Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Pattern Energy Group (NASDAQ:PEGI) made its public debut on Friday, September 27. Shares of the independent wind power company ended their first day with gains of 5.8% at $23.27 per share.

While the 5.3% dividend yield looks attractive, investors are advised to be cautious. The leverage and payout ratio is quite aggressive. Combined with the fact that the company has little upside potential given its hedging policies, I remain cautious.

The Public Offering

Pattern Energy Group focuses on the ownership and operating of power projects with long term stable cash flows, operating in attractive market with potential for growth.

The company currently owns an interest in 8 wind power projects through the US, Canada and Chile, with a total owned capacity of 1,041 MW. Note that 2 of these projects are still under construction, while work on 2 new projects will commence before the end of the second quarter of 2014.

Pattern has entered into long-term fixed price agreements with creditworthy counterparties, allowing the firm to "lock-in" stable cash flows. A total of 95% of electricity being generated is sold under these contracts, as agreement have an average life of 19 years.

Pattern Energy Group sold 16 million shares for $22 apiece, thereby raising $352 million in gross proceeds. All shares were sold by the company, with no shares being offered by selling shareholders.

Bankers and the firm set an initial price range of $19 to $21 per share. Shares were eventually sold above the high end of the guided range.

Some 31% of the total shares were offered in the public offering. At Monday's closing price of $23.40 per share, the firm is valued at $1.20 billion.

The major banks that brought the company public were BMO Capital Markets, RBC Capital Markets, Morgan Stanley (NYSE:MS), Bank of America/Merrill Lynch (NYSE:BAC) and Wells Fargo (NYSE:WFC), among others.

Valuation

Pattern Energy Group has been solely focused on wind energy for the moment, creating a diversified portfolio of projects across different geographical areas.

The US is the second largest market for wind energy generating capacity, according to the Department of Energy (DoE), to be found in the S1-Filing. Wind power became the biggest source of new electricity generating capacity in 2012. Similar trends have been witnessed in Canada and Chile.

Lower equipment costs, stability of input costs, and geographical diversification makes wind increasingly more attractive for investors. Note that Pattern might diversify from wind to other projects as well including non-renewable energy projects and transmission projects.

For the year of 2012, Pattern Energy generated annual revenues of $114.5 million, down 15.7% on the year before. The company reported a $6.3 million loss compared to $8.9 million profit a year earlier.

For the first six months of 2013, Pattern Energy Group generated revenues of $102.5 million, up 62.1% on the year before. Earnings rose from $6.4 million to $29.1 million, driven by revenue growth and a $7.4 million tax benefit instead of a provision, and other incidental benefits.

Growth was driven by the fact that the Spring Valley, Santa Isabel and Ocotillo project came online in the second half of 2012, adding 476 MW in generation capacity.

The company operates with $41.8 million in cash and equivalents and $1.32 billion in total debt, for a high net debt position. Note that the majority of proceeds will be used to pay PGE Limited Partners for Contribution Transactions. Some $56 million will be used to repay outstanding amounts under the credit facility.

With the equity in the business valued around $1.2 billion, operating assets are valued around 10 times annual revenues for 2012. Note that this multiple will come down to an expected 5 times revenues for 2014.

Investment Thesis

As noted above, the offering of Pattern Energy Group has been a reasonable success. The company priced the offering at $22 per share, some 10% above the midpoint of the preliminary offering range.

Shares have seen more upside in the meantime, rising to $23.40 per share, trading some 17% above the midpoint of the preliminary offering range.

The company came with quite some upbeat comments and outlook for the remainder of 2013 and into 2014. Cash to be distributable for 2014 is seen around $55 million, as adjusted EBITDA will increase towards to $218 million. The company aims to use these flows to pay out a $0.3125 quarterly dividend, for a dividend yield of 5.3%.

Note that the company targets a payout ratio of 80% of distributable cash flows. The first dividend is expected to be payable in January of next year.

These dividend payout ratio's are quite aggressive, especially if more B shares will be converted in A shares next year, and given the significant leverage being employed. Yet operations are growing rapidly at the moment due to recent projects coming online. Full year revenues for 2013 are seen around $210 million, expected to increase towards $240 million in 2014.

Modest net income and high deprecation charges should result in solid cash flows allowing for debt repayment and dividends. Yet the leverage employed and aggressive dividend payout ratio's are anything but conservative.

Other risks include low gas prices, poor wind conditions which should be partially overcome by diversification and severe weather which could damage the wind turbines. Tax credits remain an issue, as lack of Congress funding could hurt new project developments.

At this point in time, the long term risks seem to the downside. Pattern has locked in pretty much all of its expected production in long term contracts, locking itself out of more favorable energy prices. This this "conservative" strategy might still have downside issues if counterparties might default on projects amidst plunging electricity prices. Damages or maintenance to the turbines could also negatively affect production levels, putting the share price, which in its turn is largely dependent on the dividend, under pressure.

While a 5.3% yield looks extremely attractive, note that this is only achieved because of a high 80% payout ratio and amidst a leveraged balance sheet.

I remain cautious and stay on the sidelines.

Source: Pattern Energy Group - Strong IPO On Headline Dividend Yield