Is the 11.7% yield for this FTSE 250 stock too good to be true?

A double-digit payout from a FTSE 250 stock’s often a warning sign to steer clear. But is NextEnergy Solar Fund an exception to the rule?

| More on:
Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The FTSE 250’s known for its growth opportunities. But it’s also home to a diverse range of dividend-paying enterprises, some of which offer impressive yields. Among the most generous in June this year is NextEnergy Solar Fund (LSE:NESF).

The stock currently offers an impressive 11.7% yield. To put that in perspective, for every £1,000 worth of shares, investors are earning £117 in passive income. Considering the average is closer to 4%, it’s a pretty spectacular income return.

Sadly, high yields also have a habit of being unsustainable. And while income generation in the short-term can be sweet, the long-term performance can eventually sour investor’s moods. However, there are always some exceptions to this. So is NextEnergy a terrific income stock to buy and hold? Or should investors steer clear? Let’s take a closer look.

What does the business do?

As the name suggests, the firm operates within the renewable energy industry, owning a portfolio of 103 solar and storage assets scattered across the UK as well as the rest of the world. The business model is similar to other firms in the renewable space like Greencoat UK Wind and Foresight Solar Fund. Clean electricity is generated by its solar assets and then sold to energy companies for redistribution.

Given that demand for electricity continues to climb, the firm’s had little trouble generating cash profits. And while earnings are dependent on the weather, increasingly hot summers are proving advantageous to solar farms. The end result is a predictable and steady stream of cash flow funding a generous dividend policy. In fact, May marked the 11th consecutive increase in shareholder dividends.

This income-bolstering’s certainly part of today’s 11.7% yield. But most of it actually stems from a decline in share price. Over the last 12 months, the stock’s down almost 30%, trading at a massive discount to its net asset value. What’s going on?

Renewables and interest rates

Building and maintaining renewable energy infrastructure isn’t cheap. And the situation’s only exacerbated for real estate investment trusts (REITs) since they aren’t able to retain the majority of their earnings. As such, many businesses in this space have racked up considerable amounts of debt. And NextEnergy Solar Fund’s no exception.

As of May, the firm has just under £338m of outstanding loans on its books, a third of which is subject to fluctuating interest rates. As capital structures go, the firm isn’t overly leveraged, with some analysts suggesting there’s nothing particularly wrong with the fundamentals of the business. So why has the stock tumbled?

There are a lot of moving factors, but it seems the renewable space as a whole is currently out of favour with investors. Higher interest rates not only make debt more expensive but also drag down the valuation of its solar assets. If that’s indeed the case, then when the Bank of England eventually cuts borrowing costs, these shares may be primed for a resurgence.

The bottom line

NextEnergy Solar Fund suffers from a lot of similar weaknesses as its peers. The group has virtually no pricing power and is constantly negotiating with debt lenders to secure future growth. However, the FTSE 250 stock’s impressive yield looks like it’s here to stay. At least, that’s what I think.

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 no position in any of the shares mentioned. 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.

More on Investing Articles

Investing Articles

9.4%+ yields! 3 proven FTSE 100 dividend payers I’d buy for my Stocks and Shares ISA

Our writer highlights a trio of FTSE 100 shares with yields close to 10%. He'd happily pop them into his…

Read more »

Mixed-race female couple enjoying themselves on a walk
Investing Articles

Are Raspberry Pi shares a once-in-a-lifetime chance to get rich?

With Raspberry Pi shares surging after a successful IPO, could this UK tech startup offer a long-term wealth creation opportunity…

Read more »

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

This steady dividend payer looks like one of the best bargain stocks in the FTSE 100

A yield of 4.7% and a consistent dividend record make this FTSE 100 company look like good value in an…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

£9,000 in savings? That could become passive income of £19,175 a year

It's possible to invest affordable sums of money into building a big passive income stream. Here's how I'd go about…

Read more »

Black father and two young daughters dancing at home
Investing Articles

Legal & General shares: a once-in-a-decade passive income opportunity?

Is a dividend yield at its highest level in a decade, combined with a strong record of increasing payouts, a…

Read more »

Investing Articles

With a 7% yield and 4.1 P/E, is this the best passive income stock on the FTSE 350?

Millions of Britons invest for a passive income. While our writer isn't buying this stock yet, he believes it's worth…

Read more »

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

This amazing FTSE 250 has a 8.8% dividend yield and trades at just 4x forward earnings!

Our Foolish writer believes this FTSE 250 stock is worth keeping a very close eye on. However, he's not keen…

Read more »