- Brookfield Renewable Partners has been deflating since the January 2021 bubble top.
- The stock has been an income investor favorite and we have watched it for a long time as well.
- We examine the Q4-2022 results and tell you how we read the large distribution hike.
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When we covered Brookfield Renewable Partners (NYSE:BEP) and its corporate counterpart, Brookfield Renewable Corporation (NYSE:BEPC), in October 2022, we felt that the valuations were finally coming into the right zone. We examined the Q3-2022 results and gave you our rationale why we upgraded the shares from a Sell rating. The decision not to go two rungs at once on our rating scale was a good one and BEP gave no joy to the bulls as it underperformed the market by over 25% in just four months.
The company just released its Q4-2022 numbers that had some solid groundwork for the bull case. We examine those and tell you if we're ready to give this the green light.
The headline numbers were a bit on the weak side with funds from operations (FFO) coming in at 35 cents a share.
This was shy of consensus at 36 cents.
Due to rounding, the annual numbers missed the mark by 2 cents per share. Unlike what we saw with many other firms, BEP did not get the usual benefit of analysts rapidly reducing estimates. That behavior which has become all too common in the markets has allowed for several companies beating lowered estimates.
The estimate miss aside, it was a solid quarter that capped a very strong year.
The Fiscal Year
While we do get caught in the quarterly noise, BEP is one company that's best examined by looking at the annual data. There is a good degree of variability of how assets perform quarter to quarter and only the entire year gives the true picture.
For 2022, that picture was as perfect as it gets and BEP delivered in terms of revenues, FFO and long-term power generation. With renewable energy, a lot of things are outside a company's control. Solar and Wind energy can be quite unpredictable quarter to quarter in any given region. You can see below that Wind was the culprit for 2022. Despite capacity additions, Wind came in under 2021 levels for actual power generation, revenues, adjusted EBITDA and FFO.
That uncontrollable negative aside, BEP's diversified set of assets across the globe helped mitigate these risks to the maximum extent possible.
It also helped that BEP's energy production has been primarily underpinned by Hydro assets, which tend to perform in a far more predictable manner.
Interestingly, this number has come down over time as BEP has focused on expanding solar and wind opportunities. Hydroelectricity assets cannot be created at will and the existing ones are extremely expensive to purchase. These factors have been behind the trend in moving Hydro from 52% today from over 80% in 2018.
So you tend to see more variability today than what you saw five years back.
With the renewable energy group, conventional earnings estimates have little relevance. Instead, we must focus on the aforementioned FFO and also cash available for distribution aka CAFD. In the case of BEP, FFO had a nice total gain and also increased about 8% on a per unit basis. CAFD was a different matter and almost came in flat as a pancake year over year.
The key difference as the picture above shows, came in from realized gains on asset sales. These were far weaker in 2022 versus 2021 as opportunities for capital recycling dried up under volatile conditions. Distributions increased in 2022 at a brisk pace. That brisk pace was matched by FFO expansion but not by CAFD. As a result CAFD payout ratio reached 94%. The company does address this in their supplemental information.
We target a payout ratio of 70% of FFO over the long term. We also monitor our payout ratio on CAFD. FFO and CAFD payout ratios for the year ended December 31, 2022 were 77% and 94%, respectively. We continue to benefit from an investment grade balance sheet, robust liquidity, strong debt maturity profile, access to multiple funding levers and a growth strategy that allows us to retain control on capital spending. These levers afford us the flexibility to expect to continue to lower our payout ratio to our long-term target patiently over the medium-term.
Source: BEP Q4-2022 Presentation
It's interesting that they're pushing so high on CAFD. It's even more interesting that in spite of that, they just hiked their distribution again.
The next quarterly distribution in the amount of $0.3375 per LP unit is payable on March 31, 2023 to unitholders of record as at the close of business on February 28, 2023. This represents a 5.5% increase to our distribution, bringing our total annual distribution per unit to $1.35.
Source: BEP Q4-2022 Presentation
This continues BEP's phenomenal streak which has gone past two decades.
But can they deliver on decreasing that payout ratio? On the FFO levels, yes, this is very much in the cards. BEP has invested a lot in new assets that should start generating revenues in 2023. BEP also gets a bump on inflation adjustments annually on a vast majority of its contracts. These two should create very sizable bump in FFO. In fact, FFO estimates for 2023 stand at $1.80, a good 14% over the actual numbers for 2022.
So that FFO payout number should be coming down, despite that big distribution hike. CAFD is more tricky as we think realized gains on asset sales is likely to be weak even in 2023. We see this CAFD payout ratio as trending over 90%. Nonetheless, the distribution is exceptionally safe here, supported by an investment grade balance sheet and improving cash flows.
Valuation and Verdict
Our longer-term story with BEP has been one where we have exercised great caution in embracing the widely held view. While most cherish the idea of buying everything with Brookfield name, we think that deflating bubbles always surprise on the downside. BEP did become an enormous bubble in early 2021 and that deflation is something we have been "dodging" since then.
That article is a great read for the comments to see how hard it was for the bulls to believe back then that they would get a decade of zero returns from the peak. Fortunately for the tired bulls, valuation compression is doing its magic and the stock now trades at just 15.5X 2023 FFO.
In 2020, investors delirious with stimulus checks were ready to destroy their capital by buying BEP at 37X FFO and BEPC at 47X FFO.
That unwinding was completely predictable and we're now about 75% of the way through it. At present we think that investors can buy BEP around here with hopes of a decent total return in the neighborhood of 7% a year. Certainly, you're no longer engaging in a high risk activity. One must still be cautious and not assume that the great returns of the past can be replicated, even from this reduced price. The key reasons are that interest rates are far higher and BEP has dialed up debt about as far as it can go. Higher rates are still flowing through the FFO and over the last two years have risen significantly. In March 2021 BEP was paying 3.9%.
Today we are up to 5.4%.
Competition for new builds is also intense and BEP is unlikely to get the same returns on capital invested as in the past. Many companies including BP (BP) are complaining about the poor returns from renewables. We think a good buy point is around $25.00 a share, which works to around 14X FFO. In fact we got close to that in late December and we took the opportunity to buy BEP and sell the May 19, 2023, Covered Calls against it.
That works out to a nice yield. Early assignment is possible but that would push the annualized yield to near 50%, something that we rather not complain about.
That is our strategy here, to be defensive and look for great risk adjusted plays. We think we will likely see BEP breach $25 before we hit a final bottom and for now we rate it a "Hold."
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of BEP.UN:CA 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.
Long position is via covered calls.
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