Gresham House Energy Storage Fund — Rising revenues and big plans for the future

The BESS sector faced a challenging period during the first half of 2024 (H124), due to a sharp deterioration in the revenue environment in Q124 and the slower than expected implementation of NESO’s Open Balancing Platform (OBP), which is intended to automate National Grid’s control room and thus improve access to trading opportunities for battery operators. As reported in a recent trading update (see our last note for details), GRID’s NAV per share declined to 109.16p at end June 2024, down 19.91p since 31 December 2023. Third-party revenue forecasts contributed 19.47p of this decline, principally due to a general reduction in revenue assumptions by third-party forecasters, combined with the introduction of a new, more conservative third-party provider. The adverse impact of this and other more minor factors on GRID’s NAV was partially offset by the favourable influence of the revaluation of several pipeline projects as they came on-line, and share buybacks, which are accretive to NAV.

During H124, GRID’s manager, Ben Guest, and its board implemented a strategy to stabilise the company and see it through this difficult period. This strategy focused on near-term cash flow generation and completing GRID’s 2024 construction pipeline projects. This strategy has yielded positive results, assisted by an improvement in the market environment since its nadir in Q124.

GRID’s operational portfolio revenues decreased 12.8% year-on-year to £17.9m in H124 (H123: £20.5m), and EBITDA declined 23.9% to £10.4m (H123: £13.8m), due to the poor market conditions during Q124. However, revenues have since begun to rise. Net revenues in July and August averaged their highest levels of the year so far and were c 25% higher than average net revenues in H124.

GRID’s revenue outlook has been further enhanced by a landmark tolling arrangement with Octopus Energy, which was agreed in May 2024. This deal ensures a significant improvement in revenues in 2025, as it contracts over half of GRID’s portfolio (568MW) for two years, starting in H224, at a level above current merchant revenue levels. It thus gives the company significant certainty on more than half of its revenues over this two-year period. Since the end of H124, 170MW of assets have been onboarded by Octopus under this tolling arrangement, with the remaining projects expected to transfer by the end of 2024. GRID’s manager estimates that using merchant revenue levels as at August 2024 (based on Modo Energy estimates), earnings should more than double from their current (H124) annualised rate of £20.8m to £45.7m during the tolling arrangement, due purely to this deal and the expected increase in operational capacity over the remainder of 2024. This is a conservative estimate given that merchant levels are forecast to rise over this period.

The second half of 2024 is expected to see the conclusion of GRID’s current construction programme of new projects and augmentations to several already operational projects, which are a very profitable way of increasing capacity, as they take only two to three months to implement and cost relatively little (see Exhibit 1). Once complete, the capacity of GRID’s operational portfolio will increase from its current level of 790MW (up 14.5% from end December 2023) to over 1GW for the first time, with an average battery duration of 1.6 hours.

However, despite this push to expand capacity, as previously announced, the manager is seeking to sell some existing projects to reduce leverage. The company is in discussions with several interested parties, but no deals have yet been concluded.

Looking beyond 2024, the company’s H124 results revealed that subject to the availability of fresh funding, the manager is considering opportunities to augment more of GRID’s existing portfolio in 2025, and also to resume work on the company’s long-term construction pipeline. Increasing the portfolio’s capacity from 1.6 hours duration to 2.0 hours during 2025, as Guest proposes, would add 300–400MWh to existing capacity of 1,701MWh, and generate ‘considerable potential revenue upside’. These augmentations and new project plans, and possible solutions to the company’s current capital constraints, will be the subject of a three-year plan to be revealed at a capital markets day in November this year. The plan is intended to maximise capacity, revenues and cashflow from 2025 to 2027, while reducing the volatility of earnings. Details of this event will be released in due course.

In the analyst update following the release of GRID’s half year results, Guest noted the current low level of battery prices and stressed that even taking a conservative view on revenue uplifts from duration extensions, such augmentations represent an exciting returns opportunity for the company. Given this, he indicated that he would consider further augmentation of existing assets up to three or four hours, once the immediate plans to increase portfolio duration to two hours have been realised. He also confirmed that he and his team are closely monitoring investment opportunities in foreign markets. The events of Q124 prompted them to indefinitely defer plans for GRID’s first foreign investment, in the US-based Project Iliad, but Guest sees opportunities for future investments not only in the US, but also in Europe, Australia, Japan and Canada. As Guest notes, ‘everyone needs batteries’, and he seems determined to resume GRID’s expansion into foreign markets as soon as circumstances and financing allow.

With revenues set to rise significantly during 2025, and capacity also likely to rise over time, subject to funding, GRID is in a stronger, more stable position than it was in Q124, well-positioned to benefit as market conditions continue to improve. Guest argues that ‘fundamentals are on our side’. Battery prices are falling, increasing the ability of new pipeline projects to achieve attractive returns. In addition, the penetration of renewable energy sources is rising, as expected, and will continue to do so. The last of the UK’s coal-fired power plants was retired on 30 September 2024, and nuclear power plants are being phased out over the rest of this decade. Greater reliance on renewable energy will increase power price volatility, especially for longer duration batteries. Furthermore, while the transition to NESO’s new platform has been slower than expected, it is still progressing and, with time, should improve trading conditions and revenues for GRID and its BESS competitors.

GRID suspended dividend payments in February this year to preserve cash as the revenue environment worsened. However, GRID’s chairman noted in the company’s half-yearly report that efforts this year to increase revenues provide ‘a supportive backdrop for the recommencement of dividend distributions’. The board expects to revisit the dividend policy in 2025, and has indicated that the resumption of dividend payments remains ‘a key priority’, subject to discussions with shareholders.

Until a year ago, GRID’s shares usually traded at a premium to cum-income NAV (see chart at the start of this note), but a sharp share price decline over the past year has seen the share price enter discount territory. The company initiated a programme of share buybacks in February 2024, repurchasing a total of 4.4m shares before buybacks ceased in April 2024, to focus capital allocation to the construction of new projects and augmentations. The discount exceeded 60% at this point but has since narrowed to closer to 50%. This is likely to be due at least in part to the improvement in GRID’s revenue outlook over recent months, especially since the agreement of the tolling arrangement with Octopus Energy.

In addition, investors may be beginning to see value in the shares. Alternative valuation estimates released by GRID for the first time in its H124 results show that at current merchant revenue levels and based on current operational capacity and the tolling arrangement discussed above, the company is valued at 9x EV/EBITDA, with a P/E ratio of 5.7x, on a forward basis. However, capacity is set to rise by end 2024, and medium- to long-term revenues are forecast to increase significantly based on third-party revenue curves, so both the EV/EBITDA and P/E ratios are likely to fall over time. This suggests the company’s shares offer potential value at their current level.

The current wide and arguably unjustified discount may represent an opportunity for those investors who share the confidence of GRID’s manager and board in the long-term viability of the battery storage industry and in the company’s prospects. It will take more time for conditions in the sector to improve, and for GRID’s revenues to fully reflect recent developments, but as and when they do, the company’s share price discount has significant scope to narrow back towards its historical levels.