The company posted a solid Q3.
No change in dividend level, but the outlook is encouraging.
Carlsbad looks to be an accretive asset.
Clearway is still cheap compared to peers, which creates room for outperformance when the company finally hikes its dividend.
Clearway Energy (CWEN) (CWEN.A) recorded a great quarter in terms of CAFD generation and 2020 outlook. Another slight positive is that the Carlsbad acquisition is back on the table under revised terms. Though the company had a good quarter, the shares moved little, probably due to the mediocre news about the unchanged dividend. I do believe that Q3 shows that the company is well capable of hiking its dividend back to its old level by next year.
California Valley Solar Ranch, owned by Clearway. Source: DOE.
If you need more information on what terms like CAFD are about, please check out my YieldCo guide, which can be found among my author's picks.
The company generated a CAFD of $177m in Q3, versus $156m in the same quarter last year. The results of the quarter are also a trend-break versus the rest of the year as H1 2019 CAFD was just $55m vs $94m for H1 2018. Adjusted EBITDA increased to $300m versus $290m Q3 last year. The improvement versus earlier this year is mostly caused by improved wind speeds around its wind farms.
Surprisingly, the company maintains full year guidance at $250m, meaning Q4 should see a CAFD generation of just $18m. Last year’s Q4 CAFD was $41m, even if this year’s will see a small adverse impact from working capital items, as management states, it shouldn’t be too hard to beat 2019 CAFD guidance at this point. However, as always, quarterly results are not the most exciting for YieldCos. Capital allocation and dividend developments are what investors should look for.
Earlier on, the company formulated two conditions for raising its dividend back to its old level: clarity from PG&E (PCG) and forbearance agreements from lenders to allow projects to continue to upstream cash while PG&E’s bankruptcy case is being settled. The company says it made significant progress on forbearance agreements. CWEN sees PG&E emerging from bankruptcy in June next year.
Based on what the company said, I would think that at the earliest, CWEN would raise dividend at the next announcement, but at Q2 2020 earnings at the latest.
The case remains that as more forbearance agreements are secured, cash from CAFD piles up. Bear in mind that every quarter that the company pays its lowered $0.20 dividend, it ‘saves’ about $25m (or $100m annually) versus its previous quarterly dividend level of $0.33. In the call, management clarified that the total restricted cash that is built up at PG&E projects, which should otherwise be released, is $60m to $70m. But the company also said that it plans to use that cash for acquisitions, rather than returning the capital to shareholders.
The fact that the company doesn’t want to return the trapped cash shouldn’t surprise us because YieldCos are fundamentally challenged when it comes to gathering equity capital for acquisitions. The companies pay out roughly 90% of their available cash flow, or CAFD, and shareholders are usually not happy with an equity issue. This has created a trend among YieldCos to increasingly use creative financing to gather capital without hurting their credit rating too much. Examples are preferred shares by Pattern Energy Group (PEGI) and the two financing deals by NextEra Energy Partners (NEP).
In other news: as concerns around PG&E fade, Carlsbad comes back on the table. Earlier on, CWEN opted to not invest in Carlsbad due to the asset's PPA with PG&E. As it looks like PG&E will honor its renewable energy PPAs, CWEN plans to go through with the deal, but on revised financials.
Source: Q3 earnings presentation.
The parties structured the deal in such a way that the CAFD yield is up, but on higher leverage. It looks like CWEN is slowly increasing leverage, just like some other YieldCos do to finance growth and make it look accretive. The positive part about this leverage is that it is at the project level and is self-amortizing. This means that the risk of the project going bust is a bit higher, but a far larger share of the potential losses would be for debtholders. Overall, I find the financing deal attractive because there is no recourse to the corporate level, 4.2% is relatively cheap, and because the asset CAFD yield is lifted to 15%. This is accretive because the stock has a CAFD yield (including corporate leverage) of 8.3%.
On multiples, Clearway Energy continues to look good compared to peers. Most importantly, it continues to maintain healthy EV valuation ratios compared to most peers.
*Net project debt was excluded in EV/CAFD, and interest on corporate debt was added back to CAFD. **Pro forma payout calculates payout on run rate CAFD. Source: author’s own calculations and estimates. For 2019/2020 estimates, CAFD and EBITDA, midpoint of respective company guidance was used whenever available. For NEP, the proportionate share of debt, EBITDA, and CAFD to public unitholders was used after also accounting for convertible preferred shares and financing deals. TransAlta Renewables’ (RNW in table) financials are in CAD. CWEN share price in the table is an average of CWEN and CWEN.A.
I continued to believe that the best investors can do is to favour YieldCos that have a low level of corporate debt, but also upside when project debt is redeemed.
Low corporate debt is important because repayments of corporate debt are excluded from CAFD and thus corporate level debt inflates CAFD and makes a YieldCo look cheaper than it really is. Atlantica Yield (AY) and TransAlta Renewables (OTC:TRSWF) (or RNW), look favourable on this metric.
Project debt repayments are subtracted from CAFD and it generally matures before PPAs do, which is why YieldCos with a large amount of project debt can usually expect a cash flow glut somewhere down the line. This dynamic favors CWEN and Atlantica. We can disregard Pattern Energy here because it will most likely be taken over.
Clearway has issued a 2020 CAFD guidance of $295m on a $320m run-rate. If we then take into account the company’s payout target of 80%-85%, we should see a dividend of $0.33 per quarter, its level previous to the dividend cut. This $0.33 translates into a dividend yield of 7.1%, higher than any other major YieldCo. I expect that to be the major catalyst for the stock in 2020. The company could choose to increase its dividend only moderately, but that would be very disappointing because shareholders had to wait for it quite some time and also because they will not receive a special dividend when the restricted PG&E cash is released.
The good Q3 results of Clearway Energy justify appreciation from shareholders. I also believe that Clearway will hike its dividend next year, which will be an important catalyst for the stock. Meanwhile, the company can deploy its savings from PG&E-exposed projects into new projects that will provide room for further dividend growth.
Disclosure: I am/we are long CWEN.A, AY. 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.