Clearway: The Fiscally Responsible Green Energy Play

Summary

• 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.
• Looking for a portfolio of ideas like this one? Members of Portfolio Income Solutions get exclusive access to our model portfolio. Learn More »

Nuttapon Pundech/iStock via Getty Images

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.

Source: CWEN

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.

Source: CWEN

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:

1. $45 million of income tax expense
2. $456 million of principal amortization of indebtedness
3. $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

Source: 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

Source: 10-K

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.

Source: 10-Q

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.

Source: SA

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.

Risks

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.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CWEN.A either through stock ownership, options, or other derivatives. 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.

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Comments

[FiXu Research]

You went through all the trouble to calculate "true earning power" of $528m, which is great and I appreciate. Then you say it's trading at 12X which is very misleading. It'd be trading at 12x if it had 0 debt. Always use EV and not market cap when valuing companies. If you account 8b debt this company is trading at 28X FCF to EV which is super expensive. Considering it is not a high growth company this stock is ridiculously expensive.

[Racer-X]

@FiXu Research Anythign with a sustainable dividend yield over 4%, especially in the safe energy sector during an inflationary environment, is not overvalued.

[FiXu Research]

@Racer-X I don't know the company well enough to comment on how well the dividend is covered by FCF. But the real yield is not 4%. Clone Clearway, delete the debt from the clone. Now both companies pay the same 4% dividend on paper but one has $8b debt.

Sometime in the future one has to pay that $8b debt, other can invest the extra cash on growth, share buybacks etc. If they spend most of that $528m/year earning power on dividends they will have difficulties paying back the debt down the road.

What I said might take years to play out... I understand that it's nice now there is 4% dividend and YoY growth in share price but don't fall in love with this stock thinking it is a 'value' stock.

[Racer-X]

@FiXu Research I'm just now noticing for the first time that TTE (Total Energies) actually bought a 50% stake in CWEN on the very day we were having this conversation. They valued it currently at $35ish:

seekingalpha.com/...

I'm going to have to defer to their wisdom and leave it at that. I can't compete with their research.

[ding dong]

How does Fed tightening affect the stock? While at first glance it should not matter since they are just payers of net margin between PPA prices and cost of capital, i believe many people may have bought these on margin to juice the dividends.

Those people will sell in anticipation. How low do you think this will go as the Fed raises rates.

[Racer-X]

2 more weeks until my CWEN.A one-year anniversary:

09/15/21 Dividend CLEARWAY ENERGY INC CLASS A COMMON STOCK $0.01 PAR VALUE CASH DIV ON 1000 SHS Unassigned 334.50
06/15/21 Dividend CLEARWAY ENERGY INC CLASS A COMMON STOCK $0.01 PAR VALUE CASH DIV ON 1000 SHS Unassigned 329.00
03/15/21 Dividend CLEARWAY ENERGY INC CLASS A COMMON STOCK $0.01 PAR VALUE CASH DIV ON 1000 SHS Unassigned 324.00
12/15/20 Dividend CLEARWAY ENERGY INC CLASS A COMMON STOCK $0.01 PAR VALUE CASH DIV ON 1000 SHS Unassigned 318.00
11/23/20 Bought 1000 of CWEN.A @ $27.34 (Order #1430) Unassigned -27,340.00

4 dividends and a 29.12% return for the full year so far, if I may go ahead and jump two weeks ahead to take an anniversary victory lap.

I concur with this article.

Long and Strong and many years of compounding growth to come! Green energy and the future was the whole premise. I know there are climate deniers. And I know most likely they are also mask deniers. All political. They think they know more than the overwhelming consensus of the world's scientific community. Amazing hubris.

They have no choice. Mask up, shut up, and go green. The Earth does not argue or play politics. Truth is not elusive here. It's plain as day. Only their echo chambers, self-induced brainwashing, places the logs in their own eyes by their own doing! Unbelievable hubris!

Money talks, bull3$#@ walks! And the science is clear. No debate going on except in layman circles.

[zver11]

Leasing companies always show great cashflow-as long as you ignore the cost of replacing the earning assets. While the assets here are longer lived, they still need to be replaced. I have 10 year old solar panels which were considered high output when bought. The best new panels output close to twice as much per panel. Windmills are being torn down and replaced with newer much larger windmills as material processing has been improved to the point of being able to manufacture much larger blades. I would assume a 10 year life on equipment and assume regular replacement of all producing assets. While new equipment will have higher output, still need the current equipment to generate enough power to justify its purchase before its obsolete. Financial aspects of this somewhat similar to ship leasing companies.

[1.21 Jigawatts]

Agree, thanks for the writeup. Long the class A shares and waiting for a pullback before adding, since it ran up so much recently. Patiently collecting the nice div until then. Also long NEP, BEPC, and AQN in the space. CWEN.A is absolutely the best value among them.

[Baldy2000]

The transition to renewables needs to be done over time to not disrupt our society. The fear of saying the world will end if not done right away is just plain crazy. Some sanity is needed.

[darnoc111]

Massive increases in energy costs will have a negative effect on economies all over the world. This will cause a pull back in those costs as those who push them are removed from office. This is the biggest risk to these so called green energy companies. It is to bad that rather than leaving the market work to bring in new forms of energy we are seeing the market forced to pay up for energy that is neither cost effective nor able to replace base load power supplies. And with so many subsidies that even the most favorable fossil fuel company's subsidies would blush for. Maybe the real comparison should be in the amount of taxes and costs that each type of energy uses or provides.

[jarratta]

@darnoc111 The cost of renewable energy is already cheaper than other forms in much of the the US. It's going to massively lower (sans subsidies) soon. This Lazard report is excellent:www.lazard.com/...

[darnoc111]

@jarratta It might be cheaper on a per kilowatt cost but since it is not available 100% of the time the needed batteries to make it available makes it very expensive and does damage to the environment. That was my point abut base load.

[jarratta]

@darnoc111 Agree that grid-scale batteries are needed to make renewable energy compelling. They're coming. Fast!

I also believe that battery tech is rapidly becoming more sustainable and recyclable. We can agree to disagree.

[MWinMD]

"Profitability would require some sort of seismic shift in the price consumers are willing to pay for clean energy."

If we simply STOPPED socializing the massive off-the-books costs of fossil fuels onto the taxpayer, clean energy would look much cheaper on a relative basis.

$700 Billion annually in the US alone. That comes out to about $5,000 per taxpayer. It's amazing how "cheap" a product can look when you have the taxpayer foot the real costs of it.

www.theguardian.com/...

Note: that IMF study was done in 2015. Since then we've seen RECORD years for extreme weather damage, just as scientists warned us. So it's presumably more by now.

[Jack'sson]

@MWinMD And that doesn't count 180,000 uncapped wells that spew methane.

[MWinMD]

@Jack'sson Right. Apologists for our dirty energy policy here in the US love to cite "decreases" we've managed in CO2 emissions in recent years, without mentioning that it's been "accomplished" by shifting to natural gas. Only problem is that due to the warming potential of CH4 being 20X that of CO2, the breakeven point for NG as compared to coal is if you can manage to keep leaks to 3% in the overall system. Estimates of what we're really getting run anywhere from 2-9% last I checked. Luckily the Biden EPA will be cracking down on methane, though there's only so much regulators can do.

[AlieGee]

Nice article, thanks.

Almost tripled since taking a position and don't
have plans on selling -

[xrmfgk]

Thank you for the thoughtful analysis. I appreciate the adjustments you made, and the explanations provided. Very helpful. I consistently read and value your articles on REITs as well.

[jarratta]

I was surprised you didn't report on how you view the upcoming sale of all of CWEN's geothermal assets to KKR for $1.9B that was announced on 10.25. Did you take this sale into account? What is your assessment of its impact? Thanks.

[Dane Bowler]

@jarratta The market liked the sale as I believe CWEN traded up nicely on the announcement. I see it as largely neutral as it looks like they sold those assets at about fair value. It may have positive implications for them getting labeled a solar and win pure play since they will be able to recycle those proceeds into their developments.

[jarratta]

@Dane Bowler Thanks, do you see any balance sheet implications?

[Dane Bowler]

@jarratta Could go either way on balance sheet depending on how they choose to redeploy it.