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Portfolio Update

Yieldcos Reboot

By Roger S. Conrad, on Feb. 17, 2018

The Lifelong Income Portfolio has been migrated to sister product Deep Dive Investing’s Idea Vault. For our Portfolio readers, we run through additional Idea Vault members that may be of interest–specifically US yieldcos.

US yieldcos have been around as an asset class for slightly less than five years. To date, the investment track record is a mixed bag. But the group is now getting a reboot that promises to match robust capital gains to already lofty yields.

The key is sponsorship. Or, put another way, there have never been any irredeemably bad yieldcos, only negligent parents who failed to raise them right.

Take the sector’s biggest success story to date, NextEra Energy Partners LP (NYSE: NEP). The yieldco has produced 116 percent dividend growth and a total return of over 70 percent since its June 2014 initial public offering, largely thanks to parent NextEra Energy’s (NYSE: NEE) unshakeable financial support. The parent even cut its incentive distribution rights to reduce the yieldco’s cost of capital.

That’s a stark contrast with the industry’s most challenging story to date: TerraForm Power (NSDQ: TERP) and TerraForm Global (NSDQ: GLBL). Both yieldcos were forced to eliminate dividends for more than two years when parent SunEdison filed for bankruptcy, entangling them in a web of accounting and legal disputes.

Yieldcos today are out of favor, largely because these failures are still fresh in investors’ minds. Elevated short interest is one sign of skepticism that the business model is sustainable. The industry discount is another: Top-performer NextEra Energy Partners yields more than twice the S&P 500. Its price-to-cash flow multiple of 4.96 is barely one-third of the S&P 500’s 14.3 times.

As with most dividend-paying stocks, some of yieldcos’ discount can be blamed on worries about interest rates. There’s also concern US adoption of wind and solar power may slow due to trade protectionism and a president willing to subsidize coal-fired electricity, diminishing expansion opportunities. And broad market volatility the past week has also triggered selling.

Overcoming investors’ deep skepticism about sustainability, however, is the key to driving a real sector turnaround. And after a pair of merger announcements this week, yieldcos have taken a giant leap toward that redemption.

Two Deals

On Tuesday, First Solar (NSDQ: FSLR) and SunPower (NSDQ: SPWR) announced a deal to sell 100 percent of 8Point3 Energy Partners LP (NSDQ: CAFD)—including their combined 65 percent interest—to Swiss investment firm Capital Dynamics AG. Then on Wednesday, NRG Energy (NYSE: NRG) sold its 46.3 percent ownership interest in NRG Yield (NYSE: NYLD), as well as a 6.4-gigawatt development pipeline of renewable-energy projects, to Global Infrastructure Partners (GIP).

There’s little question the NRG Yield deal is far more attractive to shareholders. GIP executives have affirmed they’re sticking to the yieldco’s structure and strategy of expanding “long-dated contracted assets” to “drive long-term dividend growth.” And they’ve already put their money where their mouth is, financially backing NRG Yield’s purchase of a 527-megawatt natural gas facility and a 154-megawatt solar facility.

In short, GIP is making the same commitment to nurture NRG Yield that NextEra Energy has maintained with NextEra Energy Partners. The result should be a resumption of the robust distribution growth that’s stalled recently. And the deal reduces risk as well, a point made by both Standard & Poor’s and Moody’s Investors Service this week in affirming the yieldcos’ credit ratings.

In contrast, Capital Dynamics’ $12.35 per share, all-cash offer is more than 15 percent below 8Point3 Energy Partners’ 200-day moving average. To justify the take-under price, CEO Charles Boynton disparaged the yieldco model as “not competitive in buying projects” and asserted “a number of operational and financial issues” threaten 8Point3’s ability “to continue as a standalone company.”

If he’s right, shareholders are certainly better off taking the deal despite the disappointing price. But there’s also room to doubt Boynton’s assertions.

The rooftop solar business in general has yet to find a profitable model, raising questions about 8Point3 Energy Partners exposure to 5,800 customers in nine states.

But the dividend is more than adequately covered by cash flow from 900 megawatts of generation that’s 100 percent under contract with investment-grade customers, with the nearest expiration nearly 18 years away. Revenue for 8Point3Energy Partners’ fiscal fourth quarter ended Nov. 30 increased 14.5 percent and cash available for distributions was 53 percent higher, covering the distribution by a strong 1.39-to-1 margin. And there’s no maturing debt until late June 2020.

Sponsors First Solar and SunPower also clearly had an incentive to accept an all-cash deal, even at a subpar price. That’s because they’re starved for liquidity in the hyper-competitive solar manufacturing industry, which has been further roiled by the Trump administration’s new 30 percent tariff on most imported solar panels to the US.

These points should be considered carefully by 8Point3 Energy Partners’ minority shareholders, who will have to approve the deal for it to close.

Shareholders have little to lose sticking around and collecting dividends, while waiting to see if the offer is sweetened. But importantly for all yieldco investors, cashing out First Solar and SunPower would eliminate the last weak hands among industry sponsors.

Last year, Algonquin Power & Utilities Corp (TSX: AQN, NYSE: AQN) took bankrupt Abengoa (Spain: ABG) out by purchasing 25 percent of Atlantica Yield (NSDQ: AY). That deal eliminated cross-default and cross-ownership agreements with lenders that had locked up cash flow from certain of Atlantica Yield’s facilities. It also restored a platform for growth through asset drop-downs, both from Algonquin’s existing portfolio and a new development venture between Algonquin and Abengoa as the latter exits bankruptcy.

Similarly, Brookfield Asset Management (TSX: BAM, NYSE: BAM) and Brookfield Renewable Energy Partners LP’s (TSX: BEP-U, NYSE: BEP) purchase of 100 percent of TerraForm Global and 51 percent of TerraForm Power eliminated yieldco exposure to SunEdison. Brookfield has already supported growth at TerraForm by backing its takeover of Saeta Yield (Madrid: SAY), a deal that could boost cash available for distribution as much as 24 percent.

The upshot is for the first time ever, every US-listed yieldco has a well-heeled sponsor. And these parents have universally made a long-term commitment to growing their yieldcos’ asset portfolios, cash flow and dividends.

That alone doesn’t ensure success. But it definitely marks a much welcome reboot of the yieldco sector. And where there is steady expansion of assets, cash flows and dividends, rising share prices will follow. In fact, upside should be explosive from today’s low valuations.

Yieldcos’ relatively short history also means Wall Street coverage is still comparatively thin. Only seven analysts, for example, cover TerraForm Power, six track Atlantica Yield, and nine follow NRG Yield. Even sector leader NextEra Energy Partners has only 16 followers. Success growing assets, cash flow and dividends in coming years is a sure bet to boost coverage, which in turn will bring buyers.

Finally, the group is also relatively un-indexed. That means limited exposure to algorithmic trading behind much of the massive stock market volatility we’ve seen recently.

Roger S. Conrad is the founder and editor of Conrad’s Utility InvestorHe also co-edits Energy & Income Advisor and Deep Dive Investing with Elliott Gue.

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