Pattern Energy Q4 2018 Power Production Preview

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About: Pattern Energy Group Inc. (PEGI)
by: Justin Law
Summary

Wind speed data points to below-average power production in the 4th quarter.

Though revenues may miss, EPS will be buoyed by K2 sale. Full year CAFD will likely come in above midpoint of guidance.

2019 CAFD is estimated to be lower due to dispositions and Gulf Wind repowering.

Introduction

This article is part of a series tracking and analyzing wind speed data in order to estimate the quarterly power production of Pattern Energy (PEGI). Briefly, Pattern Energy operates a portfolio of wind farms mostly located across the United States and Canada. Thus, it is expected that power production (and consequently, revenue) is linked directly to the wind speeds experienced at each wind farm in the portfolio. Using wind speed data published by the National Oceanic and Atmospheric Administration (NOAA), estimates for power production can be derived shortly after the quarter concludes, prior to the official earnings report. For more information on the methodology, limitations, and accuracy of this model, please take a look at this article: Can Wind Speed Data Really Predict Pattern Energy Earnings?

The Track Record So Far

No model is perfect, and this model is very simplistic and uses crude data. However, there seems to be a reasonable correlation between the model predictions and the actual reported results. Below is the historical performance:

Wind Speeds This Quarter

Source: NOAA

Wind speeds for October were slightly below average across the continent. Nothing particularly concerning stands out. Most of Pattern's wind farms were in areas close to average wind speed.

Source: NOAA

Wind speeds slowed down in November, and many of Pattern Energy's wind farms were in areas experiencing below-average wind speeds, particularly the Ocotillo, Panhandle, and Lost Creek projects.

Source: NOAA

Across the continent, wind speeds were closer to average for December. However, the Canadian portfolio was in an area of low wind speeds.

The table below sums up the quarter:

Source: Author, data produced from NOAA wind speed maps

Keep in mind that the model tends to predict a wind index that is lower than actual, particularly when low winds are experienced. It should be noted that this model does not include data for the Santa Isabel, Meikle, and Japan projects; these are assumed to be producing at 100% of long-term averages. In addition, the acquisition of the Stillwater project occurred in the middle of the quarter and will have a contribution which is not factored in. As a reminder, the wind index represents the theoretical power production, given the available wind resource. Actual production will be lower due to maintenance and repairs. Historically, Pattern Energy has been able to maintain production a few percentage points below this theoretical maximum.

Accounting for these adjustments, my expectations for the quarter are a wind index in the low 90 percentile range and actual production approximately 2% below the wind index. I invite you to examine the data and draw your own conclusions.

News Items

  • During the quarter, Pattern Energy closed on the acquisition of the Stillwater project: 35 MW for $23M at an expected CAFD multiple of <10X.
  • At the end of the quarter, Pattern Energy closed on the sale of its interest in the K2 project. Sale proceeds were $160M, representing a 15X CAFD multiple. A pretax gain of $71M is associated with this transaction. Pattern Energy will continue as the operator of the K2 facility.
  • Pacific Gas & Electric (PCG) filed for bankruptcy. PG&E is the offtaker for Pattern Energy's Hatchet Ridge project (101 MW, 3.5% of portfolio capacity). The fate of the power purchase agreement is still uncertain, but the Federal Energy Regulatory Commission (FERC) says that it shares authority with the bankruptcy court with regards to requests to cancel or renegotiate power contracts. In the meantime, it's business as usual.

Earnings Expectations

As a result of low wind resource, I think revenues will come in short of expectations. On the other hand, EPS will benefit from the gain on the sale of K2.

At the end of Q3, Pattern Energy had generated $133M in CAFD year to date. This means that only $33M CAFD is needed to hit the midpoint of guidance for the year (and coincidentally, to cover the dividend). In Q4 2017, Pattern Energy produced $41.9M CAFD with a wind index of 96% and production at 91%.

In comparison to the previous year, Pattern Energy has gained the Japan portfolio, MSM, and a partial quarter contribution from Stillwater, offset by the loss in production due to the sale of El Arrayan in Chile. Despite the expected low wind resource in Q4 2018, I believe production will likely be similar or only slightly lower than Q4 2017 due to the effects of Hurricane Maria in the previous year. As a result, I expect full year CAFD to be greater than the midpoint of guidance, probably in the $170-180M range.

Estimating Guidance

A key component of the upcoming earnings report will be Pattern Energy's guidance for 2019 CAFD. I will attempt to estimate this year's CAFD based on information gleaned from Pattern's press releases and conference calls.

Starting back with 2018's CAFD guidance of $151-181M, we see that the following factors were anticipated and included in guidance at the beginning of the year:

  • Partial year contribution from Japan acquisitions ($131.5M at 10.5X CAFD, 3 quarters' contribution). If CAFD were evenly distributed throughout the year, the full year contribution would be +$3M over the 2018 numbers, but the Japan acquisitions were mostly solar, which tend to have low or negative CAFD during the winter months. +$1M
  • Partial year contribution Mont Sainte-Marguerite acquisitions ($40M at 10X CAFD, 1 quarter contribution) +$3M
  • Wind resource at 2% below long-term average. I will assume wind resource remains slightly below average

Over the course of the year, several transactions which were not included in guidance were completed:

  • Sold El Arrayan ($70M at 10X CAFD) -$7M
  • Sold K2 ($166M at 15X CAFD) -$11M
  • Acquired Stillwater ($23M at <10X CAFD) +$2.3M

Additionally, over the course of the year, Pattern Energy initiated several cost-saving changes, including:

  • Changed auditor ($1M per quarter) +$4M
  • Property tax reduction ($0.5M per quarter) +$2M

Finally, looking forward to 2019, the following are expected:

  • Gulf Wind hedge expires April 2019 (covers 58% of production), repowering to begin summer 2019: Gulf Wind will continue to be operational during the repowering, but at a reduced capacity, probably 75-80% of normal production. Combined with the hedge expiration, CAFD from the Gulf Wind facility will definitely take a hit. By how much? According to management, CAFD has historically been in the $20M range. I will take a wild guess and say a loss of $10M in CAFD. -$10M?
  • Self-perform maintenance: Pattern Energy has been slowly taking over maintenance duties from the OEMs. Although no projects were switched to self-perform in 2018, contracts for approximately 500 MW are ending in 2019. In 2017, Pattern switched 800 MW to self-perform and saw savings of $2M per quarter in 2018. Using a similar rate, the 500 MW scheduled for self-perform should yield $5M in annual savings. I will cut this in half due to uncertainty as to the timing. +$2.5M?

Source: Pattern Energy 2017 Investor Day Presentation

  • Grady acquisition: Pattern Energy's next acquisition will likely be the Grady Project in New Mexico. Pattern Development has an interest in 188 MW of this project. Pattern Energy's recent acquisitions have been in the range of $0.60/MW, so estimated cost for the dropdown would be around $113M. This would be an excellent use for the cash received from the K2 sale. On the other hand, it is also possible that Pattern may take a 51% stake and use the extra cash to keep investing in the development business or save for the upcoming Tsugaru acquisition. Assuming a 100% stake in Grady at a 10X CAFD multiple would add $11M in annual CAFD. Timing on commercial operations is unknown, so I will cut this in half as well. +$5.5M?

Adding it all up leads to a loss of $7.7M CAFD compared to the previous year. This, of course, calls in to question whether or not it is prudent to continue paying the dividend at the current level. CAFD is barely covering the divided, but there is a bunch of cash due to the recent sales. For what it's worth, management has consistently been saying that they are comfortable with the dividend.

Obviously, there are a lot of moving parts, and adjusting the numbers for the Gulf repowering or timing of acquisitions or self-performing maintenance could change annual CAFD significantly. Suffice it to say, 2019 will be another year of transition for Pattern Energy as it works towards getting its development business fully funded and as it waits for Tsugaru to come online in 2020.

Technicals

Pattern Energy is currently testing resistance at $21. RSI is hovering around 60, indicating neutral to slightly overbought conditions. If the stock manages to break out above $21, the next resistance level is at $24. To the downside, the 50-day moving average is at $20 and the 200-day is at $19. Strong support at $17 has been tested 5 times in the last year.

Conclusion

Wind speed data from NOAA suggests that Pattern Energy power production will be below long-term averages in Q4. As a result, revenues may be lower than anticipated. However, full year CAFD will likely be above the midpoint of guidance due to the performance in the previous three quarters. Due to recent dispositions and the anticipated repowering of the Gulf Wind facility, CAFD for 2019 is expected to decrease compared to the previous year. Nonetheless, the stock is currently trading near the 52-week high. For long-term investors who already own the stock, I would suggest trimming positions or selling covered calls.

Pattern Energy is expected to report earnings in early March.

Disclosure: I am/we are long PEGI. 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.