No doubt like many of my readers, I have been buying a few shares in alternative energy suppliers – those that own solar and wind farms or grid stabilisation/battery operations. The move to decarbonise the economy has been made even more urgent by the likely reduction in gas supplies from Russia.
I have been studying the accounts of The Renewables Infrastructure Group (TRIG) in which I own a few shares, and I have some concerns. This company is an investment company which owns wind and solar farms (one example is above). A wind farm is in essence a facility where a windmill is installed to generate electricity which is then sold on to the grid, i.e. a capital asset is purchased and installed which then generates revenue. This is rather like a manufacturing company so one might expect that the traditional accounting for such a business is used, i.e. the assets are capitalised on the balance sheet and then written off through the P&L statement over the life of the asset. Income is simply the sales of the electricity.
But this model is not used at TRIG. It actually owns 50 wind projects, 32 solar PV projects and one battery storage project. There are some minority interests but most of them are 100% owned. The ownership is structured via independent companies in which TRIG has equity investments.
Those investments are valued in the accounts on the directors estimates of future revenues and cash flows. This is actually what is said in the last Annual Report on page 62:
“For non-market traded investments (being all the investments in the current portfolio), the valuation is based on a discounted cash flow methodology and adjusted in accordance with the European Venture Capital Association’s valuation guidelines where appropriate to comply with IFRS 13 and IFRS 10, given the special nature of infrastructure investments.
The valuation for each investment in the portfolio is derived from the application of an appropriate discount rate to reflect the perceived risk to the investment’s future cash flows to give the present value of those cash flows. The Investment Manager exercises its judgement in assessing the expected future cash flows from each investment based on the project’s expected life and the financial model produced by each project entity. In determining the appropriate discount rate to apply to a given investment the Investment Manager takes into account the relative risks associated with the revenues which include fixed price per MWh income (lower risk) or merchant power sales income (higher risk). Where a project has both income types a theoretical split of future receipts has been applied, with a different (higher) discount rate used for an investment’s return deriving from the merchant income compared to the fixed price income, equivalent to using an appropriate blended rate for the investment”.
In summary, the profits that the company declares, and its net asset value, are based on the managers future estimates of cash flows.
The Annual Report also contains this statement in the Audit Committee Report:
“Valuation of Investments – key forecast assumptions
The Audit Committee considered in detail those assumptions that are subject to judgement that have a material impact on the valuation. The key assumptions are:
Power Price Assumptions. A significant proportion of the wind and solar projects’ income streams are contracted subsidy receipts and power income under long-term PPAs; some of which have fixed price mechanisms. However, over time the proportion of power income that is fixed reduces and the proportion where the Company has exposure to wholesale electricity prices increases. The Investment Manager considers the forecasts provided by a number of expert energy advisers and adopts a profile of assumed future power prices by jurisdiction. Further detail on the assumptions made in relation to power prices and other variables that may be expected to affect these are included in the Valuation section of the Strategic Report.
Macroeconomic Assumptions. Macroeconomic assumptions include inflation, foreign exchange, interest and tax rate assumptions. The Investment Manager’s assumptions in this area are set out and explained in the Valuation section of the Strategic Report.
Other Key Income and Cost Assumptions. Other key assumptions include operating costs, facility energy generation levels and facility remaining operating life assumptions.
The Audit Committee considers the remaining operating life assumptions in light of public information provided by the Company’s peer group and reports provided by the Operations Manager during the year considering the remaining operational lives for investments and considering any potential extension of those lives and the recognition of additional value resulting to be appropriate. The independent valuation carried out in June 2021 also supported the assumed operating lives.
The Investment Manager has discussed and agreed the valuation assumptions with the Audit Committee. In relation to the key judgements underpinning the valuation, the Investment Manager has provided sensitivities showing the impact of changing these assumptions and these have been reviewed by the Investment Manager and the Audit Committee to assist in forming an opinion on the fairness and balance of the annual report together with their conclusion on the overall valuation.
Valuation Discount Rates. The discount rates adopted to determine the valuation are selected and recommended by the Investment Manager. The discount rate is applied to the expected future cash flows for each investment’s financial forecasts derived adopting the assumptions explained above, amongst others, to arrive at a valuation (using a discounted cash flow methodology). The resulting valuation is sensitive to the discount rate selected. The Investment Manager is experienced and active in the area of valuing these investments and adopts discount rates reflecting its current extensive experience of the market. It is noted however that this requires subjective judgement and that there is a range of discount rates which could be applied. The discount rate assumptions and the sensitivity of the valuation of the investments to this discount rate are set out in the Valuation section of the Strategic Report.
The Audit Committee discussed with the Investment Manager the process adopted to arrive at the selected valuation discount rates (which includes comparison with other market transactions and an independent review of valuation discount rates by a third-party valuation expert both at December 2020 and at December 2021) and satisfied itself that the rates applied were appropriate. The Company uses a bifurcated discount rate approach (as more fully explained on page 62)”.
The key point arising from this is that the valuations (and hence reported profits of the company), are very dependent on the discount rates applied to future cash flows.
In summary we have a business where reported profits are based on estimates of future cash flows and the discount rates that are applied, not on actual historic profits or cash flows. To my mind this creates a great deal of uncertainty.
What would the accounts look like if all the investments the company has were consolidated? That’s not an easy question to answer because the information is not readily available, and neither am I an accountant. But perhaps TRIG could supply such an answer.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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