Investing.com -- NextEnergy Solar Fund (LON:NESF) was downgraded to “underperform” from “hold,” by analysts at Jefferies on Monday as analysts warned that a breach of its preference share gearing covenant could force significant deleveraging and create risks for its dividend.
Jefferies said the closed-end solar investment company’s debt to enterprise value ratio, which is calculated using a three-month average market capitalization, has surpassed the 50% covenant limit and currently stands at 59%.
The breach means the fund is now required to seek approval or a waiver from preference shareholder USS before carrying out share buybacks, issuing special dividends or taking on additional debt.
The analysts said NextEnergy Solar Fund is targeting a reduction of the ratio to below 50% through asset disposals, but the firm will need to undertake substantial deleveraging due to the way the calculation is structured.
Because reductions in debt reduce both the numerator and denominator of the ratio, Jefferies estimated the fund would need to repay about £150 million of debt, broadly equivalent to its current revolving credit facility drawings, based on the existing market capitalization input.
The brokerage said this scale of deleveraging may be why the manager is considering expanding its capital-recycling program as part of an ongoing strategic review.
Jefferies cited limited private-market demand for UK solar assets as a major obstacle to executing disposals. The fund has been in a competitive sales process for its Grange and South Lowfield projects “for some time,” and transactional activity in operational solar assets in the UK has been described as seeing “very little activity.”
The analysts said markets for European assets, particularly in Italy, are more active, but these holdings represent only about 15% of invested capital.
The brokerage flagged risks to the current dividend, noting that the company’s high gearing level supports payments with only modest cash-flow coverage.
Coverage was estimated at 1.1x for FY25, with guidance of 1.1x-1.3x for FY26. Jefferies said significant deleveraging could challenge the payout level because current revolving credit facility drawings are accretive to dividend cover due to their low all-in cost of 5.2%, SONIA plus 1.2%, compared with the portfolio’s 8% weighted-average discount rate.
The analysts also said coverage is likely to weaken as remaining high-priced power purchase agreement hedges expire and as changes to ROC and FiT RPI-linkage under the DESNZ consultation could further reduce cover.
Jefferies said the outcome of the Bluefield Solar Income Fund formal sales process may imply negative valuation read-across for core UK portfolio assets.
The brokerage noted that three disposals to date have been at uplifts to carrying values, but two were sold to funds related to the manager. It warned that weak sale terms could increase the already high 49% total debt to gross asset value gearing.
