Dear Solar 12J Investors
(This blog has also been distributed via email and SMS).
I am sure everyone is being bombarded with daily Eskom load shedding news and the politics surrounding it. This has left many investors wondering what the real impact is on the 12J solar fund. In this email, I hope to provide you with some clarity on the matter.
Overall, the impact on our 12J fund has been mixed. Explosive growth in the residential space has not yet been mirrored by the larger electricity users in the commercial and industrial (“C&I”) world. Nevertheless, we remain well-positioned to weather the storm and unlock new opportunities. Some projects in our “Pipeline” have already moved to “Secured Projects” as we begin implementation.
Before delving into the latest load shedding news, here is an update on our projects and pipeline:
FEEDBACK: PROJECTS & PIPELINE
(1) Agricultural Solar PV transaction a success!
At the end of last year we reported the conclusion of a R5 million agricultural solar PV transaction where we bought a project with the intention to sell it at a profit at the end of February. I am glad to report the transaction materialized as intended and that the funds for the sale are safely in our bank account.
(2) Garankuwa Project well underway
Also good news is that we are actively starting to roll-out the Garankuwa Project. This project will eventually comprise more than 1,500 prepaid student and other housing apartments and even a potential shopping center coupled with residential development. Operationally it is our biggest, most challenging and certainly most exciting to date. We will control and manage the whole electricity infrastructure, from Eskom import to prepaid wallets, metering, load shedding solutions and solar. The first few blocks of units have gone live and our active roll-out has commenced. This project will be rolled out in a phased manner targeting a total project investment which may exceed R50 million, the bulk of which however only materializing over the next 18-24 months. As in life, we expect a few curveballs along the way (as this is a green fields project) and will keep you updated regarding our progress.
(3) A foot in the door
As far as our “Pipeline” is concerned, it remains a hard grind with long sales cycles, mostly out of our control. Lafarge has not allocated their tender, but we are still in the hunt. We are also pleased to report that we are now on the short-list for a Tiger Brands closed tender. Being a smaller scale energy fund we are certainly still facing a “David vs Goliath'' challenge to win any of these major tenders and are therefore actively pursuing a number of smaller scale proposals to keep the momentum going. In addition, we are now becoming less reliant on our project developers as described in the next point.
(4) The road that lead to our Energy Company Partnership
Our initial strategy when we started the energy fund was partnering with a few dedicated project developers to find, engineer and develop opportunities for our fund. This model made sense as we acquired kick-off projects while the partners continued to develop and pursue opportunities without costing the investors any fixed fees. This strategy achieved limited success, but the bottleneck remains long project development and sales cycles resulting in inadequate dealflow. Over the past few months, we therefore developed our “Energy Power Partnership'' model. In short, Futureneers now directly approach clients to co-develop and manage their energy projects. We bring the capital and the expertise, while the clients commit their projects. We now work closely with the client to develop the project and manage the tender rather than being one of the tender parties. This strategy is still new, but we are pleased to confirm that we already concluded our first agreement, while we anticipate that this proactive approach will significantly improve deal-flow over the next 6-18 months.
OK, back to what’s happening with Eskom, Load Shedding, Tax Breaks and many other news items:
LOAD SHEDDING AND THE SOUTH AFRICAN MARKET
(1) Load Shedding remains bad for everyone
We reiterate what we said last year: Load Shedding is bad for everyone! Our existing grid-tied projects continued to lose more than 25% turnover as a direct result of load shedding while we even experienced total power station failures for longer than a week in Ekurhuleni. We are working on these sites to find solutions, including potentially converting the Sunderland Ridge site into a hybrid solution and selling it to the largest off-taker, while also looking at battery solutions at other sites.
Even our “hybrid” solar installations are being hit by Load Shedding. As you may recall, “hybrid” simply means the solar system is integrated in such a manner that it can generate energy during Load Shedding (but it needs a generator or battery for reference voltage), which is not the case for grid-tied systems. However, depending on various technical factors even hybrid plants are not able to monetize all of their solar generation during Load Shedding, decreasing sales revenue and ultimately returns.
(2) Growth in Solar Roll-out: Residential vs Commercial
We are seeing explosive growth in the residential space where everyone seems to be installing some kind of solar, inverter and battery combination and paying a monthly rental for it. We also expect the large utility scale projects where producers are either wheeling or providing solutions to Eskom as Independent Power Producers at scale to do well over the next few months.
However, the Commercial and Industrial ("C&I") market is lagging behind as far as roll-out is concerned. Clients are now forced to shift focus from saving energy costs (by implementing solar for example) to additional investment in generators and batteries simply to continue to operate during Load Shedding. Solar reduces energy costs but need generators or batteries to enable it to run during Load Shedding. Operating these generators and batteries however increase average energy costs 4-7 times (400% to 700%). It it doubtful if this significant increase can be absorbed, or even passed onto clients by many businesses. This has resulted in a slower adoption and roll-out of energy solutions in the C&I space.
(3) Latest Tax Breaks
In the recent budget speech the current “wear and tear” allowance (section 12B) for companies was increased from 100% to 125%. This incentive from SARS should be applauded and means an immediate cash flow benefit should a business have current taxable income against which the allowance can be offset. To be clear - this is not an additional payment from SARS to a business, but simply an accelerated claim against taxable income of up to 125%.
As you may have read, many investment funds are now using this 12B tax incentive to raise more capital and effectively “distribute” the tax benefit to the new investor upfront. Although the investor gets the upfront tax break, future distributions are 100% taxable with no remaining wear and tear allowance in the operating structures. Also, the fund is limited to only take in capital and match the capital to projects implemented in the current tax year, since 12B may only be claimed in the year a project is implemented.
Futureneers Capital will over the next few months carefully assess how to use the 12B tax structures in the most appropriate manner, on projects as well as a tool to raise additional capital. The launch of a Futureneers 12B investment fund will only be considered should it be synergistic to the existing 12J fund and we will keep you updated in future newsletters.
THE WAY FORWARD
In lieu of the above, we are already adopting our strategy:
- The fund is well positioned having not allocated the bulk of our cash. Picking the right projects and protecting investor capital shall always remain our first priority.
- The market is changing and so are our models. Solar as a standalone solution in the C&I space is under pressure to deliver decent returns. Models are adopted to include batteries, generators and even looking at alternative energy solutions. The introduction of an energy management plan and monitoring and management system are also becoming mission critical. Our clients are now seeking energy solutions for their business needs where they were previously simply looking to implement solar as a “cheaper” source of energy. In short - clients now have to spend more on investing in energy security and storage.
- The risk profile of funding energy projects is also increasing. We are adapting by charging fixed price rental solutions rather than simply offering a “pay as you go” power purchase agreement.
- To mitigate investor risk, we may adopt debt sooner rather than later, even while still having access to investor equity. The purpose for this approach is to work with the banks to assess credit risk and approve the right projects.
- We are expanding projects beyond the C&I space. We are partnering with property developers in offering solutions for entire residential estates and are also working on solutions specifically targeting the body corporate market.
- We will remain innovative and adapt as the market conditions change. Load Shedding is not going away soon and we have to adopt accordingly.
DIVIDENDS FOR THE YEAR
The next dividend run is scheduled for July/ August based on the results for the year to end June 2023. Over the last few months Load Shedding has already decreased project returns significantly. The good news is that we are on track to pay a dividend slightly higher than last year even after absorbing the Load Shedding impact.
From a project roll-out perspective we are certainly behind schedule, but as you can see from the pipeline feedback above, we expect the larger project roll-out to now start commencing and be executed over the next 12-24 months.
As always, our funds remain next to yours. Let me know if you have any questions.
Kind regards
Jaco Gerber and the Solar 12J Fund Team