Brookfield Renewable Partners (BEP) is a leader in the green energy space, producing over 19 GW capacity of power from hydro, wind and solar. As costs have come down considerably in photovoltaic (PV) energy production, solar has become a massive pipeline for BEP and its investments are at high yields. I believe it has a compound annual growth rate of around 10% for the foreseeable future and, surprisingly, shares can be purchased for a reasonable price.
Let us begin with discussing the growth and follow with an explanation of how BEP is still a decent value despite being in the green energy space, most of which is in bubble territory.
Here is the growth outlook as presented by BEP in their investor day presentation.
Companies are obviously incented to present themselves in the best possible light, so I like to verify the claims. This bridge shows growth coming from 4 primary buckets:
- Margin expansion
Let us examine each bucket.
1-2% is entirely reasonable to anticipate. About half of BEPs contracts have inflation based escalators so that part will come automatically if/when inflation happens. The Fed has already announced that it will let inflation run well above 2%, so it is not a stretch to think this will lead to 1-2% FFO/share growth.
BEP has well developed cost efficiency practices that it is implementing on recent purchases. As this is still a nascent industry, there is substantial inefficiency in operations for many of the newer players. At this point in time, BEP is among the biggest and most seasoned players which affords it more standardized operations. Additionally, BEP has opportunity to significantly reduce cost of financing. The recent spike in market price has already lowered cost of equity capital substantially. We see improvements in cost of debt as well. Today, BEP’s cost of unsecured debt is just over 5% but given the BBB+ rated balance sheet I think they will have access to at least 100 basis points cheaper debt.
Between the operating efficiency improvement and cost of capital improvements there is potential for significant margin improvement.
This is where the solar truly comes in. BEPs legacy portfolio is largely hydro and wind, but the dramatic cost improvements in solar in recent years have made it the go-to for green energy going forward. BEP’s development pipeline is enormous at over 18GW of production.
At Brookfield’s Investor Day Connor Teskey (BEP’s then CIO and now CEO) said
“To date, we’ve deployed $4 billion into development and that has led to the delivery of 2 gigawatts of additional renewables capacity at 15% to 20% returns”
The industry is still young, but maturing a bit since BEP’s early developments which has 2 effects
- Less risk
- Lower returns
Returns on BEPs developments going forward look to be in the low to mid teens and because many of them are built with a buyer of the energy already in place, the risk is greatly reduced.
Thus, we are looking at a massive development pipeline which in totality could approximately double BEP’s size (by energy production) and that pipeline is at rates of return that far exceed its reasonably low cost of capital.
Generally spreads of this size on such a large pipeline would lead to growth far higher than the 3%-5% that BEP is projecting but the annual growth rate is reduced by the pipeline being spread over such a long time horizon. So rather than hypergrowth for a few years, BEP has moderate to strong growth for potentially decades.
As future acquisitions are not pre-announced, and potentially not yet sourced, it is not really possible to verify BEP’s claim of 4%-5% growth from this bucket. That said, there are some characteristics working in BEP’s favor.
- Former acquisitions have been accretive to FFO/share, including the recent TerraForm.
- As one of the largest players BEP can use its superior access to capital to absorb smaller peers.
- The recent growth in stock price makes any stock-for-stock acquisitions more accretive.
I think BEP can get about 10% growth without acquisitions, but this bucket could provide an upside surprise somewhere down the road.
I strongly prefer recurring revenues to 1 time revenues. Much of the solar investment space, unfortunately, is one-time in nature.
Installation of solar panels or manufacturing of components is one-time revenue. While it remains in hypergrowth as it is now there is likely to be a large number of customers, but eventually the hypergrowth will end. So while installers of solar panels are looking at a runway of many years of strong revenue, it is not a particularly enduring business model.
BEP is different in that it has somewhat perpetual revenues. When it first builds a production facility it will usually have a long contract with a buyer of the power said facility supplies. These contracts currently have a weighted average remaining term of about 11 years, but what I find particularly intriguing is that BEP’s business does not end with the contracts. BEP owns the power generating facilities so even when the contracts end they are still producing the power. The contracts, in many cases will be extended and if they are not, BEP can just sell the power to a different buyer. So unlike the solar panel manufacturers and installers, BEP owns assets that will continuously generate revenues.
Solar power viability and why it is important
As a professional investor I intentionally leave morality out of my investing. So while I believe BEP is doing good things for the world, I will only invest if I believe it financially makes a good investment. As much of BEP’s development pipeline is in solar it is of significant consequence whether solar can stand on its own financial feet or if it is merely being propped up by government subsidies.
My conclusion in this regard is that solar is situationally viable without subsidies which provides a baseline of profitability and that further advances in technology or cost reductions could make it more broadly viable. Thus, it is okay on its own with governmental/social support potentially accelerating it to being quite profitable. Allow me to show you how I arrived at this position.
Energy production is a subject best understood by scientists and engineers, but it has unfortunately been hijacked by politics. As a result, people’s views of the efficiency of solar as a power source have been skewed by bias, whether that bias is on the part of the person themselves or the writer of wherever they are getting their information. This leads to some viewing solar as not viable and only existing because of subsidies and others thinking green power is vastly superior both economically and environmentally.
The truth, as usual, is somewhere in the middle.
I am not an engineer so there is some possibility that I have misunderstood some of the data, but I will walk through the reasoning behind my conclusion that solar is close to being but not quite viable entirely unsubsidized.
Efficiency as compared to non-green alternatives
If one looks at the cost to build each kW, MW or GW of capacity, it looks quite impressive.
Solar’s capital cost at a utility scale is in line with gas and cheaper than nuclear and coal. Add on to this the fact that solar has lower operating costs. Once installed solar doesn’t require any inputs except the sun whereas you still have to buy the natural gas and coal to fuel those plants.
Capacity is not the same as actual energy production.
Capacity is the amount the power plants can produce when running at full steam. Since solar panels don’t work at night and it is not always windy, solar and wind naturally have somewhat low capacity factors (the ratio of actual power generation to capacity).
This bears out in the numbers as we can see with BEP.
Source: BEPWith a capacity of 19,317 MW, a 100% capacity factor would result in actual generation of 42,304,230 MWh or 42.3K GWh over the course of a quarter. The math here is quite simple. 19,317 X 24 hours in a day X 365 days in a year % by 4 to get to a quarter. Actual production as seen in the 2Q20 numbers above was 13.2K GWh. Thus, BEP’s capacity factor is about 31% (13.2 / 42.3). This seems about right given that BEP is a mix of hydro, wind and solar.
Capacity factors of course vary by location, but the general numbers are shown below.
Thus, in comparing the cost efficiency of solar to traditional energy we should adjust for capacity factor. With this adjustment, coal and nuclear are still slightly ahead. Costs for coal range from $26-$41 per MWh and from $27-$31 per MWh for nuclear.
Unsubsidized solar comes in slightly higher at $36-$44 per MWh.
As you can see, the cost of solar has come down rapidly and if this reduction continues it is entirely plausible that it will be the cheapest form of energy a few years from now. Today, much of the viability of solar from a business standpoint is related to subsidies, but because the cost is getting so close to equivalent, the subsidies do not have to be all that large. It is much easier to swallow this small cost for the environmental benefit than it was in the past when the cost differential was larger. Presently, the primary government subsidy in the U.S is the solar investment tax credit.
The costs of any solar project started in 2020 earn a 26% tax credit.
Given how close the cost structure is without subsidies, this tax credit makes utility scale solar viable in many locations.
The private sector seems to be providing a form of subsidy on its own. Solar power sells for more than fossil fuel based power. In fact, it sells for more than double at $83/MWh compared to $34 for fossil fuel power.
Some of this is related to solar panels being disproportionately in California where energy prices are higher in general, but it is also true that companies are often willing to pay more for solar.
Companies these days really want to advance their image as ESG (environmental social governance) friendly. One of the ways they can do this is to source their power from renewable sources. Such a move earns them approbation which can manifest in the form of happier customers, a higher trading multiple, or both. Due to these rewards, companies will often pay up for power that it can demonstrate is fully renewable. BEP recently signed a dealwith Plug Power (PLUG) in which PLUG will source 100% of its energy from BEP. Plug can improve its ESG image and BEP gets likely well above market rates for the power it is supplying. Overall BEP gets an average of $75 revenue per MWh which demonstrates how much people are willing to pay up. There is also a large movement among data centers to source their power from renewable sources. Some are doing it themselves with solar panels on the roof while others are partnering with utility scale producers like BEP.
Future of subsidies
Government subsidies are subject to elections and hard to predict political whims. They could get stronger or go away which makes government subsidies a difficult aspect to rest a bullish investment thesis upon.
Fortunately, BEP does not require government subisides to be profitable. The private sector willing to pay up for green energy is plenty of help to give BEP double digit returns on developments and this form of help is more durable.
It is particularly durable for BEP because its high revenue per MWh is largely locked in by contracts.
Overall BEP has a great growth outlook of potentially 10% FFO/share annually for over a decade.
Forward consensus estimates for BEP’s FFO/share are about $2.05 after adjusting for split in which BEPC was created. At a market price of ~$59.00 that is a FFO multiple of about 29X.
As a value investor, that is higher than I would normally go, but reliable and strong growth is scarce in this environment and most companies with even a hint of growth are trading at outrageous multiples.
29X is actually quite cheap relative to most growth stocks and extremely cheap relative to most green energy stocks.
In 2020 solar stocks have taken off like rocket ships with Solar Edge (SEDG) up 260% over the past 52 weeks.
It now trades at 78X earnings
Even the not yet profitable SunPower (SPWR) is up 82%.
BEP is up quite a bit too at +60% on the year, but it came from a place of cheap valuation and since the FFO has been growing with the market price, its multiple is still at a reasonable level.
I think there are 2 aspects that have kept Brookfield Renewable Partners reasonable cheap.
- Canadian stocks tend to trade at lower prices
- It is structured as a partnership
Investors really do not like the tax hassles of owning partnerships. They can create K1s which have to be filed and some institutions may be restricted in their ability to invest in partnerships.
As such, the field of potential investors in BEP is artificially narrowed. These aspects do not affect its fundamental value, but they have held down its market price.
In fact, we now have strong evidence that it is the structure holding down BEP’s price.
BEP or BEPC?
BEP, which is structured as an Bermuda based limited partnership recently issued shares of BEPC to its shareholders as a special dividend. BEPC is a corporation so shareholders get a 1099 instead of a K1 which most people find preferable.
BEP and BEPC are fundamentally equivalent in that they both have a claim to the same equity and they get the same dividend supported by the same cashflows. Their fundamental values should be the same.
Yet the simple difference of tax implications has held BEP back while BEPC took off.
Source E-Trade streamer
The greater than $14 difference is purely reflective of that preference and shows how much higher BEP would be trading if it was not a partnership.
This minor annoyance is why BEP is still cheap while the rest of growth stocks and the rest of solar have gotten so egregiously expensive. BEP could be one of the best remaining opportunities in the space.
This is a momentum market and momentum is a dangerous factor to play. Already expensive stocks are going to sky-high valuations creating a bit of a “greater fool” type of game. One can make money buying the expensive momentum names so long as there is someone out there willing to buy it from them at an even more ridiculous price.
Eventually, as we saw in the dot com bubble, someone is left holding the bag as prices return to earth.
BEP is a clean way to participate in the momentum. Clean both in the green sense and in the financial sense.
As an exciting green energy stock it has the potential to balloon in market price like so many of its peers, but those who buy today are not taking on that huge risk of a return to earth. BEP’s price is entirely justified by its cashflows and its growth. So if the momentum bubble pops, BEP will sill be fine. It will still be growing, producing cashflows, and paying a healthy almost 3% dividend.
In the base case where BEP’s multiple is flat, I think it will return about 13% per year for the foreseeable future (10% FFO/share growth plus dividend). There is the potential for substantially higher gains if the solar momentum market continues.
I find that to be a highly attractive reward potential relative to the somewhat low risk (as compared to the average equity stock). As a large cap with a strong balance sheet, great track record and solid management, the business is quite stable.
Solar is now prevalent among REITs and the solar REITs trade at even more opportunistic pricing than BEP. The REIT Wealth Builder portfolio currently contains 2 REITs with massive solar growth pipelines.
Disclosure: I am/we are long BEP.
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