- The stock lost 8% last week while nothing virus-related can hurt its earnings power or dividend.
- The company's earnings lagged, which was compensated with a positive outlook for 2020.
- A great feature of CWEN compared to peers is how fast it pays off its debt.
- The debt repayments depress its dividend now, but create a massive springboard for future dividend growth.
- The PG&E situation continues to look favorable and the company also expects to raise the dividend to normal levels later this year.
Last week has seen the worst broad market sell-off in our recent memory. Across the board, investors saw equity decline. Rates have also gone down sharply in anticipation of the Fed’s response to a global economic slowdown.
Though it is uncertain how sentiment will affect the global economy, it is certain that the global economy will see some effects from the virus. Renewable energy producers can be great medium-term play in that environment as their variability is mainly driven by weather instead of demand. Meanwhile, the WSJ reported that bets on interest rate cuts escalate, which is always favourable for interest rate-exposed sectors like utilities.
I see Clearway Energy (NYSE:CWEN) (NYSE:CWEN.A) as the best stock among the high-dividend renewable energy stocks, called 'YieldCos'. It is cheaper than its peers, but is underappreciated because it does the opposite of some of them: Clearway set its dividend very low while some peers pay out more than they make, which has boosted the stock prices of these peers. As discussed in some previous articles, I fully continue to expect the dividend to be raised this year and think that this will be a major catalyst for the stock.
Because of the dynamic discussed above, I found it surprising that CWEN went down by 8% last week and consider this to be a great buying opportunity.
Clearway Energy business model
In a nutshell, Clearway Energy produces (renewable) energy and sells this energy through long-term contracts called power purchase agreements (PPAs) to off-takers which are mostly utilities. This has little to do with people working less, low economic growth, avoiding public areas or anything of the sort so great in an environment full of virus fears.
Fundamentally, Clearway Energy is better off with low rates and it feels practically no impact from electricity demand as prices are set in its PPAs. The main variability in its results is in production due to solar and wind resource fluctuations.
California Valley Solar Ranch. Source: DOE
Regarding debt and rates: the business is so fundamentally stable that it is real estate-like and can take on real estate-like levels of debt. At a ND/EBITDA level of 6.5, CWEN is highly leveraged no matter your definition of leverage. However, most of this leverage (5x EV/EBITDA) is non-recourse and sits in ring-fenced projects. So, if a project goes bust (which is only likely to happen when the off-taker of the project fails), then the debt disappears from CWEN’s balance sheet along with the project’s assets. During the normal course of business, project debt amortizes over time in a mortgage-like fashion. To calculate the cash that is available for CWEN to distribute, the company takes cash EBITDA and subtracts this debt service from it, which provides opportunity as well.
The earnings and outlook
About the quarterly results published last week we can be brief: they were sub-par. In November, the California wind power portfolio suffered from low wind speeds. This was the primary reason, I think, why the company failed to do as well as I expected in the quarter with a Q4 CAFD of just $22m, taking the CAFD for 2019 to $254m. About that figure, it must be said that the company made some $15m of upward adjustments to reflect certain working capital items in Q4 that were in part related to the Carlsbad acquisition. This is not standard practice, but I’m sure the company did this to hit its own guidance of $250m (which was setting the bar low to begin with).
Source: CWEN Q4 2019 press release.
The upside was the outlook, which was raised to $310m for 2020 on the back of acquired projects (partly financed by equity raise and retained cash flow due to the low payout). The pro-forma CAFD outlook was also a positive, showing Clearway’s confidence in its medium-term future. The table below shows the 2020 and run rate guidance under normal wind speed conditions.
Source: Q4 Investor presentation.
Of course, a positive outlook can be a nice reason to set a stock higher, but I expect much more from investor sentiment on rates over the next weeks.
Conventional wisdom says that utilities benefit from lower interest rates. The chart below shows the 10-yr treasury yield over the past 5 years. Last week has clearly set a new low.
Source: The Daily Shot by WSJ.
It must be said the upside lies not in refinancing project debt. A large chunk of the debt has been guaranteed by the US Department of Energy and is for that reason alone quite ‘fixed’. Apart from that, the company has hedged its floating rate project loans up to 2041 using interest rate derivatives. The rate exposure is minimal and the latest 10-Q says that a 1% change in interest rates results in a $3.3m change in annual interest payments.
Refinancing corporate debt (1.5x EBITDA) over time will be the main tangible positive factor. But of course, the discount rate weighs much heavier on the stock and this will most likely drive it higher over the next couple of months if nothing too drastic happens.
Project debt deep-dive and YieldCo valuation
A big attractive element about Clearway Energy is the pace at which it repays its debt. All YieldCos exclude amortization of project debt from CAFD. The differences between YieldCos emerge in the relative amount of project debt, the average maturity of project debt and the choice to lower project debt amortization in CAFD calculations to ‘reflect normalized repayments,’ which is a practice only TerraForm Power (TERP) follows to a relevant extent.
Clearway Energy has something going for it in this context. In the conventional segment, debt is paid off in a relatively short period of time, with the majority in the next four years. In these years, they will be subtracted from CAFD in full, but as of 2024 they will constitute a windfall of about $180m annually relative to the run rate CAFD level of $320 million. So, when keeping other things equal, CAFD could jump to $500m in 2024.
Source: Q4 Investor presentation.
As you may recall from the 2020 guidance table earlier in this article, the principal amortization of debt in 2020 and in the run rate outlook are $339m and $350m, very similar to the figures for 2020 and 2021 in the table above. This shows that Clearway is diligently following the best practice of using actual repayments in CAFD calculations. It also means that debt will be repaid quite fast and that shareholders will see the full upside from these repayments within 5 years. I must note that the Utah portfolio and Alpine solar project have 13 to 17 years of PPA life left and it is likely that their debt will be refinanced (at possibly attractive rates) instead of repaid in 2022.
The big question is how Clearway stacks up against other YieldCos with regard to debt repayments that are subtracted from CAFD. I have calculated the run rate figures, as well as those for 2019 in the table below.
The math works as follows: I calculated the percentage of net debt repaid in 2019 as reported by the company in their own CAFD calculation. To make the CAFD figures comparable, I recalculated CAFD (this is 'comparable CAFD') with the assumption that 5% (2019) or 5.5% (run rate) of the respective company’s net debt has to be repaid each year. This method obviously benefits YieldCos that have relatively little debt that doesn't amortize (i.e., corporate debt), such as Atlantica Yield (AY), but hurts those that have a lot of that such as NextEra Energy Partners (NEP). The adjustment also benefitted CWEN and TransAlta Renewables (OTCPK:TRSWF) that repay their debt at a fast pace and account for it as well, while the method hurt TerraForm Power which does not account for a large part of the debt it actually repays.
Figures are in USD mln except for figures for TransAlta Renewables (RNW), which are in CAD mln. Net debt figures exclude unconsolidated debt and are as of Q4 2019 with the exception of TERP which uses Q3 figures. Net debt for NEP also includes financing deals with private equity. 2019 CAFD is reported CAFD (with the exception of TERP) with minimal adjustments and CAFD run rate figures use company estimates or 2020 outlook if no run rate guidance is available. Market cap of CWEN uses a blended stock price of A and C shares. Source (of other data): author’s own calculations or estimates.
Looking at 2019, Atlantica and TransAlta are the clear winners with comparable CAFD yields of over 6%. But run rate figures favour Clearway much more because 2019 saw wind production headwinds that should neutralize going forward. Though its repayments are relatively high, TransAlta sees only a small positive effect from CAFD adjustments because its debt is modest compared to CAFD.
For a more complete overview of the stocks, I added the valuation table below.
*Net project debt was excluded from EV, and interest on corporate debt was added back to CAFD. **Pro forma payout uses run rate CAFD. P/CAFD uses the run-rate CAFD. ***NEP historical CAFD figures use the current common unitholders’ share in the corporation for comparison purposes. Source: author’s own calculations and estimates. Figures for RNW are in C$. 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. ND figures include 50% of respective company’s perpetual debt.
Regardless of multiples, Clearway Energy does well in a DCF because of its quality assets and relatively conservative method of calculating CAFD, as discussed earlier on in this article. TerraForm Power and NextEra Energy Partners, on the other hand, are still very expensive. In my opinion, this is due to the unconservative CAFD calculation methods of these firms and their corporate debt-funded growth. If you would like to know more about how the DCF of this stock works, please have a look at my YieldCo Guide.
Dividend and PG&E update
The company reiterated its narrative of the past quarters that it continues to monitor the PG&E (PCG) situation and that it continues to assess the dividend level pending PG&E and its own ability to receive distributions from all of its projects. Furthermore, the CEO said this on the call:
Clearway continues to see the PG&E situation evolving positively, with the contracts performing in their normal course, and anticipated resolution in the summer of 2020 […] And we anticipate the dividend will be adjusted to a more normalized level once PG&E emerges from bankruptcy.”
CEO Chris Sotos on the CWEN Q4 earnings call.
Like the company, I also believe that the PG&E bankruptcy will have no lasting negative effects on Clearway Energy and that it will raise the dividend back to its normal level later this year. The company also raised the quarterly dividend to $0.21, which I don’t view as very material, but it is encouraging, nonetheless. If by ‘a normalized level’ we understand $0.32, which would be a payout of 82% on run rate CAFD and equal to the level before the cut to $0.20, the A-shares would yield 6.5%. That 6.5% is a higher yield than any other major YieldCo pays.
Though the earnings and EBITDA of Clearway Energy were sub-par, the day was saved by its bullish outlook. Another encouraging sign is continued positivity from management regarding the PG&E situation and the normalization of the quarterly dividend later this year.
I continue to like Clearway from a fundamental perspective, not in the least because the company is rapidly paying off its debt, paving the way for future growth. The company is worth still over $22 in my DCF calculation. It is also the last remaining YieldCo that is undervalued on a DCF-basis.
This article was written by
Analyst’s Disclosure: I am/we are long CWEN.A. 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.
I am short NEP
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