- Wind and solar are exciting fields with great demand drivers.
- Companies are willing to pay more for green energy which benefits CWEN's bottom line.
- CWEN develops the power infrastructure at high rates of return making it high cash flow.
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Clearway Energy The Buy Thesis:
Clearway (NYSE:CWEN) is an energy producer using wind, solar, geothermal and a little bit of traditional dirty energy. They have a massive pipeline of new green energy projects with contracts in place to sell that energy. If green energy does take off CWEN is positioned to benefit, but the aspect that makes it the fiscally responsible green energy play is that massive change is not required for the company to succeed. It is highly profitable today and trades at a multiple of Cash Available For Distribution (CAFD) around 16X. I spot true earnings power at $528 million which puts it at a multiple of just over 12X. The 4.0% dividend yield on Clearway Energy Class A shares (NYSE:CWEN.A) is fully supported by sustainable cashflows.
Let me begin with discussing why some of the hotter green energy plays are extremely risky compared to CWEN which participates in similar upside, but does not require a massive shift in global energy infrastructure.
I will then follow with a deep dive into CWEN’s accounting to get to a true earnings figure.
Big change takes time
There are quite a few popular green energy stocks that are hemorrhaging money and their business models require some sort of Green New Deal or other massive environmental package to become financially successful. Plug Power (PLUG) is a clear example of this sort of stock. Their clean hydrogen capabilities are really cool, but in today’s environment the cost structure is such that the more hydrogen and hydrogen products they produce/sell the more money they are losing. Profitability would require some sort of seismic shift in the price consumers are willing to pay for clean energy.
Maybe this will happen - maybe it should happen, but that is a very risky investment bet to take. A skiff can change directions much faster than a battleship and global energy is an absolute behemoth.
From an investment standpoint there are better ways to participate in green energy. Profitable companies that can win regardless of which way legislation moves or how slowly it moves.
With investing, I think it is important to take a dispassionate approach. One in which we recognize the sheer scale and complexity of global energy production. No matter how badly we might think green energy needs to happen for the future of humanity, we must recognize how slowly things might change given the scale and cost structures.
Rather than investing in stuff that can only work after those changes occur I would much rather invest in green energy that is profitable today and potentially more profitable upon such changes occurring CWEN is this kind of company.
The pipeline and the key differentiator
CWEN has well over a gigawatt of capacity coming online over the next couple years.
The key differentiator is that CWEN develops these energy projects with a buyer of the energy already lined up. Their pipeline comes with 14 years of average contract length. Thus, these projects can be underwritten with highly visible cashflows and these projects are immediately accretive to cashflows upon delivery.
With revenues largely being contractual in nature, I would value CWEN in a fashion similar to a triple net REIT. Instead of FFO or earnings, CWEN uses CAFD as its primary earnings metric. Guidance for CAFD is below.
Pro Forma CAFD of $395 million equates to about $1.85 per share which is a multiple of 16X. Compared to the rest of the market, that strikes me as a value, especially considering CWEN is growing and has access to further growth in green energy. Most ESG companies trade at substantially higher multiples. We should note, however, that CAFD is a non-GAAP number and as such does not have a standard definition. Quite frequently, companies will make elections that are fully legal because they are disclosed, but misleading because they might add back stuff that is a real expense.
Thus, we will review the full reconciliation of CAFD below.
There are quite a few adjustments to get from net earnings to CAFD but let’s look at some of the bigger ticket items that are sometimes done wrong in company reports.
- Non-cash Equity Compensation of $5 million – should not have been added back in
- Line items related to non-controlling interests – correctly adjusted for in guidance
- Interest expense of $338 million – correctly subtracted from EBITDA
- Maintenance capex of $33 million – correctly subtracted
Overall, it is a pretty clean number. I disagree with the $5 million add back from stock comp, so that would take my version of CAFD to $390 million instead of $395.
However, as an investor with a long term focus it is not really the cash accounting I care about. It is more the true long term sustainable earnings figure that matters so there are a few more adjustments I think should be made. Three items are of particular interest:
- $45 million of income tax expense
- $456 million of principal amortization of indebtedness
- $600 million of Depreciation ARO expense and contract amortization
So, starting from the $390 million of CAFD using my adjusted number we potentially need to make adjustments for these numbers.
Generally I would consider the income taxes to be a real expense and take those out, but CWEN has a unique situation in which it has $1.2 billion of net operation loss (NOL) carry forwards as per this snippet from the 10-K
As such, I don’t see them having to pay taxes for quite a long time.
The $456 million of principal amortization of indebtedness is also quite straight forward. I do not consider amortization of debt to be a real expense, it is just debt paydown. The only reason its subtracted from CAFD in CWEN’s guidance is because it is a cash based measure and paying down debt does take cash. However, because it is reducing debt dollar for dollar the impact to true earnings is $0. Therefore, I would bump up the true earnings figure by that $456 million. Here is the principal amortization schedule for CWEN.
The pro-forma guidance must be using a straight line figure to get to the $456 which I think is appropriate.
That puts us at $846 million, but the cash accounting of CAFD also misses non-cash expenses. The $600 million of depreciation, ARO, and contract amortization was added back in. While it is true these are non-cash expenses, they are real expenses or at least a portion of them is real.
Asset Retirement Obligations or AROs are essentially the accounting for an expense that will later be incurred in order to properly dispose of an energy asset. They accrue over the useful life of the asset until the expected end of the useful life at which point they become a cash expense in implementing whatever the sealing or clean-up procedure is.
I think the accrual accounting properly captures the impact to true earnings so I would deduct the full amount of AROs. The annual amount of AROs is a bit bumpy but the latest 10-K spots the year over year change at $42 million
Depreciation is a bit trickier to handle. Coming from a REIT background, the typical treatment is to add back all of the depreciation to Funds From Operations (FFO) because properly maintained buildings tend to hold their value or even appreciate over time.
It’s a bit different in the energy production space, however, as oil fields run dry and solar panels need to be replaced. Thus, depending on the type of depreciation, at least a portion of it is a real expense on a run-rate basis. In the latest 10-Q, CWEN shows the breakdown.
I’m going to count the $31 million attributed to conventional as real depreciation because the associated fields legitimately do become depleted, so the assets are in fact losing value.
It is the renewables number that I think is artificially inflated.
In an effort to encourage green energy, the U.S. government created what is called the Modified Accelerated Cost Recovery System, or MACRS, which allows any wind and solar projects to be depreciated over a 5-year period rather than their useful life which is much longer.
The Tax Act also provides an option for projects to be immediately expensed provided they are placed into service between September 27, 2017 and January 1, 2023. This would be considered accelerated depreciation.
It is of course beneficial to energy companies to depreciate these projects as fast as possible so as to shelter their income from taxation. Indeed, CWEN is taking advantage of this accelerated depreciation with many of its renewables depreciated on either the 5-year or 0-year schedule.
For example, CWEN recorded $9 million of accelerated depreciation in 2Q21 related to the Pinnacle wind facility.
Overall, I would ballpark that the $89 million renewables depreciation is closer to $30 million of actual value loss via depreciation.
That puts annual ((real)) depreciation expense at $276 million.
So, based on the aforementioned factors I calculate sustainable earnings power at $528 million ($846 million less $42 million of AROs less $276 million of true depreciation).
Divided over 213.5 million pro forma shares that is earnings power per share of $2.47 which I see as a strong return on the roughly $30 market price.
CWEN or CWEN.A?
CWEN has four different classes of common stock, with the CWEN and CWEN.A being publicly traded. I view the CWEN.A as significantly better than CWEN because its market price is lower yet it has the same claim on the underlying earnings, dividends and assets.
There might be some voting power or liquidity reasons to prefer the CWEN, but for the sake of a long term value based buy and hold sort of investment I see CWEN.A as the clear winner.
Energy production assets are at risk of weather impacts. The California fires created counterparty risk with PG&E and the Texas freeze was also costly. I have no means to predict how many weather disasters there will be in the future, but at least some losses will likely be sustained as a result.
Contract expiry presents both risk and upside potential. As contracts roll off, the energy production capacity will need to be sold at the then current market rate. The risk or upside depends on where rates move as compared to current contract terms.
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