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Brookfield Renewables: Value To Be Gained From This Safe Haven Play

|About: Brookfield Renewable Partners L.P. (BEP), Includes: TAC
Summary

Non-cyclical renewable energy stocks act as refuge from potential upcoming market turbulence.

Brookfield Renewables (NYSE:BEP) offers best of both worlds with emphasis on total return (income & growth) regardless of market condition.

Concentration in hydroelectricity particularly attractive.

Strong operational moat and an excellent business strategy orientated to capital-recycling.

Cash flow is contracted and protected over a long time-horizon.

Investment Thesis:

Brookfield Renewable Partners (NYSE:BEP) is not only an investment opportunity that offers great growth potential, but, most importantly, it is well placed to survive even the most turbulent of markets and bearish of climates. BEP owns $43bn worth of renewable energy power assets located in 25 key markets across the world, making it one the largest pure-play renewable energy businesses globally.

Hydro Focus:

The lion’s share of BEP’s long-term annualized (LTA) generation comes from its hydroelectric assets, which generated 36,282GWh of electricity in 2017, accounting for 72% of the 50,137GWh total.[1] Hydroelectricity offers a number of advantages over other forms of renewable energy: lasting over 100+ years with little maintenance, hydroelectric is a long-life asset with low costs, high cash margins and is one of the most environmentally-preferred forms of power generation. BEP has been improving its hydroelectric productivity year on year through operational efficiencies and has been taking advantage of the controlled output of hydroelectric facilities by releasing energy from the reservoirs during high-priced periods. They have been able to capture prices in the $60/megawatt-hour range in the USA, and in the $165/megawatt hour in Brazil.

Refuge in the Macro Climate

Being a non-cyclical electricity utility stock, BEP is well positioned to weather any upcoming market downturn, providing both growth and income in even the toughest market. Electricity is an essential good that is demanded in all business cycles. Operating across multiple markets spreads their risk and lowers their dependence upon any one market’s business cycle for revenue. Moreover, it is insulated from potential trade war concerns with profits not reliant upon import/export regimes. Further macro tailwinds include the proliferation of electric vehicles, growth of ESG funds, and the global transition to renewable energy.

Key markets have drastically cut their budget for renewable subsidies in recent years; the UK cut their budget by 56% in 2017[2], and the Trump administration is pushing for a 72% cut to the Energy Department’s renewable energy and energy efficiency program by 2019[3]. This has removed a potentially strong tailwind for growth and profitability, but the resultant price-fall in renewable energy stocks across the board has created an excellent buying-in opportunity for BEP. (Not to mention the growth down the line, when subsidies are re-introduced, most likely during the next financial recovery period).

Declining renewable subsidies and the sheer scale of infrastructure and investment required in order to produce low-cost renewable energy combine to create a strong barrier to entry to compete against BEP. This moat makes BEP an excellent play in this sector, which they further reinforce with their operational expertise.

Growth & Income

Brookfield Renewables doesn’t target explicitly a dividend return or a growth return, but rather one of total return – looking at the two combined. CEO Sachin Shah states the total return aim is 12-15%, made sustainable by $600-700mn equity investment every year.

BEP has a safe and growing dividend distribution, currently yielding 7.21%. The management is aiming for mid-single-digit distribution growth for the foreseeable future. This is a very reasonable assumption given that BEP’s growth investments should yield high single-digit FFO/unit growth rates and the balance sheet has strong liquidity.

For a stable non-cyclical stock, BEP generates strong growth.

  • $674mn revenue in Q3-2018, 10.86% increase upon Q3-2017.
  • $105mn Funds from Operations (FFO) in Q3-2018, 15.38% increased upon Q3-2017.
  • $0.33 FFO/unit in Q3-2018, improvement on $0.28 FFO/unit in Q3-2017.
  • 5,552 GWh electricity generated in Q3-2018 (5,198 GWh was generated in Q3-2017).
    • Partially thanks to the acquisition of new wind farms, doubling wind FFO to $29mn.

Strategy – Capital Recycling Fuelled Growth

What makes Brookfield Renewable Partners stand head and shoulders above the rest is a compelling business strategy which provides growth on top of their healthy dividend-driven income.

BEP’s strategy is to “acquire renewable power assets and businesses at below intrinsic value, finance our investments on an investment grade basis, and optimize cash flow and value utilizing our depth of operating expertise”.

In the Q2-2018 Earnings call, the management team shared their belief that the company trades at a deep discount in public markets, relative what renewable power assets are selling for privately.[4] Sachin Shah, the CEO, appeared on Bloomberg in November saying that their Canadian hydro-assets are attracting a premium multiple north of 20 times. They are looking for assets that they can invest in that are trading at 5-8x multiples, creating opportunities to create accreditation for shareholders.[5] Subsequently their logic is that it is more efficient to raise capital through capital recycling, than through share issuance.

In simple terms, BEP acquires renewables energy projects, operates them successfully, and ultimately disposes of them at a profit, using the proceeds to repeat the process and pay unitholders healthy dividends. This process of capital recycling has proved to be highly profitable for Brookfield over the years. For example, BEP has sold fully-valued assets in South Africa in order to re-invest into developing markets and undervalued assets.

BEP ended Q2-2018 with $1.7bn of liquidity, which leaves them well-positioned to behave opportunistically and catch any deals that arise during any upcoming market fear and turbulence. Moreover, by the end of 2018 BEP plans to sell $1bn worth of assets (resulting in $850mn in net proceeds), taking total liquidity to $2.55bn. This is yet more cash that can fuel BEP’s capital recycling strategy.

We are at a point in time where the company is about to enter the next stage of capital recycling, from Q1-2019 onwards, and acquire a lot of new sites. Sachin Shah has talked of seeing opportunities to invest and gain strong returns in India and China.[6] If this is done well, which all the evidence suggests it will be, a lot of value will be unlocked, and the share-price should bolster.

Protected Cash Flow

The company has a highly stable, predictable operational cash flow sourced from electricity sold under long-term fixed-price contracts with credit-worthy counterparties. Cash flows provided by operating activities totalled $928mn in 2017.[7]

The average contract length is 15 years long and 90% of clients are public authorities/industrial users. These contracts include inflation escalations, ensuring long-run profitability. Approximately 90% of electricity generated is contracted.[8]

Competitors:

A commonly talked about competitor stock is TransAlta Renewables (TSE:RNW). While 46% of TransAlta’s cash flow comes from wind, this stock is not a pure-play renewable energy company, with 47% cashflow derived from natural gas. Similar to Brookfield, TransAlta offers a great dividend yield (8.3%), however TransAlta is much smaller in scale: owning 2.4GW of generation capacity in comparison to BEP’s 17 GW[9]. This limits RNW’s opportunities to much smaller projects. Exemplifying this difference in scale is Brookfield Renewable’s purchase of Isagen, the third largest power producer in Columbia, in 2016.[10] Not only is this one asset larger than TransAlta Renewables (3 GW of capacity), but Isagen has a pipeline of projects that could more than double its production

Risks:

  • Weather Dependency: Whilst revenue not being at the whim of market sentiment is a major benefit of this stock, the flipside of that coin is that revenue is at the whim of the weather. As can be see in figure below, there is a large level of quarterly variance in LTA electricity generation. (Large dips in several key markets in Wind & Hydroelectric during Q3).
    • Solution: BEP could make up for this by diversifying away from hydroelectric, and expanding into solar for example, smoothing out quarter-to-quarter electricity generation.
  • The company has paid out more in distribution than it produced in operating cash flow or FCF, which could be a problem.
  • Investments in China are at the hands of the opaque regulatory environment.
    • Solution: Sachin Shah, CEO, says whilst subsidies in China have fallen, the air quality in the major urban hubs is so poor that it has become a major quality of life issue and therefore foreign investors into renewables are actually much desired.[11]


[1] Brookfield Renewable Partners L.P. (2017). Annual Report 2017. Pg. 3.

[2] Dramatic fall in UK investment into wind and solar power since Government slashed subsidies

[3] Trump's cuts to renewable energy put us on the ropes in the fight against climate change

[4] Brookfield Renewable Energy Partners (NYSE:BEP) Q2 2018 Earnings Conference Call Transcript -- The Motley Fool

[5] Bloomberg TV. 1 Nov 2018. “Brookfield Renewable CEO sees Opportunities in India and China”

[6] Bloomberg TV. 1 Nov 2018. “Brookfield Renewable CEO sees Opportunities in India and China”

[7] Brookfield Renewable Partners L.P. (2017). Annual Report 2017. Pg. 51.

[8] Brookfield Renewable Partners L.P. (2017). Annual Report 2017. Pg. 6.

[9] Brookfield Renewable Partners L.P. (2017). Annual Report 2017. Pg. 2.

[10] Brookfield Renewable Partners L.P. (2017). Annual Report 2017. Pg. 117.

[11] Bloomberg TV. 1 Nov 2018. “Brookfield Renewable CEO sees Opportunities in India and China”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.