QD view – Sweet Harmony

Harmony Energy Income Trust, the battery storage fund, recently launched a C share issue. The ‘problem’ is that its existing shares are trading on a discount – about 3% today, but were around 9% when they made the announcement on 29 September. I have put ‘problem’ in quotation marks because I don’t think that it is insurmountable, in fact, I think the fundraise may succeed.

Investors in Harmony Energy Income Trust at launch paid 100p for shares that now have an NAV of 116.6p (according to Morningstar). The trust is targeting an 8p per share dividend for 2023. The expectation is that investors in the C share will be entitled to receive this.

Hit by mini meltdown

The fund has long tended to trade on a premium. A brief spell of trading on a discount in August probably arose because the NAV jumped higher than investors had expected, and it took a while for the share price to catch up. However, in common with most of the investment companies sector, the trust took a hit when the ‘mini’ budget was announced (as an aside, have you seen the latest investment companies monthly roundup? Only 45 of 346 investment company securities rose in value in September!).

Deadline looming

The board had been planning the fundraise for a while we think, but the Queen’s funeral and the budget will have delayed things. The timetable for the fundraise is quite tight – the Primary Bid retail offer and the placing for professional investors both close at 1pm on 11 October – this is because the trust’s placing programme only runs up to 14 October 2022. Beyond that, it would have to issue a new prospectus, which is expensive and time consuming.

Harmony Energy Income has a portfolio of new battery projects that it wants to buy. These are being developed by Harmony Energy Limited and the trust has an exclusive right of first refusal over them. The three projects that are ‘shovel-ready’ (Wormald Green, Hawthorn Pit, and Rye Common phases I and II) would add 181.9MW to the trust’s existing 312.5MW portfolio.

Crucially, the new projects have already agreed the dates at which they will be connected to the power grid. Securing those slots is essential and they are in short supply. If you saw the recent story that Renewables Infrastructure bought the rights to develop three battery storage projects, you may have noticed just how far out the installation of the proposed grid connections are for those assets – ranging between 2024 and 2029. By contrast, the Harmony Energy projects are due for energisation between Q4 2023 and Q3 2024.

If the trust cannot secure the funding it needs for these projects, it is highly likely that they will be sold on to a cash rich buyer. The developer cannot afford to wait, and these are desirable assets.

C share issues work even when ords on discount

But how can the trust raise the money it needs if it is trading at a discount? After all, you may have seen us rail against previous attempts by funds to go down this route. However, C share issues offer a way of getting round this problem.

In a C share issue, the funds raised sit in a separate pool and operate like a distinct fund, albeit with the same board, manager etc. Only once the proceeds of the C share issue have been substantially invested are the C share and ordinary share pools merged. The merger is done on the basis of the two pools’ respective NAVs, not their market caps. Therefore, the ordinary shareholders are not diluted by the new money and this point is key.

The quid pro quo for this is that the C share investors have to recognise that if the ordinary shares are still trading on a discount when the merger occurs, they will see a fall in the value of their investment (or more likely, the C shares may trade at a discount too). In this case, the discount is now pretty small anyway and may soon be eliminated.

We need the energy storage

The three energy storage funds are doing well. Harmony Energy Income Trust is the newest of the three and so a bit behind the curve when it comes to profiting from the investments that it has made. However, it is about to start commercial operations at its first big battery project, Pillswood in Yorkshire. The 98MW asset is due to come on stream in November. It is differentiated from most operational plants by having batteries that can discharge over a two-hour period (of the 79 battery storage projects currently operating in great Britain, three have a two-hour duration while most are 1-1.5 hours).

The managers say that the flexibility that these longer duration batteries offer helps make them more profitable. They point to the success of a similar project that the trust does not own but which was also developed by Harmony Energy. This has been earning around three times the revenue per MW that the trust was expecting at launch.

The services that the energy storage funds provide, such as helping to balance the grid, providing fast-response power when supply dips, and providing the energy needed to help kick start the grid in the event of a blackout (which, unfortunately might be called upon as the national grid is likely to come under severe strain this winter) pay pretty well. The funds can also make additional revenue by facilitating trading in intraday fluctuations in power prices.

It is important that these projects get built and I would like to see the trust get to build them. Clearly though, you need to make your own mind up as to whether you think the issue is attractive. We recommend you read the information published by the company on its website before making a decision, and – as always – there are geographic restrictions on who can participate in the offer.

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