We are quite surprised by the Biden administration's decision to investigate solar tariff circumvention given the president's policy stance towards renewables and the current geopolitical situation around energy. Prior to the announced investigation, solar was expected to be the most popular form of renewable energy in the U.S. Perhaps this was driven by solar energy having significant tax advantages over wind power.
The Solar Energy Industries Association has warned that the investigation is likely to further disrupt solar projects, which are already dealing with supply chain challenges. Smaller developers are likely to be the most impacted as they have neither the supply chain flexibility nor the bargaining power to obtain what they need to complete installations.
The Commerce Department's decision to open an investigation has sent solar stocks down significantly over the past month. The Invesco Solar ETF (TAN) and several other renewable energy yieldcos are down over 15% since the opening of the investigation was announced. This compares to the S&P 500 which is down ~9%.
A bipartisan group of senators urged the Biden administration to quickly review the Commerce Department's investigation as the damage to the workers and development is already well underway. Additionally, some news sources have indicated the investigation is likely to be a swift one.
We believe that this investigation is likely to be closed relatively quickly and that the larger than expected decline in NextEra Energy Partners represents an attractive entry point. We see limited downside of ~10% and upside potential of 40% to 50% over the next 3 to 5 years.
Protection of the U.S. solar panel manufacturing industry has been a hot button issue for the last 10 years. In 2012, several U.S. solar panel manufacturers filed a complaint with the Commerce Department stating that China was subsidizing domestic firms' production of solar panels. Chinese suppliers were dominating the U.S. market as solar installers had purchased $3.1B of Chinese made solar panels, making up more than half of the U.S. Solar Panel market in 2011.
In response to the complaint, the U.S. announced a 31% tariff on solar panels imported into the U.S. from China. Just 2 years later, the U.S. further increased import duties to as high has 165% as some Chinese producers found a loophole to sidestep the 2012 tariffs. In 2018, Donald Trump imposed further duties on the solar modules. Back in February, Biden extended the tariffs for another four years.
In February of 2022, Auxin Solar alleged that assembly operations in Cambodia, Malaysia, Thailand, and Vietnam were using cells and modules originally manufactured in China, allowing for tariff circumvention. These four countries make up approximately 85% of U.S. solar panel imports. The Commerce Department at the end of March agreed to open an inquiry into whether the tariffs were in fact being circumvented.
The decision to open this investigation goes against 10 years of precedent as it relates to importing solar panels from countries outside of China that source their inputs from China. The commerce department ruled in 2012, 2014, 2020, and in 2021 that the process of converting solar wafers into electricity producing solar cells requires enough technological sophistication and capital investment when it occurs outside of China that even if Chinese made components are used, the solar cells should not be subject the 2012 anti-dumping duties applicable to Chinese solar panels. So across three different presidential administrations, the policy around purchasing solar panels from countries outside of China has been the same, that tariffs should not be imposed.
One final aspect of this situation, which we believe supports a continuation of the current policy, is the fact that the 10 years of imposed duties on Chinese solar panels has resulted in U.S. solar panel assemblers being sold out of solar panels through 2024. Even at full capacity, it is expected that the U.S. solar panel industry is only capable of fulfilling between 10% and 20% of total demand.
Overall, we agree with the industry that this was a massive blunder by the Biden administration. This decision has created significant uncertainty not only with respect to future duties, but also created the issued that tariffs can be retroactively imposed. This decision to impose duties on other Southeast Asian exporters will not only lead to a slower development of solar electricity, but also drive installers back to China where they know what the duties already are.
The announcement to open an investigation by the commerce department in combination with market volatility has killed virtually all solar stocks. The Invesco Solar ETF is down 14.8% since the announcement.
NextEra Energy Partners' (NYSE:NEP) stock price has taken an outsized hit during the last month down almost 18%. We attribute this to the fact that the company's parent, NextEra Energy Inc. (NEE) is the largest expected installer of solar over the next 4 years. NextEra Energy Partners has historically relied on acquiring assets from NEE's renewable develop arm NextEra Energy Resources (NEER) in order to grow distributions over time. We believe investors are concerned that a significant portion of the solar installations may be at risk as companies pull back on investment.
Source: S&P Global - US tariff investigation could imperil some utility-scale solar plans
However, we believe the fears around future growth at NEP are likely unfounded. Particularly in the short-term, management issued a press release and reiterated on their Q1 2022 earnings call that they can continue to meet their targeted distribution growth rate of 12% to 15% through at least 2024.
Statement by NextEra Energy Resources President and CEO and NextEra Energy Partners President Rebecca Kujawa on agreement between the U.S. Department of Justice and ESI Energy - NextEra Energy Partners, LP.
In addition, while some development projects may get cancelled or delayed, NextEra Energy is the largest installer of solar in the U.S. with strong contracts and a complex global supply chain. Management believes they can lean on this to continue to meet their development goals.
"Based on what we know today, we believe that approximately 2.1 to 2.8 gigawatts of our expected 2022 solar and storage build may shift from 2022, to 2023. Despite the delay, given our competitive advantages, including the strength of our supplier relationships and contracts, we remain comfortable with our current development expectations for wind, solar and storage, which are to build roughly 23 to 30 gigawatts over the four-year period from 2021 through the end of 2024." - Bloomberg Transcripts, NextEra Energy Partners LP Q1 2022 Earnings Call
Additionally, even if solar development comes under pressure that doesn't mean that investment in other technologies will not proceed. Management believes that the company can benefit from a potential shift back towards wind driven by a less cloudy investment outlook.
"We run a diversified business in energy resources that includes multiple renewable energy technologies and provides a macro hedge against temporary disruptions, like the one our industry is currently experiencing. In fact, in light of the uncertainty in the solar supply chain, we believe renewable demand will likely temporarily shift in part from solar to wind. And we believe energy resources have terrific competitive advantages in wind development." - Bloomberg Transcripts, NextEra Energy Partners LP Q1 2022 Earnings Call
NEER expects that more than 25% of their renewable development through the end of 2024 is expected to come from wind and wind repowering projects, giving NEP plenty of assets to potentially acquire at accretive levels.
Overall, we still think NEP's distribution growth rate targets are achievable and will provide an excellent source of growing income for the next few years and beyond. Management is optimistic that the Commerce Department will maintain its current policy, and, in the meantime, there are plenty of other projects that should come online over the next couple of years.
We also continue to believe that increasing European demand for natural gas will play some part. These are tough times, and less development of solar in the US in part means more domestic natural gas demand, at a critical time as Europe is moving aggressively to wean itself off Russian energy supplies.
NextEra Energy Partners reported their first quarter earnings on April 21st which were in line with management expectations and slightly exceeded Street expectations. Big picture, results were excellent. Excluding certain one-time items, EBITDA and CAFD were up 31% in the quarter.
The company also announced the acquisition of a 67% interest in a battery storage project in California, which has a 15-year contract with an investment grade counterparty. The company paid $191M, representing 8.3x and 12.3x the project's run-rate EBITDA and CAFD, respectively.
NEP also sold their Monument Pipeline to a 3rd party for $203M in the quarter. Management did not provide a transaction multiple but said that the sale was accretive and that the proceeds will be used to acquire future renewable projects.
NEP's management continues to execute well and create shareholder value.
One final note, Jim Robo announced that he was retiring as Chairman and CEO of NEP earlier in the year. As of March 1st, John Ketchum became Chairman and CEO of the company. John has been with NextEra since 2002 and played a pivotal role in the formation of NEP, so we think the company is in great hands.
Below is our operating model and valuation for NEP. Note that dividends per share are expected to grow at a 15% CAGR through 2024, which is the high end of the company's guidance range.
The company has a very conservative capital structure with net debt to EBITDA at just 3x. Essentially all of the company's generation capacity is contracted for 15+ years with mostly investment grade counterparties.
Overall, the quality of the company's portfolio, its track record and its world class management/parent suggest a premium valuation is warranted for NEP. We see upside potential of 15-20% from recent prices in 12 to 18 months and 40% to 50% in a few years.
We believe downside is fairly limited at current prices, but may directionally follow the market lower, perhaps to the mid $50s. Admittedly, the biggest risk to our valuation is higher interest rates as stocks with utility like characteristics tend to be correlated with the level of long-term interest rates. However, we'd also note that there are just two companies in the S&P 500 utility sector that are expected to grow their earnings over 10% this year and both trade at premium valuations to NEP. We would expect that any signs of cooling inflation, a slowing economy, or a dovish fed driving rates lower would massively benefit NEP's stock price.
Here is the chart of NEP dating back to 2013:
Based on this year's expected dividend per share, at a 5.75% yield (about the highest spread to the US 10-year treasury going back to 2015 with the exception of the pandemic sell-off), NEP would trade to $55.13, downside of 10.1% including dividends.
Only rarely does the market gives investors the opportunity to acquire high-quality renewable energy assets at reasonable prices. While not exactly cheap on a P/E basis, it is quite reasonable at only 16.3x 2022 DCF (distributable cash flow) and only 14.3x 2023 estimated DCF. That suggests a solid margin of safety for a name with long-dated secular growth potential.
While fears surrounding the Commerce Department's solar tariff investigation may be a drag for an undetermined length of time (up to a year), we anticipate that, even if new duties are imposed, companies like NEP will simply pass along higher solar panel costs to their customers.
The long-term outlook for investment in renewable energy within the U.S. cannot be understated. Today renewable power makes up 20% of electricity generation. The Biden administration eventually wants 80% of US power to come from clean sources. That is a massive undertaking in the early stages, requiring years (perhaps decades) of investment. This investigation is merely a bump in the road in our view.
We also would highlight management's expertise along with NEP's strong 4.4% dividend yield and well above average growth profile compels us to say this stock is a must-own.
We are buyers below $70 and consider high $50s/low $60s to be "pound the table" levels.
Finally, we point out that purchasing NEP does NOT entail a K-1, as interest is reported on Form 1099s.
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This article was written by
I have buyside analyst and portfolio management experience. My strategy is to seek to invest in the highest quality businesses I can find. I believe that companies with free cash flow conversion consistently close to or greater than 100%, low debt, above average EPS growth history and forward growth prospects will typically lead to market beating returns over the long term. Valuation still plays a critical role in my process. I rely on valuation regression models to determine good entry points.
follow me on twitter @njvalueinvestor as I'm looking to provide more of my daily musings there.Collaborating with Thomas Lott for his Marketplace service Cash Flow Compounders.
Disclosure: I/we have a beneficial long position in the shares of NEP, CWEN, BEP 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.