In this article, I compare Q1 results for NextEra Energy Partners (NYSEMKT:NEP) with references to 8Point3 Energy (NASDAQ:CAFD). I already expressed my opinion on 8Point3 Energy and the implications of First Solar (NASDAQ:FSLR) selling its interest in this yieldco in another article.
Before I start my review, for those readers who come across the subject of yieldcos for the first time, a condensed description of the concept and core competencies.
Yieldcos sell equity to buy assets for growth. At least in early stages of portfolio building, selling equity is a must, and need to be done in a way to get the share price, above the cost of capital. The goal is to buy enough assets so they can generate cash available for distribution and in turn, they can pay for operating and financing costs, advantageously including debt amortization. Yieldcos should have their assets to generate a return on investment greater than the cost of the capital they use. The cost of capital is a combination of cost of debt and equity, and professionals do not consider the dividend yield as the latter metric. The dividend yield is an expense to reconcile when selling equity and does offer measurement how costly equity can become with high yield.
Equity offerings have to be effectively priced. For one, as mentioned, they need to be above the cost of capital. Otherwise, they would cause deficit or negative return on investment or ROI. They also need to be ample, to supply liquidity when selling equity may not be possible. Distributions divided by the cash available are referred to as a payout ratio. High payout ratios are expected from yieldcos, but very high ones are prohibitive to the growth of dividend, especially in periods when equity cannot be sold.
NextEra Energy Partners reported $12M in net income or $0.22 per share for Q1, based on the revenue of $175M. For the 2017 estimates for cash available for distribution or cafd, are $310 to $340M using a run rate for December 31, 2017. NEP’s cafd excludes $320M for principal and interest expense. It also excludes estimated $70M in incentive distribution rights or IDRs.
The dividend distribution, using Q1 2018 quarterly dividend annualized to $1.62, and calculated on 155M shares of NEP OpCo, totals $251M. 54M shares are own by NEP and rest by the sponsor, NextEra Energy Inc. (NYSE:NEE). Against the $340M, the payout ratio is projected at 74%.
NEP’s portfolio currently holds 2,926MW, including 521MW solar. Solar portion increased in the fourth quarter by the acquisition of 132MW or 24% interest in Desert Sunlight Solar Centre. In May, NEP will buy from NextEra Energy Resources (NEER), a company serving as the internal developer, 250MW Golden West Wind Energy Center located in El Paso County, Colorado. The $422M transaction will be paid for in full with debt, adding $27M of cafd before corporate and IDR expenses. NextEra, with over 3GW of renewable energy generation, will become the largest renewable yieldco, followed by TerraForm Power (NASDAQ:TERP) which accounts for 2,983MW. The potential for future dropdowns runs on 13GW of renewables already in the service of NEE with NEER having 5.4GW of projects scheduled for 2017 to 2018 season. Via investment in wind projects during 2016, NEER has also secured around 10GW capacity, with full access to 100% production tax credit or PTC. Finally, NEP can consider two new pipelines as potential acquisitions, to add, to 500 miles it already ows.
The company continues to support five years of 12 to 15% annual increase in the dividend until Q4 2022, with an estimated annualized dividend payment of $2.78 to $3.26. The quarterly payment coming up in May, annualized to $1.46, indicates 4.5% yield based on $32.42.
For long-term investors, the equity growth potential appreciated to the same yield by 2022, would offer $61.80 to $72.42 per share or 91 to 123% return. Also, dividend payments for the next five years would return a range of $12.82 to $14.19 in cash, per share. Using five years return on investment also referred to as ROR or rate of return, the amount returned is ($61.80 plus $12.82) or $74.62. Based on $32.42 initial investment per share, annualized ROI is 18.1%, accounting for 12% dividend growth. When dividend growth per year is 15%, the amount return is $86 and ROI is 21%.
Moving to 8Point3 Energy, based on the 2017 cafd calculated at $91 to $101M, using the 12% dividend growth, the payout is $88M, resulting in 87% payout ratio. The tactical review does not offer growth in 2018 if conditions remain constant. Speculative 12% increase would drive payout to $98M by the end of 2018, without asset additions and without the ability to pay existing debt, even if the corporate bond was sold to replace loans and lines of credit. As mentioned many times now, CAFD is not repaying debt, which now stands at $700M. The maturity for most of the loans falls during 2020.
The same ROI calculation, as used for NEP, with an initial investment of $12.09 per share will produce 9.2% ROI for CAFD, accounting for a payout of dividends but not an appreciation of equity. If in 5 years CAFD shares are worth $10, the ROI is 6%. The reality of investing in CAFD today does not forecast five years of a runway. Chances are, upon receiving $1.11 in the dividend, within a year CAFD could be sold, for a price which I consider to be closer to $10 per share. I calculated $10 to be an attractive price to a private equity buyer, given 15 years of annualized 7 to 8% ROI. The ROI is, of course, negative for an individual investor buying CAFD shares now, to sell them a year later for $10. CAFD’s 9% dividend yield is explained by distress conditions.
In a range just slightly longer than a year, four yieldcos have suffered to circumstances impacting own sponsors. The formula for distress originated with two reasons: the bankruptcy and business cycle. The market reaction to the bankruptcies of SunEdison (OTCPK:SUNEQ) and Abengoa had an overall negative impact on share prices of other yieldcos and brought down prospects for sponsors of 8Point3 to the uncertain path.
That combination of cyclical weakness and capital intense expansion plans had forced the need for liquidity for CAFD sponsors, in the time when the yieldco is struggling with own liquidity concerns operating with high payout ratio and lack of debt repayment. Due to financial concerns described in my Q4 analysis summarizing CAFD, I suggested avoiding the company. Those concerns have been justified further with recent development.
The sale announcement made by First Solar has put the company in limbo, and it is difficult to expect shares move up, as the negotiations about the price are likely to cause pressures on the stock. I suspect that equity would not be sold after all despite at-the-market ability. The company may want to preserve the capital structure for a future buyer. At one point I thought utility sponsored yieldcos could be interested in a merger. However, with over 20GW of renewable energy for NEP, and equally ample amount of GW for NRG Yield (NYSE:NYLD) available for dropdowns, the most likely consideration to take CAFD private, in my opinion, is a private capital consortium.
While NEP stock is up from the time of my last article, the company is still off the mainstream radar. I consider this as a continuous opportunity for accumulation of shares.
The safety of utility sponsored yieldcos is recognized now with lower yields, but the yield needs to be considered as just one of the factors. The growth, secured by the availability of cash, the precise, long-term vision, describing dividend evolution combined with undervalued equity becomes the sum of all factors. Low yield signals stability in a situation when all other factors are satisfied.
NextEra is the company which I find to fit all the criteria.
Below are this year’s recommendations, described in my articles and published this year. NEP remains undervalued, with plenty of opportunities based on indicators of dividend growth and up to $35.66 share price for this year. Investors who have five years’ horizon for holding stocks, should find the name attractive. The risks NEP and investing in it may face are associated with an increase in interest rates and lack of recognition of the value, moving the dividend to a higher yield. There is also a highly unlikely shift in the dividend growth strategy which would change the investment thesis. However, the low probability of change in the long-term forecast, the case of higher yield outcome, unlike CAFD’s condition, would become a confirmation to add more shares.
Disclosure: I am/we are long CSIQ, NEP.
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.