8.2% dividend yield! An energy stock to buy right now?

I’m hunting for top-notch income stocks, and this beaten-down, high-dividend-yield business looks like it could be a solid addition to my portfolio.

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The energy sector is filled with high-dividend-yield stocks in 2023. Uncertainty regarding the state of the supply/demand balance for oil & gas has dragged the valuations down of many businesses in this industry. And that would certainly explain the elevated level of payouts. However, oil companies aren’t the only ones being hit hard right now.

The renewables sector is correlated with movements in gas prices since the latter directly impacts the cost of electricity. That’s especially true in the UK, where gas turbines generate over a third of the country’s power. However, it seems interest rates are having the biggest impact right now.

It’s no secret that renewable energy sources, like solar power, come at a lofty installation price tag. And for firms like Foresight Solar Fund (LSE:FSFL), the higher cost of debt is sparking some concern. But is this fear justified? Or are investors looking at a terrific opportunity to lock in some chunky passive income?

Building a solar empire

Foresight’s asset portfolio contains 50 solar farms in the UK, four in Australia, and another four in Southern Spain. Management has also recently been introducing exposure to the energy storage market with three battery facilities in Britain.

The business model is fairly straightforward. Establish or acquire solar assets and then let the sun generate clean electricity that’s sold through the grid. That does make the revenue stream highly dependent on the state of the weather. And looking at past results, the word “lumpy” is certainly an apt description.

However, the continuous creation and sale of green energy makes for a cash-generative enterprise. And that’s supported an eight-year streak of inflation-linked dividend hikes, even with lumpy earnings.

Fear for the future

With the effects of global warming becoming ever more apparent, I think it’s safe to say that the transition to renewables is unlikely to stop anytime soon. And while energy storage is one of the biggest challenges to fill the gaps when the sun isn’t shining, new solutions are emerging to tackle this.

However, in the short term, there are some significant challenges to consider – primarily debt. Today, the group has around £524.8m of outstanding loans, with an estimated £320.2m exposed to the Bank of England’s recent rate hikes.

This exposure has been almost entirely hedged by management. So the debt level doesn’t look too problematic right now. But the higher cost of borrowing makes securing new loans far more expensive. And that could have a significant impact on the group’s future growth efforts.

It also doesn’t help that the UK government have placed a 45% tax levy on renewable energy generators for profits from electricity sold above £75 per MWh until 2028. For reference, the average price today is hovering around £101.

All these factors have resulted in the firm’s net asset value dropping, dragging down the share price with it. Since the start of 2023 alone, Foresight shares have tumbled 25%. However, given the solid balance sheet and continuously rising demand for clean electricity, I can’t help but feel investors might be overly pessimistic.

Therefore, while further share price volatility might be on the horizon, the 8.2% dividend yield looks sustainable, in my eyes. And that’s why I’m considering this business for my income portfolio once I have more capital at hand.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Foresight Solar Fund. 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.

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