At the current price we think investors can probably get 5.5%-6.0% total annual returns over the next decade with the bulk coming from dividends. Our appreciation for the asset base is tempered by the extreme levels of debt (7.0X debt to EBITDA). We think the cash secured puts for $30 are looking attractive on a relative basis compared to the dearth of opportunities in the market. For BEP the August 2022 $30 strikes offer a good yield and modest price buffer.
Source: Price Of A Bubble Deflating
The stock rallied strongly from that price point but has retreated in recent weeks. Is this an opportunity to get in or cash out the 10% return since our last article?
BEPC and BEP benefitted from the extremely strong rush into renewables since the Russian invasion of Ukraine. Soaring energy prices are putting a floor on energy generating assets. This makes sense as in a rising cost environment the replacement cost of existing renewable energy generating assets has to move up. Also to the extent that these assets are exposed to electricity prices, they also benefit. Now readers may think that the paragraph so far does not fit with the heading above it. That is because we have not got to the most important aspect of valuation. That aspect is what BEP pays you to own it. BEP's dividend yield is just 3.39% at the current price and very unenticing compared to its history.
More importantly though, it yields just 46 basis points over the 10 year Treasury note. Unlike the dividend yield above, this measure just hit an all-time low.
This is because Treasury rates are rising faster than the prices of BEPC and BEP are falling. We think longer term BEP should yield at least 2% and perhaps 3% over the 10 Year Treasury rate. There is severe downside in the stock here by this measure. Of course bulls will argue this time is different and we will of course point out that it never is. But let us look at it via a different measure. This below is the spread between BEP's dividend yield and BAA corporate bonds.
BEP being equity has historically yielded a sweet premium to these bonds and today these bonds yield 1.46% above BEP. Shocking right?
Even conventional non-comparative measures of valuation are very, very challenging for BEP. BEP trades at 21x EV to EBITDA and with a 7X debt to EBITDA. Yes, we get that the assets are good and the Brookfield name will help the growth curve. But at these valuations things are getting dicey. We are hence putting a sell rating on the common shares at this price point.
Well we have previously suggested the lower strike point cash secured puts and they are always preferable to owning the equity outright. Today, we think we would not even go there as there are far superior alternatives in the market. But if you have our heart set on Brookfield there are a couple of choices.
The preferred shares of BEP have been slammed, unlike the common shares and now offer a modest yield for those desiring some fixed income exposure.
At slightly over 6% yield you won't get rich, but we think you will avoid the damage that is likely in common shares. While we put a buy rating on these, we don't own these either though
These are listed only on TSX so keep that in mind before hunting for these on Seeking Alpha. They traded at $25.16 CAD on Friday.
We love these for a couple of reasons. The first is that they are in the primary currency for us, which is the Canadian dollar. The second is that while they yield a little less (stripped yield of 5.74%), they will be fairly resilient in any environment.
The Annual Fixed Distribution Rate for each Subsequent Fixed Rate Period will be equal to the greater of: (1) the sum of the Government of Canada Yield on the 30th day prior to the first day of such Subsequent Fixed Rate Period plus 3.94%, and (2) 5.75%.
Source: BEP.PR.O Prospectus
The Government of Canada yield here refers to the 5 Year bond, which is at 2.65%. These shares are thus protected to its reset date of April 30, 2024 in any climate. If rates collapse, the 5.75% floor protects the price. If rates explode up, BEP will have to pay a pretty penny to keep our money.
Conservative Income Portfolio targets the best value stocks with the highest margins of safety. The volatility of these investments is further lowered using the best priced options. Our Cash Secured Put and Covered Call Portfolios are designed to reduce volatility while generating 7-9% yields. We focus on being the house and take the opposite side of the gambler.
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Conservative Income Portfolio is designed for investors who want reliable income with the lowest volatility.
High Valuations have distorted the investing landscape and investors are poised for exceptionally low forward returns. Using cash secured puts and covered calls to harvest income off value income stocks is the best way forward. We "lock-in" high yields when volatility is high and capture multiple years of dividends in advance to reach the goal of producing 7-9% yields with the lowest volatility.
Preferred Stock Trader is Comanager of Conservative Income Portfolio and shares research and resources with author. He manages our fixed income side looking for opportunistic investments with 12% plus potential returns.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
Additional disclosure: We have long positions in BEP.PR.O.