Despite being predominantly known for growth, the FTSE 250 is filled with high-yielding dividend shares. Some even venture into double-digit payout territory, including Foresight Environmental Infrastructure (LSE:FGEN), which currently has the highest yield in the entire index at 11.4%.
As its name suggests, this UK-based investment trust focuses on managing a diversified portfolio of environmental infrastructure assets across Europe. That includes projects like renewable energy, waste-to-energy, and biomass energy solutions.
With the growing need for clean electricity, the business has enjoyed fairly predictable and consistent inflation-resistant cash flows. And subsequently, despite the recent weakness in its share price, investors have reaped 10 years of consecutive dividend hikes.
So, with such a high yield on offer, should income investors go against the crowd and capitalise on this seemingly lucrative source of passive income?
The challenge of interest rates
Investing in the development of renewable energy infrastructure is not cheap. And when interest rates were near 0% in the past, Foresight had little trouble raising affordable capital. But this debt-heavy strategy has backfired following the resurgence of inflation in 2022.
With central banks hiking interest rates, the leveraged balance sheets of renewable energy trusts became enormous liabilities. And in many cases, it forced asset sales at depressed prices to prevent insolvency.
Today, interest rates are slowly coming back down. Nevertheless, they remain elevated. And when combined with sector-specific construction delays, higher input costs, and long-term energy price downgrades, Foresight remains shrouded in uncertainty.
A hidden opportunity?
To management’s credit, the group’s debt exposure is being tackled. Gearing landed at 28.7% in its latest financial results, down from around 36% in 2021. And further debt reduction efforts are under way.
What’s more, while investor sentiment surrounding renewables remains weak, that doesn’t change the fact that most of Foresight’s energy contracts are inflation-linked.
In turn, so are dividends. And with management having a fairly strong track record of deploying capital, the company could be in a strong recovery position once further interest rate cuts reinvigorate investor appetite in this sector.
Of course, there’s no way of knowing exactly when the tide will change. Inflation is proving annoyingly stubborn. And we’ve already seen the Bank of England delay rate cuts as a result.
For long-term investors with the patience to wait, that may not seem like a problem. Sadly, that’s not the case. With upcoming debt maturities, Foresight will likely begin refinancing its loans. And if interest rates are still elevated, the group’s average cost of debt could rise significantly, putting pressure on its cash flow as well as dividends.
This is one of the main reasons why the shares are trading at a steep discount to net asset value and why investors are seemingly reluctant to jump on the double-digit yield.
The bottom line
The combination of macroeconomic, operational, and sector-specific risks surrounding this business certainly explains why investor sentiment is weak. Yet with all these risks already seemingly baked into its share price, the yield is tempting in my mind.
There’s no denying investors will need patience. But if Foresight is able to successfully navigate through the current challenging market environment, the long-term rewards could open the door to phenomenal passive income. That’s why I’m taking a much closer contrarian look at this FTSE 250 enterprise.
