- A new partnership and investment by PSP, a Canadian pension fund.
- Pattern can be thought of as a bond proxy with a great yield.
- Accounting issues give an attractive entry.
I never really gave Pattern Energy (NASDAQ:PEGI) much thought until late 2016. I was always one to look at traditional utilities with renewable operations, instead. Like many other investors, I doubted the continued viability of yieldcos after the well documentedSunEdison (SUNEQ) implosion. I almost missed a gem by ignoring them. Pattern Energy is a great value for dividend investors and has recently had its quality reaffirmed, with a major investment by a Canadian pension fund.
Source: Pattern Energy
What is a yieldco?
Yieldcos are slightly complicated entities, but let's try to keep it simple for the purpose of the article. You can read a more in-depth explanation here. In short, yieldcos are the entities created by a parent company that holds renewable energy assets. They are able to limit their tax burden by rapidly growing their asset base and there are tax implications, but as a Canadian, they're taxed differently than in America. Read more about yieldco taxation here. What's inherently wrong with yieldcos? Nothing. The thing that has really set the sector back has to do with its former poster-child, SunEdison and its yieldcos, TerraForm (TERP) and TerraForm Global (GLBL).
Pattern out with the bathwater
You can see the yieldcos get taken down with SunEdison.SUNEQ data by YCharts
What fascinates me about this is that Pattern has nothing to do with SunEdison or its yieldcos, yet it got taken out with the pack. In fact Pattern and its parent Pattern Development have been snapping up projects off SunEdison, it's a competitor off the table. The only two reasons I can think Pattern would get taken to the woodshed along with the Sun family is:
- Concern grew about whether Pattern would be a Terraform 2.0, or its parent a SunEdison.
- Investors saw depressed valuations in the Terraform companies and took their money out of Pattern
There can also be a discussion for another day about whether the Terraform companies represent deep-value, but I view comparing them to Pattern like comparing a Ford Pinto to a Mercedes S-Class. There is a serious question as to what a post-SunEdison world looks like for its daughter companies.
Let's talk about stability
Pattern Energy got hammered by the markets in 2016 when they announced they had found accounting discrepancies in their Q3 2016 results. Investors smelled SunEdison and ran for the hills. Here's a quote from the company's 10K filing last year (PG 78):
Our training program was not effective at ensuring internal control responsibilities were properly communicated to and performed by new and existing personnel. Specifically, training was not timely communicated regarding the required documentation to demonstrate and ensure that controls consistently operated at a sufficient level of precision to prevent and detect potential errors. This led to inconsistent performance of controls throughout the control environment.
Our accounting policies and procedures were not effective in providing reasonable assurance that accounting transactions are consistently recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles. This led to varied understanding of the risk of material misstatement to the financial statements and the related inconsistent performance of controls throughout the environment.
Our monitoring controls and management review controls were not effective at ensuring the timely detection and prevention of all potential material errors within our consolidated financial statements. In addition, we need to improve our review of the completeness and accuracy of information used to execute these controls, including key spreadsheets. This led to varying levels of review by management in the performance of monitoring and key spreadsheet related controls.
Our controls for the review of contracts were not effective to ensure the completeness of contracts reviewed or to ensure the appropriate identification and timely accounting for provisions within our contracts. This led to inconsistent performance of contract review controls.
Additionally, based on our assessment, our management believes that our procure-to-pay procedures were not effective as of December 31, 2016 because an aggregation of internal control deficiencies resulted in a material weakness relating to the design, operation, enforcement and effective communication of changes to our delegation of authority policy.
This is obviously concerning to investors, but I think it has been largely negated at this point. The company has investigated into these issues and says it has no impact on their financial results. What's much more important for investors is the recent investment my a major Canadian investment fund after the discrepancies were found.
This investment not only reaffirmed faith in Pattern Energy, but announced along with it was a $1 billion investment into Pattern Development. Since Pattern Development is a private company it was hard to know how well they were really doing... it's reassuring for investors that Pattern Development is financially sound... as we all remember what happened to yieldcos the last time a parent blew up.SUNEQ data by YCharts
Pattern Energy's strategic partnership with PSP Investments is intended to expand capital access and improve flexibility in managing capital requirements. As part of the transaction, PSP Investments has agreed to purchase a 9.9% interest in Pattern Energy from Pattern Development 1.0, at a 2.5% discount to the 20-day volume weighted average price of Pattern Energy as of June 9, 2017, making it the largest shareholder. A person designated by PSP Investments may be added to the Pattern Energy Board of Directors at a future date.
In addition, Pattern Energy and PSP Investments will co-invest in ROFO projects based on a process that will be controlled by Pattern Energy. PSP Investments will invest at the same purchase price and on the same terms as Pattern Energy. Pattern Energy can elect the percentage interest to offer PSP Investments in each project, which are expected to range from 30% to 49.9%. Pattern Energy will continue to maintain operational and management control.
PSP Investments has agreed to cooperate with Pattern Energy on future third-party acquisitions and to support the Company's funding through potential bridge financing for projects under construction.
"We are pleased to partner with Pattern Energy, whose talented leadership team has built a solid reputation in the renewables sector, the fastest growing market of power generation," said Patrick Samson, Managing Director, Infrastructure Investments, PSP Investments. "This relationship grants us access to a portfolio of projects and a source of new assets in renewables, and we believe it will provide good and stable returns for our contributors and beneficiaries. Furthermore, it demonstrates our ability to structure large complex transactions that fulfill both our needs and those of our partners."
"PSP Investments is a well-respected, experienced, global and long-term investor in power assets, including renewable energy," added Mike Garland. "Their commitment to provide up to $500 million in capital supports our growth strategy and our ability to fund continued growth in the portfolio through alternatives to conventional equity and debt. We look forward to their participation in our business both at the Board level and as co-investors in projects."
Pattern also secured a major partner and investor in PSP, the Public Servant Pension Fund in Canada. The fund manages over C$130 billion and has had quite a good track record. What I love about this is this tie-up is the second opinion Pattern will get on new projects. Pattern Development is now stronger, Pattern Energy has a new partner with VERY deep pockets who will be partnering on new projects. This is a win-win-win for Pattern Energy.
While the entire market has rallied over the past 9 months, Pattern is just back to where it was pre-accounting issues. With those issues largely behind them (PSP proves the company is financially sound in my eyes) you are able to pick up Pattern at a relative discount.
The value proposition today is pretty easy to articulate
- 7% yield
- 4-5% CAFD/share growth
Pattern claims they will grow CAFD 15% this year, but that is unlikely to continue in the long run, considering a backdrop of rising interest rates and an increasingly competitive sector. The company does carry fixed-rate debt, so interest rate concerns would stunt future growth, not immediately hurt the company...PEGI data by YCharts
Can't stump renewables
The company continues to ramp up its dividend and fund new projects. With that said, many have worried that Pattern is exposed to a less renewable-friendly GOP administration. The entire renewables sector sold off, Pattern cratered 10% the day Donald Trump was elected. I don't see this as a material concern for Pattern. Most government incentives for wind power and thus Pattern come from the states and not the federal government. The majority of Pattern's biggest operations are located in states with GOP administrations. Wind has reached a point that it is not only strong enough to stand on its own two feet, Republican governors want wind projects in their states as well. Unlike a mine that has, say, a 20-30 year life, where a town builds around it and is crushed when it closes, these wind projects will bring jobs for a long time... On top of that, the overwhelming majority of Pattern's capacity is sold through PPA, essentially guaranteeing them a rate of return. If things really turn sour in America, Pattern will just go elsewhere, they already have projects in Canada, South America and Japan.
Pattern is pretty hard to beat when it comes to a safe, growing 7% yield. With the accounting irregularities largely defused by a major pension investment, this makes Pattern an attractive buy. I believe Pattern will continue to 'blow' past expectations.
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