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The FTSE 250 is home to many income stocks offering enormous dividend yields. While the index is mostly known for its UK-focused growth opportunities, there are currently just shy of 60 stocks with a payout of 5% or more. And standing near the top of the list is Greencoat UK Wind (LSE:UKW).
With management maintaining shareholder dividends and weak sentiment dragging the share price down, investors can now tap into a massive 10.5% income opportunity!
As experienced investors know, a payout that high can be a giant red flag of unsustainability. However, there are always some rare exceptions. And investing against the crowd in those situations can not only lock in enormous yields but also deliver impressive share price gains from a recovery rally as well.
So is Greencoat a hidden bargain, or an obvious trap?
What are investors nervous about?
Greencoat shares are down just over 25% since the start of the year. That might sound surprising considering the government’s continued push to invest in renewable energy infrastructure, particularly when it comes to wind power.
There are a few factors at play here. But the three biggest things bothering investors right now are:
- Higher interest rates are making Greencoat’s debts far more expensive to service, pushing the group’s self-imposed leverage threshold right to the limit.
- The elimination of green levies in the latest Autumn Budget directly impacts the group’s revenue stream, which is already suffering from falling energy prices.
- Plans to change the Renewable Obligation subsidy inflation indexation from the retail price index (RPI) to the consumer price index (CPI) will cause a downward shift in cash flow generation for all energy generators.
The combined effect of these negative catalysts is a surge in uncertainty. Throw in the fact that changing weather patterns are resulting in lower wind speeds around Britain, and it’s easy to understand why shareholders are exiting their positions.
Is this an overreaction?
The concerns surrounding this business are justifiable. And there’s no denying the regulatory uncertainties in particular have increased Greencoat’s risk profile for investors.
However, fundamentally, even with the added pressure of higher interest rates, the company continues to generate enough cash flow to cover shareholder dividends with more to spare.
At the same time, with the stock trading at a 30% discount to its net asset value, it seems that the market’s pricing in the worst-case scenario regarding adverse regulatory changes. That seems a bit too pessimistic, given the government’s actively engaging with the wider renewable sector to try and minimise widespread disruption.
With that in mind, Greencoat shares could actually be well-positioned for a recovery once the regulatory and political policy environment begins to stabilise.
A golden buying opportunity?
Sustainable 10% dividend yields are rare to come by. And Greencoat’s robust financials, paired with, in my opinion, overly negative investor sentiment, suggest this stock might indeed be an exception.
Having said that, there’s no denying this payout comes with significant risks, especially if energy prices and wind speeds continue to stumble. But if income investors are comfortable with an elevated risk profile, Greencoat could be worth a deeper dive.
