2017 Yieldco Portfolio Update - Shares Are Up, But They Remain Undervalued

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Includes: NEP, NYLD, PEGI
by: Robert Dydo

Summary

Second quarter results reaffirmed by drop-downs, positive earnings, and new prospects.

NextEra Energy Partners corporate changes lead to more independence, preferred shares issue will fuel growth.

NRG Yield’s share appreciation could slow down while waiting for the sale of interest by the sponsor.

Pattern Energy completes 20% investment in Pattern Development 2. Dividend growth slows, but value remains.

In February and March of this year, I have recommended three yieldcos as buys for 2017. The table below shows the current share appreciation for those companies, as well as the dividend yield, based on the recent increases in dividend payouts.

I wrote articles in the past itemizing each recommendation, so for the more detailed view, in addition to this update, I have included links for those who wish to explore them.

NextEra Energy Partners

NextEra Energy Partners (NEP) was described in my most recent article, which was an update to the article originally published in February. The company has performed very well year to date. In addition to the appreciation of share price, during the conference call and investor day in June, the company announced a number of exciting updates to the structure of the corporation. For the full review of those presentations, readers should access the library link. The slide below is taken from slideshow used during the Investor Day and does describe corporate changes. I believe those changes will create more capable, independent management of the yieldco, and produce an even greater performance.

After results of the second quarter, the company increased quarterly dividend payment to $0.38, or $1.52 per share annually. I noted already that the company planned to grow dividends in the range of 12% to 15% per year, with visibility until 2022. The dividend payment based on the range of 12% to 15% would reach $2.78 and as much as $3.26. in April, I estimated the value of shares, based on those dividends to be $61.80 to $72.42 per share having a 5-year timeline to reach them.

However, I believe we are witnessing possible raised valuation by the market in light of the new corporate developments. The transition was best described with the quote taken from the second quarter release offered by the company:

In addition to the modified incentive distribution rights structure that we instituted earlier this year, we believe the changes we announced at our June investor conference for NextEra Energy Partners, including enhanced governance, stand-alone issuer credit ratings in the mid- to high-'BB' category and the agreement to issue convertible preferred securities, significantly enhance what is already an outstanding investor value proposition. With clear visibility into future growth and even greater financial flexibility to fuel that growth, NextEra Energy Partners is well-positioned to meet our long-term financial expectations without the need to sell common equity until 2020 at the earliest.

While the common equity is not being issued, the issuance of preferred equity does provide for the same financial benefit bringing fuel for growth. The preferred shares can be converted, as an option, into common equity in 2019, on a one-to-one basis. The amount of $550M will require the issuance of 14M shares at $39.22 per share. As the slide below explains, the issue comes with a coupon of 4.5% or $1.75 per share, per year. The conversion process, distributions, adjustments to payouts have a complex structure, but under the initial impression, they appear to have a very attractive investment profile. The sale of preferred securities is expected to be completed by the end of the year.

Operationally, during the second quarter, the company added 250MW Golden West Wind Energy Center to its portfolio, now consolidating over 3GW of renewable resources, with wind being above 2.8GW. The company also receives revenue from 542 miles of natural gas pipelines.

The new corporate format and $550M in new money have increased value of shares and as a result lowered the dividend yield. An update to my estimate made in April, when using the 3.77% dividend yield, improves five-year price targets. The yearly dividend payment of $2.78 per share would now see $73 per share by 2022. Having $3.26 yearly dividend, based on a 15% yearly increase, the share price could reach $86 per share, offering the potential return range of 80 to 112%, based on the current price of $40.36 per share.

Shares of NEP remain as a buy.

NRG Yield

NRG Yield (NYLD) has released its second quarter, meeting expectations. The company has increased dividend payment to $0.28, which brings the annualized dividend to $1.12 and the dividend yield to 5.93% based on the price of $18.90 per share

For the year, the company has reaffirmed its financial guidance, importantly confirming cash available for distribution. Operationally NYLD added remaining percentage of the already owned Wind TE Holdco project and it is evaluating further business initiatives with ROFO (right of the first offer) and non ROFO assets held by the sponsor NRG Energy (NRG). The company's portfolio, after recent additions, includes 1.9GW of the wind and almost 1GW of solar resources. Conventional assets, the natural gas energy plans, amount to 1.9GW and the company has also thermal energy generation sites.

The shares of NYLD increased the least in comparison to other two stocks, but since May update, they are up from a price of $16.50. I believe that potential sale of the interest in the yieldco by its sponsor may have slowed down the price appreciation until the sale is completed. The price achieved in this transaction will influence the value of the publicly owned shares, but perhaps more importantly, the transaction will set future sponsorship arrangements and determine the direction for NYLD. As one of the scenarios considered for the execution is a yieldco consolidation. NextEra executives have declared an interest in assets available for sale on the market and I believe those assets may very quickly increase in price due to U.S. market conditions. The political climate and possibility of the trade war over solar modules have created potent demand for renewable assets with wind projects becoming a natural filler of the future gap. In my view, those conditions support an increase in a value of existing assets, therefore, improving the valuation of yieldcos.

Shares of NYLD remain as a buy, but buyers/holders should consider the pending sale transaction of NYLD by NRG as a potential factor responsible for share value fluctuation. Identifying new sponsor, and the new relationship influence over the growth could produce exceptional situation for an increase. However, prospects hold as much of the risk, due to an unknown level of interest and unidentified parties taking part in discussions. NRG’s urgency to complete the transaction, as well as the structuring of the transaction will play an important role in the process. Due to the quality of the assets, existing liquidity and NYLD’s dividend, shares remain attractive. My current estimate still uses 15% growth of the dividend until 2019. Using a $1.12 dividend with a two year’s growth runway, the price target for shares is $25. The return is 32% based on the current price of $18.90 per share.

Shares of NYLD remain as a buy.

Pattern Energy

I have written extensively on Pattern Energy (PEGI) in this update. The results for the second quarter are scheduled for the August 8th, and I suspect that investors will see reduced cash on hand as the transaction for Broadview project will be reflected in the financial statements. There should be an increase in revenue from the energy generated from the same project. On July 27th, the company invested $60M into a 20% ownership of Pattern Development 2.0 (PD2) signaling completion of the initial funding for this business. PD2 started announcing new acquisitions recently with 80MW Farm in Montana slotted for completion in 2018, and 103MW Willow Creek project in South Dakota. King Pine, a 600MW project in Mine, part of the PD2 portfolio is back in the news as part of a joint bid for 1.3GW of wind energy along EDP Renewables (OTCPK:EDRVF). According to this article, the project has received support from Gov. Paul LePage’s Energy Office.

I do not foresee any changes to my expectations, based on the results of a coming quarter. PEGI, by receiving an investment from the large Canadian pension manager, managed to reduce the risk to its business strategy. Engaging this new and old financial resources will enable the realization of its 2020 objective to have a 5GW portfolio (current 2.7GW). In my view, this improvement still awaits recognition. When accomplished, a dividend yield could reach 5%, and with an annual dividend payment of $1.67, could offer $33 per share. Investors should understand a limited change in a cash available for distribution until more drop downs are executed, perhaps in 2018. As a result, the dividend growth is expected to slow down. Still, having the annual dividend 50% larger than NYLD ($1.67/$1.12) with the highest dividend yield, at 6.63%, PEGI shares remain deeply undervalued and therefore are recommended as a buy. The return potential based on the target price of $33 is 30%, using current price of $25.20 per share.

Disclosure: I am/we are long CSIQ.

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.