By Tom Konrad Ph.D., CFA

Despite a run-up in the fourth quarter of 2023, it has been a long time since valuations of clean energy stocks have been this cheap.  Perhaps it is worries about hostility towards clean energy under a new Trump administration, or disappointment at the slow implementation of the Inflation Reduction Act.  Whatever the cause, prices are low, and many clean energy stocks are likely to  produce good returns even if the political climate turns further against them.

This is especially true for companies that are less dependent on favorable policy or subsidies.  For instance, Yieldcos, high yield companies that own and develop clean energy assets like solar and wind farms get most of their profits from things which are already built.  New subsidies, like those included in the Inflation Reduction Act, almost exclusively target new facilities.  Because of this, changes in subsidies and interest rates will affect a Yieldco’s growth prospects, but will have limited effect on its short term earning potential.  

Yieldcos such as Brookfield Renewable Energy (BEP and BEPC), Atlantica Yield (AY), Clearway (CWEN and CWEN-A), and Nextera Energy Partners (NEP) fell as much as 50% in 2023.  At current prices, I love them all.  Collectively, these four names account for a fifth of the portfolio.  My current favorite is Nextera Energy Partners, which I have historically felt was consistently relatively overvalued because investors have had faith in its strong sponsor, Nexterea (NEE).  That valuation did not survive the effects when persistently high interest rates led NEP to sharply cut its dividend growth targets last September.

Among the Yieldcos, NEP got the least benefit of the strong rally in the fourth quarter, and it is still trading at a price that gives it an 11% dividend yield.  That high a yield would normally signal that investors are expecting a dividend cut.  I think such a cut is unlikely.  First, NEP’s liquidity and cash flow ratios are in line with other Yieldcos, and if management felt that a dividend cut might be necessary in the near future, they would have done it when they were already disappointing investors by slashing their dividend growth plans.  Instead, I expect NEP’s dividend growth to stall for several years.  But at 11%, who needs growth?  

Another likely scenario would be for NEE to buy back the outstanding shares of NEP to improve its own cash flow ratios.  This is far from unprecedented – Transalta (TA) did exactly that last year by buying back the outstanding shares of TransAlta Renewables (Toronto: RNW).  NEE, like TA, would buy NEP at a 10-20% premium to current prices.  NEP has significant convertible debt financing, much of which will need to be refinanced in 2026.  If NEP has trouble refinancing this convertible debt, I expect the most likely scenario will be a buyback by it parent, NEP.   I’d prefer to collect an 11% dividend for several years to come, but a small short term gain is not something to scoff at.

DISCLOSURE: As of 1/15/2024, Tom Konrad and funds he manages own the following securities mentioned in this article: Brookfield Renewable Energy, Atlantica Yield, Clearway, Nextera Energy Partners. He expects to add to (but not sell) some of these positions in January 2024.  This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  All investments contain risk and may lose value. Past performance is not an indication of future performance. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

ABOUT THE AUTHOR: Tom Konrad, Ph.D., CFA is the Editor of AltEnergyStocks.com (where this article first appeared) and a portfolio manager at Investment Research Partners.

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Tom Konrad, Ph.D., CFA

A reader asked:

Read your recent article on Pattern Energy (PEGI). Great summary and thoughts.

Would like to ask your view on TERP potential takeover by BEP (via shares swap) and whether you reckon the recent run-up on TERP is too excessive?

It’s a good question, and one that Robbert Manders on Seeking Alpha did a thorough analysis of here.  For the details of the merger, I refer you to his work.

While his analysis is careful and complete, I disagree with his conclusion.  TERP shares are not trading at a significant premium to the merger value.  The reason is one that Manders touches on, but dismisses as immaterial.  He says:

There is one more factor that can sow confusion which is that the shares to be issued to TERP shareholders will be BEPC, a new corporate share class. It is created to accommodate shareholders who want to own shares of a corporation instead of a partnership. The shares will have the same economic characteristics as BEP units and they will be convertible as well. I regard this as a minor detail to the thesis.

The difference between BEP and BEPC is not a minor detail.  I discussed this new class of shares in December:

Brookfield Renewable Energy Partners announced a stock distribution and the creation of a new corporation, Brookfield Renewable Corporation (BEPC).  This will allow investors who are not able to invest in limited partnerships like BEP to also invest in the stock, which is designed to have identical distributions to BEP and will be exchangeable for BEP units.  The stock price of BEP has been climbing since the announcement in anticipation of the new demand for shares from this new potential class of buyers.

It is also important to note that while BEPC shares will be convertible into BEP partnership units, Brookfield has not said that the exchange can happen in reverse.  The convertibility of BEPC shares into BEP will thus put a floor on the BEPC premium.  Without the ability to convert partnership units into BEPC, there will be no upper limit to the premium at which BEPC shares will trade compared to BEP partnership units.

If Brookfield did not think that BEPC shares would trade at a premium, why would they have bothered to issue the new share class?

Without the ability to convert BEP units into BEPC shares, I predict BEPC will trade at a premium to BEP.  We can see a similar effect with Clearway’s two share classes: CWEN trades at more than a two percent premium to CWEN-A based solely on better liquidity.  The only economic difference between CWEN and CWEN-A is that CWEN-A shares have more voting rights than CWEN, but large investors value the additional liquidity so much that they pay more than 2% extra to give up most of their votes.

With BEPC, many large investors will be able to buy BEPC but not BEP, so the BEPC premium over BEP is likely to be higher than CWEN’s premium over CWEN-A.  I expect it to be a little more than the 4% that has Robbert Manders trumpeting an arbitrage opportunity that will turn out to be illusory, and could easily lead to him losing money.

Disclosure: Long PEGI, TERP, BEP, CWEN-A. Short TERP Calls.

The post Why is Terraform Power Trading at a Premium to the Brookfield Renewable Merger Value? appeared first on Alternative Energy Stocks.

by Tom Konrad Ph.D., CFA

This morning, hedge fund Water Island Capital called on Pattern Energy (PEGI) Shareholders to vote against the merger with the Canada Pension Plan Investment Board (CPPIB).

Water Island claims the merger is undervalued compared to the recently surging prices of other Yieldcos, and that PEGI would be trading at over $30 given current valuations.  There are not a lot of other Yieldcos left, especially if we eliminate those with their own special circumstances.  These are Terraform Power (TERP) which is subject to its own buyout agreement with Brookfield Renewable Energy (BEP), and Clearway (CWEN and CWEN/A) where the PG&E (PCG) bankruptcy is still causing a little lingering uncertainty.

Of the remaining Yieldcos, NextEra Energy Partners (NEP) is up 25% since the merger was announced, Atlantica Yield (AY) is up 33%, and Brookfield Renewable (BEP) is up 50%.

PEGI’s pre-merger price was approximately $23, meaning that if it had risen as much as its peers, it would currently be trading between $28.75 and $34.50, so Water Island’s valuation is credible.

Scenario Analysis

Let’s consider the options:

1. A shareholder could sell the stock today for approximately $28.00 a share.
2. A shareholder could hold the stock and vote against the merger:
   1. If the vote fails, the voting period will likely be extended.  Subsequent extensions could last until November.  CPPIB might raise the merger price to induce more shareholders to vote for the merger
   2. If the vote succeeds, shareholders will walk away with $26.75 plus one or two dividends of $0.422 each.  $27.172 or $27.594 total.

Between 1 and 2b, selling now is clearly the better choice.  In the case of 2a, we need to consider likely changes in Yieldco valuations between now and November.  If they continue to increase, we will see an even higher valuation for PEGI, but we could have also invested the $28 we got by selling today in one of the other Yieldcos.

If Yieldco prices stay the same, we will have a return of between $1 and $7 compared to our $28/share in the next 9 months.  That’s about 14%, which is good, and fairly large compared to the risk that the merger goes through.

I chose to take the money and run.  $28 cash seems like a good deal in an uncertain market.  The decision is more because I worry about Yeildco valuations overall than my concern about the small loss if the merger does go through.  If Yeildco prices fall back to more reasonable levels, the potential gains of voting against the merger vanish.

Naturally, if PEGI’s price falls back down or rises more by the time you read this, the calculations will change.  $0.50 either way can make a big difference in this risk-reward calculation.  Expect the stock to remain volatile until we know the result of the vote on March 10th, and even longer if the first vote fails.

Disclosure: Long PEGI, short PEGI calls, long BEP, AY, CWEN/A, TERP, short NEP.

The post Should Pattern Energy Shareholders Vote Against the Merger? appeared first on Alternative Energy Stocks.