for durability
One of the most critical metrics for assessing dividend quality is free cash flow. Companies must be able to generate sufficient excess cash flow from operations. This provides the capacity needed to not only pay dividends but also maintain them at a comfortable level.
So where does NextEnergy Solar stand when it comes to dividend coverage? Looking at the latest results, this metric stands at 1.3x for the 12 months leading up to March. As a quick reminder, any number greater than 1.0 is what we want to see, and the bigger the better.
Furthermore, management expects dividend coverage to remain healthy for the foreseeable future. So much so that the dividend was increased by 11% to 8.35p per share following the full-year results published last month. But if dividends are so healthy, why aren’t investors taking advantage of this income opportunity?
Every investment involves risks
Building and maintaining renewable energy infrastructure isn’t exactly cheap. The company has subsequently built up a significant debt mountain over the years. Today, 29.3% of the group’s capital structure is debt. That’s hardly an exorbitant amount, but NextEnergy’s gearing has increased over the years.
In the past, this wasn’t such a problem. However, with interest rates now above 5%, the group’s loans are becoming increasingly expensive to service, with average debt costs down from 3.9% a year earlier to 4.5%. As a side effect, valuations of the group’s solar assets have also fallen.
So if the company is forced to sell assets to pay off debt, shareholder value may be lost rather than created.
A buying opportunity?
The risk surrounding this business cannot be ignored. After all, NextEnergy has no control over monetary policy, but its revenue stream is very sensitive to it.
But with the Bank of England expected to cut interest rates later this year, these negative pressures could start to abate. And with demand for electricity not going anywhere, that gives a lot more flexibility to expand the solar portfolio, boosting cash flow and therefore dividends.
At least I think so. And management seems to agree, as it has been busy buying back shares to take advantage of the weak valuation. As a result, I think there may be a buying opportunity here, and it’s a company I’ll be diving into more deeply this month.
