The Q4 and full-year 2018 results show that Brookfield Renewable Partners (BEP) is allocating its capital prudently despite facing numerous growth challenges in its operating markets, making it my top buy in the renewable energy space and its recently hiked distribution confirms its place as one of the best dividend growth and retiree stocks available today.
BEP grew FFO/unit by 14% in 2018 despite facing strong headwinds to growth across many of its markets. Much of this was in part due to significant historical underperformance in its hydro assets in 2017, so the comparables were easier. However, management also drove strong growth while simultaneously strengthening its balance sheet by prudently allocating capital.
BEP navigated a suppressed valuation of its common equity relative to the intrinsic value of the business throughout the year by recycling richly valued, de-risked assets and exiting non-core markets (where they lack some of the competitive advantages and growth potential enjoyed in their core markets) instead of issuing additional discounted units.
In fact, these sales enabled them to repurchase 2 million units at an average price of $27/unit, which appears to be quite accretive. However, this still amounts to less than 1% of the total units outstanding, so the impact was minimal. Management invested the remainder of their recycled capital alongside debt and preferred equity issuances ($550 million in total) into its growth pipeline during the year.
Perhaps most impressively was the fact that cost-cutting in its U.S. and Colombian businesses generated ~3% growth in its entire FFO, illustrating the power of its operational expertise to drive strong outperformance.
BEP also strategically capitalized on relatively higher energy rates in South American markets by locking in long-term power contracts. In addition to locking in long-term lucrative contracts, these moves enabled management to increase the leverage on these businesses significantly in a low-risk manner, improving the return on invested equity and freeing up capital to invest elsewhere and buy back shares well below intrinsic value.
Finally, management continued positioning the balance sheet to be able to capitalize aggressively on future opportunities. Liquidity is projected to reach $2.2 billion early in 2019 as agreed to asset sales close and the average debt maturity length is 10 years, with no material maturities until 2023. Furthermore, only 7% of North American and European debt (markets where interest rates are rising) is floating rate. Currency hedging also remains robust as a 10% move in currencies would only have a 4% impact on FFO. As a result of this liquidity and lengthened debt maturity profile, BEP was able to confidently hike this year's distribution by 5% - putting a strong tailwind behind the unit price - and minimize their dependence on common equity issuances to fund the distribution and growth investments. In fact, BEP remains positioned to continue opportunistically repurchasing its units.
The news in 2018 was not all rosy. The annualized payout ratio remained elevated at 90%. While - when combined with the company's growth drive and strong balance sheet - it is not in any imminent danger of being cut, it still minimizes the amount of free cash flow available for reinvestment in the business, placing a headwind on its growth prospects. This growth headwind is further exacerbated by the rich valuations seen in renewable assets across many of its markets.
Furthermore, due to the prolonged period of low interest rates and elevated asset valuations, investments in development projects have become so prevalent that the risk-return profile is unattractive to BEP at this point. As a result, management signaled in the earnings call that investors should not expect much growth to come from development projects moving forward.
Additionally, due to the trade and geopolitical risks in the country, growth in China will also very likely remain muted for the foreseeable future. Finally, in North America power contract rates remain relatively low, preventing BEP from locking in more attractive long-term contracts in that region.
Shares remain attractively valued today. With the forward distribution rate at ~7.1% and well supported by the business model and balance sheet, those cash flows alone should provide a nearly market-matching return. Additionally, BEP has managed to continue growing its distribution by at least 5% each year despite the current aforementioned growth headwinds with a long-term outlook for even higher growth as the payout ratio continues to decline and growth opportunities increase. As a result, management's view that a $27 unit price (i.e., a 7.6% distribution yield) implies an annualized return of mid-to-high teens does not appear too far fetched. BEP appears bound for long-term returns of at least 12% if growth opportunities improve soon.
In the meantime, management has indicated that it sees adequate opportunities to deploy capital into India as well as Southern Europe and pockets of the United States. Between its BBB+ credit rating, lucrative current yield, strong and long-term growth prospects, capable management, and considerable competitive advantages, BEP is one of the best stocks for retirees today.
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Disclosure: I am/we are long BEP. 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.