Not long ago, I published an article in which I detailed my belief that now is not the time to buy utility stocks. This argument pertained to the electric utilities, many of which I believe are significantly overvalued, trading for P/E ratios at multi-year highs. A side effect of overvalued electric utilities is that their current dividend yields are near multi-near lows, since stock prices and dividend yields are inversely related. Because of their low projected earnings growth over the next several years, I do not believe electric utilities offer a compelling enough risk-reward scenario at their current valuations.
But not all utilities are created equal, and not all utilities should be avoided. The utility sector is broader than some might realize. A niche industry within utilities that should see long-term growth, well ahead of the electric utilities, is renewable energy generation. For income investors put off by the electric utility valuations and low dividend yields, who are still looking for high yields to generate income, Brookfield Renewable Partners (NYSE:BEP) is the one utility stock I'd buy today.
The Most Attractive Utility
The reason is that, unlike its electric utility peers, Brookfield is still modestly valued, and still has a high yield, primarily because it hasn't rallied nearly to the extent of electric utilities. The other major factor behind Brookfield's hefty yield is that it has raised its distribution at much higher rates than many utility stocks. At its current unit price, Brookfield yields 6%--far higher than electric utility dividend yields. It's almost twice the yield of the Utilities SPDR Select ETF (NYSEARCA:XLU).
A 3.25% dividend yield is far too low for a utility stock. Not only is Brookfield a much better pick for current yield, it's a better pick for growth as well. Brookfield has a long runway of growth ahead of it due to the underlying growth of its industry, which makes Brookfield a particularly compelling utility stock for growth and income.
The growth of renewable energy, particularly wind energy, is compelling. Growth in consumption of renewables far exceeds that of fossil fuels, and moving forward, this is only expected to accelerate. The U.S. Energy Information Administration predicts total renewables used in electricity generation in the U.S. will grow by 13% in 2016, and another 3% in 2017. Within renewables, wind energy is a particularly strong area of growth. According to the EIA, wind capacity in the U.S. was up 13% in 2015, and is set to grow another 10% in both 2016 and 2017.
Not only are demand and consumption rising, but thanks to a focus on cost reduction, the economics of renewable energy are more favorable than ever. For investors looking to capitalize on this trend, Renewable Energy Partners is a great long-term play on renewable energy. According to Brookfield, it generated 16% compound annual total returns for investors since 1999. A key piece of Brookfield's hefty distribution. As an MLP, the company passes along the majority of its cash flow as distributions to unit holders, which results in a high yield that should be very attractive for income investors.
Brookfield's business fundamentals are solid. Last year, although revenue declined 4%, the company increased adjusted funds from operation by 0.5%, and it increased its distribution by 7%. Last year, Brookfield's distribution represented 74% of its FFO, which is a comfortable payout ratio that leaves room for future increases. Over the long term, Brookfield expects to increase distributions each year by 5%-9%. Brookfield is off to an even better start this year. In the first quarter, revenue and core FFO increased 56% and 21%, respectively, thanks to 31% growth in quarterly generation in terms of gigawatt hours.
Brookfield's growth is still in the early stages. It more than doubled its asset base in just the last five years, and has a large portfolio of future growth projects in the pipeline. Brookfield maintains an organic growth pipeline of 3,000 megawatts of capacity. Demand for these projects is very high. Approximately 90% of Brookfield's 2016 generation output is contracted to end users including utilities and industrial firms. The agreements for Brookfield's assets have a weighted-average duration remaining of 17 years.
From a valuation perspective, Brookfield is a much better buy than most electric utilities. The XLU exchange-traded fund has an average P/E of 17, which is close to the S&P 500 multiple. I feel this is too high, given the inherently low growth nature of utilities. But Brookfield trades for 13 times its 2015 FFO, a non-GAAP measure similar to earnings per share. This is a much more attractive valuation than most utilities offer.
Growth is Just Beginning
I feel that investors buying Brookfield Renewable Partners will generate far superior returns to those buying electric utilities today. At a 6% distribution yield, if the company raises its distribution by 7% per year on average as its guidance dictates, investors buying at this level will generate a nearly 12% yield on cost in 10 years. If an investor reinvests distributions, the results will be even better. Compare this to the average electric utility, which might offer a 4% dividend yield and 2%-4% annual dividend growth. The latter scenario would provide just a 5.4% yield on cost in 10 years, assuming 3% dividend growth each year.
I also feel that the outlook for renewables as a source of energy will produce much higher growth rates. With this in mind, it is reasonable to think Brookfield could continue to provide double-digit annualized returns, in line with its average returns since 1999. As a result, Brookfield Renewable Partners stands a great chance of providing significant alpha within the utility sector.
Disclaimer: This article represents the opinion of the author, who is not a licensed financial advisor. This article is intended for informational and educational purposes only, and should not be construed as investment advice to any particular individual. Readers should perform their own due diligence before making any investment decisions.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.