Making Money in Renewable Energy

We all exert great effort to make money in the stock market, and occasionally we find opportunities to do well by doing good. I personally am not a big socially responsible investing (SRI) guy -- nothing against it, but I like the sin stocks like tobaccos just as much. But in the last couple years I have been a fan of the renewable energy names. Mostly I have been tracking them rather than owning them, since the profit experience has been checkered, to put it diplomatically. My interest in renewables is less a matter of being socially active and more because at some point the industry will mature to be competitive with fossil energy sources, and at that point, growth could take off. Solar is probably there right now, and it has exited from a severe and protracted down cycle. I went positive on solar nearly a year ago, so far with good results, and I believe the group still has room to run. As the Dividend Diva, I also like current income, which has been lacking in the renewables group until recently. After a handful of IPOs this year, there is now a critical mass of income vehicles using renewable energy projects to put cash in the pockets of investors. The so-called yieldcos represent an attractive way for income-oriented investors to also do well by doing good, or at least do well. Seven investment-grade yieldcos are public in the U.S., and another four are traded in Canada. They all are spinoffs from large parent companies that own power projects that use the major renewable sources: solar, wind or hydro. They all pay an attractive dividend, and they intend to increase those dividends over time. As Morgan Stanley analyst Stephen Byrd said in his recent initiation on the group: With several publicly traded YieldCos and a growing market cap, we view the investment vehicle as having arrived. We believe it offers attractive valuation with dividends similar to utilities, but with growth at 4x the rate. Indeed, the yieldcos are an alternative to utility stocks for income-oriented investors who would like to also see some growth of principal. Here are the names investors can consider in the group: NRG Yield (NYLD): The spinout from NRG Energy (NRG) owns solar farms with a couple nat-gas power plants thrown in for good measure. Market cap is $1.2 billion, and yield is 2.7%. Pattern Energy Group (PEGI): This spinout from the private company Pattern Energy owns wind projects mainly in the western U.S., Canada and Chile. Market cap is $1.1 billion, and yield is 4%. NextEra Energy Partners (NEP): This was a recent spinout from Florida-based NextEra Energy (NEE) that owns wind and solar projects. Market cap is $550 million, Being new, it has not yet declared its first distribution. Note that this one is a limited partnership, so the tax treatment of distributions will be more favorable than the standard C corporation vehicles. Abengoa Yield (ABY): This recent IPO is a spinout from the Spanish renewable energy giant Abengoa. Abengoa Yield is more diversified, owning solar plants as well as conventional power assets and transmission lines. Assets are in North America and Europe. Abengoa Yield is large, with a market cap of $2.8 billion. Although traded in the U.S., it is technically a U.K.-based company. TerraForm Power (TERP): The most recent IPO was this well-received spinout from solar giant SunEdison (SUNE). This one is also large, with a market cap of $3 billion. Being a solar company spinout, it naturally owns a large portfolio of solar projects in the U.S., Canada, the U.K. and Chile. Brookfield Renewable Energy Partners (BEP): Brookfield Renewable is the giant of the group with a $7.5 billion market cap. It was spun out of the Canadian real estate giant Brookfield Property Partners (BPY), and as such, it is a Canadian company traded on the NYSE (as well as the Toronto exchange). The dividend is a fat one at 5.3%, and given its size, the cash flow behind it is pretty safe. Note that Brookfield Renewable is also a limited partnership, so the cash flow is only taxed once ... when you get it. This one is different from most of the rest of this list, because the portfolio is almost exclusively hydro, although the company expects to broaden into other power sources over time. Hannon Armstrong (HASI): Hannon is a bit different from the other yieldcos, but it is still an income vehicle. It raises financing for energy efficiency projects by securitizing the projects. Hannon figured out how to form itself as a real estate investment trust (REIT), bestowing additional tax advantages on the income produced. Hannon is still small at a market cap of around $300 million, but it sports a very attractive 6% yield. When you examine these names in more detail, here are a few key elements to study closely. Many have what are called ROFO -- right of first offer -- deals with the parent companies, so that the yieldco gets first shot at buying any good projects the parent is developing. Many of the parent companies have disclosed explicit plans for which projects will eventually be sold to the yieldco. Importantly, prices are often locked in for some time, so the yieldco could get a good deal as asset values grow over time. Check on the terms of the ROFO that your target of research may have in place. Do beware of the tight relationship between parent and yieldco. While that relationship can create good value in the ROFO, it can also tempt the parent to cram down bad projects to the yieldco. The risk is double when both companies share the same management team. Some yieldcos, mainly the Canadian ones, are more focused on developing projects in-house rather than buying them. Study the corporate strategy of buy vs. build. Many yieldcos offer guidance for dividend growth, so you can get a feel for your future yield. The analyst Tom Konrad wrote a great summary in a recent research piece: NRG Yield (NYLD) is the most ambitious, and expects to grow its dividend by 15% to 18% for five years. In order of decreasing ambition, Terraform Power (TERP) aims for 15% growth for 3 years, NextEra Energy Partners (NEP) expects 12% to 15% growth for three years, Hannon Armstrong Sustainable Infrastructure (HASI) expects 13% to 15% growth for two years, Pattern Energy Group (PEGI) aims for 10% to 12% for three years, and Abengoa Yield is aiming for relatively modest 6.5% growth over the next 12 months. Canadian yieldcos, like TransAlta Renewables (TRSWF or RNW.TO) and Brookfield Renewable Energy Partners (BEP, BEP-UN.TO) have not laid out specific dividend growth targets, but do have reasonably aggressive growth plans which are likely to boost distributable cash flow and dividends over time. Check what are called incentive distribution rights, which can offset those great dividend growth plans. The IDR specifies that the parent gets to retain more of the dividend payouts as they grow ... often up to 50%! So while they are incentivized to grow the dividend, they may also take unnecessary risks to do so. Also remember that the incentive is only one way -- the retention does not get reduced if the dividend needs to be cut.

Making Money in Renewable Energy

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