I’ve been pounding the table for buying yieldcos all year. Now it appears I have company, sugg...
NextEra Energy: Best in Show
06/01/2016 10:00 am EST
Roger Conrad, a long-standing expert in utility stocks and dividend investing, explains the pros and cons of yieldcos, a lesser-known income sector that has faced some headwinds. The editor of Conrad’s Utility Investor focuses on one favorite that he considers the “best in show” within the sector.
Steve Halpern: Today, we are joined by one of my very favorite guests, Roger Conrad, editor of Conrad’s Utility Investor. Roger is the leading expert in income investing, and here we’re going to talk about the pros and cons of yieldcos. First, Roger, how are you doing?
Roger Conrad: I’m doing great. How are you?
Steve Halpern: Very good. Now, yieldcos are an interesting subsector of the market that many people aren’t familiar with, and they’ve become increasingly popular, but I’ve ran into some head winds and challenges very specific to that sector. Can you give our listeners a background of the whole yieldco story?
Roger Conrad: Yeah, absolutely. You know, this was basically a construct modeled on Master Limited Partnerships, which were very successful. They’ve been a very successful financing vehicle for building out pipelines and so forth.
So what happened about two or three years ago was a few companies started to look at a way of financing what they thought was going to be a pretty big buildout of renewable energy, primarily, meaning utility-scale solar and wind power plants, which the cost of power has really come down, and which are supported by governments, as well as by tax credits.
We just had those tax credits actually extended into the next decade for solar and wind development. There’re 29 states that have renewable power standards, which means that the power generators have to get a certain percentage of their energy from renewable power by a certain date.
So these are pretty aggressive buildout targets, and as a result, we’re seeing a lot of building of wind and solar plants.
These were conceived of as a way of these companies that are doing the development of basically giving the public an opportunity to participate in the cash flows from contracts on these projects, thereby, in the form of dividends, and then also allowing the developers to recycle capital to do more development.
What we saw a lot of the IPOs come out. And then as we saw MLPs come down in price, there was a lot of disillusionment with the yieldco sector as well.
Even though you had companies that were getting their cash flows from pretty much locked-in contracts, there was a question mark about whether they could finance what we call dropdowns -- in other words, the purchases of these wind and solar power assets from the developers -- and thereby supporting their dividend growth model. So there’s been a major shakeout in the sector.
I think what’s been lost is that this model does work for companies that are backed by a strong parent and that are focused on, again, utility scale projects, and not in residential solar or some of these other more risky areas of renewable energy.
There are some very good models of success here. There are also some definite models of failure, as well. But as usual, if an investor is discriminating, they can really capture some big yields, some strong growth, at very little risk.
Steve Halpern: So, as you alluded to, selection is really critical here, and one of the long-term winners that you see is NextEra Energy Partners, LP (NEP). Could you explain what NextEra Energy Partners does and its relationship to the utility NextEra (NEE)?
Roger Conrad: NextEra Energy Partners is actually the only yieldco that has both an investment grade-rated parent, being Utility NextEra Energy, which serves South Florida area, and also the largest developer and producer of wind and solar power under long-term contract in the United States.
So it has a really strong parent. And also, it combines that with not having any residential solar exposure. I don’t know if your viewers are familiar with the short seller Jim Chanos, but he’s called residential solar a giant subprime of accidents waiting to happen, particularly companies like Solar City.
Well, NextEra Energy Partners doesn’t have that exposure. All their customers are big utilities, big companies that are very creditworthy. So it’s a pretty nice situation, and again, they have a lot of dropdowns from the parent, NextEra Energy, which again, is the largest developer of wind and solar power in the US.
It’s also doing a lot of building, so all those are potential dropdown situations, and as they get more assets from the parent, they’re able to pay bigger dividends, and of course, that’s a nice model for capital growth, as well.
Steve Halpern: So when you look at a yieldco, one of the things that you rank highly in your assessment is the distribution growth potential. Could you touch on that area in terms of NEP?
Roger Conrad: What we’re hearing from NextEra Energy, and this has been consistent guidance since this company went public, which was back in 2014, has been for 12% to 15% a year distribution growth, and they’ve exceeded that by a pretty wide margin.
They actually grew well over 20% over the past 12 months, but that’s a pretty good, pretty solid rate, so if you look at the current yield right now, about 4.5%, if they stick to that growth rate through the guidance period, which is the end of 2020, by the end of 2020, if you buy it now, you’re going to be getting right around 9% on your initial purchase price.
And of course, by that time, our view is that the price of NEP will also be rising over that time, so pretty nice combination of income growth, distribution growth.
And it’s very high quality, because, again, unlike some of these other companies, yieldcos that are attached to companies -- like SunEdison, which is not bankrupt -- NextEra Energy is a very strong investment-grade credit, and with a lot of capital to back it up.
They backed up NextEra Energy Partner’s growth plan consistently, and that’s again, the best guarantor that we are going to see that kind of distribution growth over time.
Steve Halpern: Now, you mentioned that the company’s actively involved in renewable energy, but in your latest report, you also point to some of its involvement within the wind power sector. Do you view this as a long-term benefit for the company?
Roger Conrad: I think so. I mean, the key, really, is contracts, and are these power plants contracted to utilities over a 20, 30-year period, and if they are, those are revenues you can pretty much count on as an investor.
You know, NextEra Energy’s renewable energy development arm is contemplating something like 3.4 gigawatts of new wind power capacity just through the end of this decade, and those are all potential dropdowns to this company, so it’s a tremendous benefit.
I think there are risks in wind power. I mean, it’s not strictly competitive in many areas. In fact, it can’t really be economically constructed in some parts of the country; there’s just not enough wind.
It’s an intermittent source of energy, so you know, when the wind’s not blowing, you don’t have a lot of output there, but again, the key is contracts, and this company has them.
NextEra has them, and when they drop down the assets to NextEra Energy Partners, they also, you know, those convey to NextEra Energy Partners.
Steve Halpern: Now, finally, before I let you go, you mentioned the yield was an important part, obviously, of a yieldco, and you note that this company has chosen to be treated as a corporation for US tax purposes. Could you explain what that means and how this differs from some other yieldcos?
Roger Conrad: Yes; you know the master limited partnerships, in particular, one of the complaints that we hear all the time from our customers is that they have these K-1s you have to file.
So they’re a little more complicated than a traditional corporation, where you get a 1099 and basically pay taxes, which are at a preferential rate under the bill that was passed in 2003 and continues to today.
Filing the MLPs and paying those K-1s, you do have tax advantages, but a lot of people don’t like those complications, and you don’t have that with NextEra Energy Partners.
The parent, NextEra Energy, has the benefit of a partnership structure with NextEra Energy Partners, so that’s a good thing for them, and it does convey some tax advantages.
For NextEra Energy, they can pay up a higher yield, but there’s not the tax complication, and so your dividends are pretty much just qualified dividends, and you would pay just as any other normal, common stock.
Steve Halpern: Again, our guest is Roger Conrad, editor of Conrad’s Utility Investor. Thank you so much for your time today.
Roger Conrad: Thanks for having me, Steve.
By Roger Conrad, Editor of Conrad’s Utility Investor
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