High dividend yields are a treat for income investors. And while, in many cases, an 8.6% payout can be a warning sign, the cash-flow-generating capabilities of Greencoat UK Wind (LSE:UKW) suggest this impressive dividend stream’s here to stay. Pairing that with a 20% discount to net asset value, this REIT looks like a screaming buying opportunity.
So is now the time to start buying the shares? Or is there something else going on?
Monster dividend yield
Greencoat may not be a household name. But its portfolio of on- and off-shore wind farms generates the electricity for an estimated 2.3 million British homes. That makes it the fifth-largest wind farm owner in the country. And with relatively low operating costs, its business model of generating and selling clean electricity to energy suppliers is highly cash generative. So much so that investors have enjoyed nine years of uninterrupted dividend hikes, outpacing inflation.
Today, the story remains largely the same. Rising demand for renewable energy’s proving to be a handy tailwind, creating new growth opportunities for management to capitalise on. In fact, despite its depressed valuation, management’s still investing in expanding its stake in new and existing wind farms, growing revenue and, more importantly, cash flow.
So if dividends are so secure, why aren’t investors rushing to buy?
The burden of higher interest rates
With the bulk of excess cash flows being returned to shareholders via dividends and buybacks, Greencoat’s balance sheet only has £8m of cash to hand. By comparison, there’s just shy of £1.8bn in debt & equivalent liabilities.
Needless to say, it’s a highly leveraged business. And that’s far from ideal, given we’re currently operating in a higher interest rate environment, adding financial pressure and risk to margins. Higher interest rates also have an adverse impact on wind farm asset values. As such, if Greencoat suddenly needs to raise money, selling off portfolio assets will likely be executed at a discount. And the market seems to think that the discount will be around 20%.
There’s no denying the high level of gearing introduces risk. However, it’s worth pointing out the firm’s average cost of debt is only 4.68%. That’s pretty close to last year’s 4.63%, and thanks to some recent refinancing, there are no upcoming loan maturities until 2026.
That gives the Bank of England ample time to cut interest rates, creating cheaper refinancing opportunities in the future, reducing pressure on margins and allowing dividends to continue growing.
The bottom line
A discounted share price limits management’s ability to raise capital through equity. And since debt’s currently rather expensive and the market value of wind assets is equally depressed, Greencoat’s ability to raise capital’s weakened right now.
As such, portfolio expansion’s likely to be slower compared to previous years. However, as interest rates drop, the pressure from these headwinds also falls. Since that’s already started to happen, I think Greencoat UK Wind’s definitely worth a closer look for passive income-seeking investors.
The post 8.6% dividend yield! A dirt cheap FTSE 250 REIT to buy and hold for passive income? appeared first on The Motley Fool UK.
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Zaven Boyrazian has positions in Greencoat Uk Wind Plc. The Motley Fool UK has recommended Greencoat Uk Wind Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
