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August 17, 2015

Green Bonds From Terraform Global, SolarCity, and Hannon Armstrong

by the Climate Bonds Team

Yieldco TerraForm Global (GLBL) issues a whopping $810m green bond (7 years, 9.75%, B2/B+)

TerraForm Global Operating has issued an $810m green bond, with 7-year tenor, 9.75% coupon and ratings of B2 and B+ from Moodys and S&P respectively. TerraForm Global is a recent yieldco spin off (IPO last month) of SunEdison (SUNE) group (have a look here if the yieldco concept is new to you).

Terraform Global owns and operates renewable energy assets - solar, wind and hydro - in emerging markets, in the following locations:

  • Solar: China, India, South Africa, Honduras, Uruguay, Malaysia and Thailand.
  • Hydro: 6 projects in Peru (for 336MW aggregate capacity), as well as 3 small operational hydro projects in Brazil (aggregate capacity of 42MW).
  • Wind projects: China, Brazil, South Africa, India, Honduras, Costa Rica and Nicaragua.

The emerging market focus sets Terraform Global apart from its sister-yieldco Terraform Power Operating, which has so far issued 3 bonds for a total of $1.25bn, but who only has one emerging market project, in Chile. Their renewable energy power plants are predominately in the US, with some assets in Canada and UK.

Terraform is really showing the potential for yieldcos to issue green bonds to finance renewable energy in a wide range of countries – way to go!

SolarCity (SCTY), the US largest solar developer, comes to the green bond market yet again with $123.5m of solar asset-backed securities. The 7-year tenor green ABS is split across two different ranking tranches; the larger $103m senior A-rated tranche has a 4.18% coupon and the smaller $20m junior tranche, rated BBB, with a 5.58% coupon. Great to see solar-backed ABS moving up the credit ratings!

SolarCity has been a pioneering company in the solar securitisation space; in November 2013, they were the first corporate to issue a fully solar-backed ABS, and several more deals followed in 2014.

This latest deal from SolarCity adds to other recent green ABS deals, with July seeing green ABS issuances from both RenewFund and Toyota.

Hannon Armstrong (HASI) announced it will issue another round of green asset-backed securities (it calls them Sustainable Yield Bonds), this time for $125m and 25-year tenor. As its previous issuances of green asset-backed securities, they will be backed by renewable energy and energy efficiency assets. The ABS offering will be offered by an indirect subsidiary of Hannon Armstrong.

——— The Climate Bonds Team includes Sean Kidney, Tess Olsen-Rong, Beate Sonerud, and Justine Leigh-Bell. 
 The Climate Bonds Initiative is an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

August 04, 2015

New Green Bonds From Terraform And Goldwind

by the Climate Bonds Team

Second green bond from TerraForm to finance wind power acquisition, $300m 10yr, 6.125% s/a coupon, BB-/B1

TerraForm Power Operating [TERP], the yieldco spin off from SunEdison [SUNE], has issued a second green bond shortly after tapping its inaugural green bond for a further $150m (making their first green bond a whopping $950m!). The new $300m green bond has 10-year tenor and semi-annual coupon of 6.125%, and was issued in the US private placement market. It is sub-investment grade with a rating of BB- from S&P and B1 from Moody’s. Underwriters for the deal were Bank of America Merrill Lynch, Barclays Capital, Citi, Goldman Sachs, Macquarie, and Morgan Stanley.

Proceeds from the bond will be used mainly to finance the acquisition of 460MW wind power plants from Invenergy, with the remaining proceeds used for other eligible green projects. As with its first green bond, Terraform chose not to get a second review on the green credentials of this bond, presumably because it is a renewable energy business with no brown assets on the books.

Great to see another issuer coming back to the green bond market for more!

TerraForm Global Operating [GLBL] another yieldco subsidiary of the SunEdison group which just completed its IPO also announced a $810m green bond. Proceeds will be used for wind, solar and hydro projects.

First labelled green bond from a Chinese company, Goldwind, is launched in the Hong Kong market,$300m, 3yr, 2.5% s/a coupon, A1 (credit enhanced)

As we already mentioned in a special blog last week, Xinjang Goldwind Science and Technology [2208.HK] is the first Chinese corporate to issue a labelled green bond (though technically speaking, the bond was issued by its wholly owned Hong Kong-based subsidiary). The $300m green bond issued in the international dollar market was a massive success with an orderbook of $1.4 billion! The bond has a 3-year tenor and semi-annual coupon of 2.5%, and credit enhancement by the Bank of China (Macau) brought it up to an A1 credit rating. The lead underwriters for the deal are Bank of China, Deutsche Bank and Societe Generale.

We’re happy to see that Goldwind got DNV GL to do a second review of the green bond, giving investors confidence in the first green bond issuance from a new country. (Although, the domestic Chinese green bond market will be governed by official guidelines for what is green rather than the second opinion model).

Now, it’s worth highlighting that the Goldwind green bond does not follow the use of proceeds model most commonly seen in the green bond market where the proceeds of the bond sale are earmarked to finance specific eligible projects. Instead, Goldwind’s green bond is a general-purpose bond that allows proceeds to be used for any expenditure by the company. The reason investors can accept this different structure is that the green bond is issued by a pure-play company (meaning over 95% of revenues are from climate-aligned assets). This gives investors comfort that proceeds will be used for green - in Goldwind’s case, wind power plants and wind turbine manufacturing assets. It is the same model used in Danish corporate wind manufacturer Vestas’ [VWDRY] green bond earlier this year.

We’re all for pure-play issuers labeling their bonds as green to improve discoverability for investors. But we were a bit surprised that there are no plans for additional reporting on the actual use of proceeds of Goldwind’s green bond, as in theory the company could use proceeds to finance any project – green or not so green. Of course, since Goldwind’s a pure-play wind developer, it’s almost certain that the company will use the proceeds on fully climate-aligned wind projects. But it would be good to see reporting on this to provide certainty for investors.

There are many firsts to come for Chinese green bonds this year – in particular we are waiting for the first green bonds in the overseas RMB and domestic Chinese bond markets that has a seal of approval from the central bank and financial bond regulator, PBoC. We’re expecting these to be coming to market later in 2015.

——— The Climate Bonds Team includes Sean Kidney, Tess Olsen-Rong, Beate Sonerud, and Justine Leigh-Bell. 
 The Climate Bonds Initiative is an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

July 13, 2015

Recent Green Bonds: Toyota Hybrids, SunRun, Efficient Homes and Data Centers

by the Climate Bonds Team

Last month Toyota closed their second green bond for a whopping $1.25bn. Standard auto loans backed the issuance with proceeds to be used for electric and hybrid car loans; that means it’s more like a corporate green bond, where proceeds from a bond backed by existing (non-green) assets are directed green loans still to be made.

Sunrun issued $111m of solar ABS, and a small unlabelled energy efficiency ABS was also issued by Renew Financial and Citi for $12.58m. Sunrun and Citi/Renew Financial are examples of ABS where the assets backing the issuance are green. This type of green ABS introduces new low-carbon assets to the securitisation market, such as solar leases and energy efficiency loans.

Toyota issues second green ABS US$1.25bn, 1-5yrs, AA+/Aa3

The finance arm of Toyota issued their 2nd green ABS with an impressive US$1.25bn deal, after being the first to issue a labelled green ABS in 2014. There are 7 tranches with a range of tenors (1-5yrs) and coupons (0.3%-1.74%). Citi, Credit Agricole and Bank of America Merrill Lynch were the lead underwriters.

In line with Toyota’s last green ABS issuance, proceeds from the bond will go to fund a pool of leases and loans for low-carbon Toyota vehicles. To give you an idea of the size of the pool – Toyota’s first green ABS bond financed the purchase of 39,900 vehicles! Toyota sets clear criteria for eight different models of cars that can be funded:

  • Gas-electric hybrid or alternative fuel powertrain
  • Minimum EPA estimated MPG (or MPG equivalent for alternative fuel vehicles) of 35 city / 35 highway
  • California Low-Emission Vehicle II (LEV II) certification of super ultra-low emission vehicles (SULEVs) or higher, which would include partial zero emissions vehicles (PZEVs) and zero emissions vehicles (ZEVs)

Citi and Renew Financial issues US$12.58m ABS backed by energy efficiency loans (6yrs, 3.51%, A), as part of WHEEL, a Pennsylvania Treasury initiative

Citi and Renew Financial issued US$12.58m of climate-aligned asset-backed securities. Although not labelled as green, we include this deal in our universe of unlabelled climate-aligned bonds.

The deal is the first ABS issuance arising from the US-based Warehouse for Energy Efficiency Loans (WHEEL). WHEEL is a public-private partnership established in 2014 with the State of Pennsylvania Treasury. The set-up is that approved local contractors offer low-cost loans to customers to finance energy efficiency projects, which are then bought into a financial warehouse by the company Renew Financial. To do this, Renew Financial uses a credit facility capitalised by a mix of public money, from the Pennsylvania Treasury, and private money, from the commercial bank Citi. This process continues until the aggregated amount of loans in the warehouse meet the size requirements of the capital markets, and the loans are bundles together and sold to institutional investors as securities backed by energy efficiency loans.

Brilliant to see private sector actors collaborating with state and local governments to get the deal off the ground. This is exactly the kind of collaborative setups we need to have to rapidly grow a green securitisation market, in the US and globally. Bravo all involved!

Sunrun issues $111m ABS backed by solar leases in two tranches (100m, 30 yr, 4.4%, A; 11m, 30 yr, 5.38%, BBB)

Sunrun Inc., a US provider of residential solar, issued $111m of "Solar Asset-backed Notes" in two tranches. $100m with a coupon of 4.4% rated A by KBRA, and $11m with a coupon of 5.38% rated BBB. Tenor for both tranches is 30 years. Credit Suisse was the lead underwriter for the deal.

The notes are backed solely by the cash flow generated by a portfolio of residential solar energy systems and related customer agreements. This transaction represents Sunrun's inaugural issuance into the asset backed securitisation market. SolarCity pioneered issuance of ABS in the solar space in 2013 and 2014.

We’re looking forward to seeing more exciting green ABS issuances this year – this flurry of deals demonstrates the potential for green ABS to grow investment in a wide variety of small-scale low-carbon assets.

Digital Realty Trust issues US$500m green bond (3.95%, 7yr) for low-carbon buildings

Real Estate Investment Trust (REIT) Digital Realty Trust Inc. has issued its first green bond for US$500m to finance green buildings for data centres. The bond has 3.95% coupon and 7 year tenor. Bank of America Merrill Lynch, Citigroup, J.P. Morgan, RBC Capital Markets, and US Bankcorp are the deal underwriters.

The proceeds of the green bond will go to fund eligible green building projects. Instead of a second review from an independent party, Digital Realty has referenced existing green building standards, setting specific performance criteria that building projects must hit to be eligible. For example, buildings must have received, or be expected to obtain, LEED certification Silver, Gold or Platinum; BREEAM certification level Very Good, Excellent or Outstanding; BCA Green Mark rating Gold, GoldPlus or Platinum; Green Globes 3 or 4; CEEDA Silver or Gold or CASBEE B+, A or S.

Projects funded can be new or on-going building developments, renovations in existing buildings and tenant improvements. Any upgrade projects must improve energy or water efficiency by a minimum of 15% and be checked by an external party. Excellent that they have nominated a hurdle rate – something we should expect all green property bond issuers to do.

Digital Realty will report annually on their website covering the allocation of proceeds to eligible projects and status of green building certifications of the projects. An independent accountant will verify the company’s statement.

Next time we hope to see even more ambition with hurdle rates, and we'll be keen to see more detail about the (excellent) commitment to onsite renewables used. Also, some building standards cited are not as good as they could be — for example Singapore’s Green Mark Gold only represents the legislated minimum for a new development, with most new developments achieving well above the lowest nominated. We’re working on that to make it easier for issuers! But the great improvements around green property commitments in US market demonstrated by this bond outweigh such concerns for us.

Digital Realty have done a great job with their debut bond.

Latvenergo’s EUR75m green bond issued last week (1.9%, 7 yr, Baa2) will use proceeds for bioenergy, environmental preservation and sustainable environment

The first Latvian green bond from power utility Latvenergo was upsized from EUR 50m to EUR75m (US$84.8m), with a fixed annual coupon of 1.9%, 7-year tenor and rated Baa2 by Moody’s. The sole underwriter was SEB.

CICERO’s second opinion rated Latvenergo’s bond as “dark green”. Proceeds will be used for energy efficiency projects in the electric power grid and other projects (renewable energy, environment preservation, biodiversity and R&D for sustainable environment).

The renewable energy projects focus on bioenergy power plants. Experts tell us that using sustainable feedstock is crucial in bioenergy (see the Climate Bonds Standard for more details). Latvenergo is using only local Latvian wood, which is good to hear, although it would be good if investors were given certainty on whether the feedstock for Latvenergo’s bioenergy plants will be certified – from what we can tell only 50% of Latvia’s forests are certified under the Forest Stewardship Council.

Projects in the environmental preservation and sustainable environment category seek to minimise the environmental impacts of existing operations, such as hydropower and the electric grid infrastructure. Safety and flood management improvements for hydropower, protecting fish migration around dams and monitoring electric power poles for white storks nests (a protected species) are all eligible projects.

R&D also falls into the sustainable environment bucket. Proceeds from green bonds are generally used for green assets rather than R&D into future projects; we are interested to see how the green outcomes will be reported next year. It’s worth noting that only up to 10% can go toward this project type.

Overall: great to see Latvia’s first green bond in the market!

European rail finance powerhouse Eurofima issue unlabelled climate-aligned kanga bond for A$35m ($27m)

We’ve covered “unlabelled” solar and wind bonds in the past; we will now start including other unlabelled bonds that are climate-related. This week’s example is the large rail finance entity Eurofima (a supranational: a financing agency backed by mutliple governments) issuing an A$35m 10-year bond with 3.9% coupon. It has a AA+ and Aa1 rating from S&P and Moodys respectively.

Rail infrastructure is a key part of low-carbon transport, since rail is far superior on emissions performance compared to road-based travel. According to our 2015 State of the Market report there are $418.bn of low-carbon transport bonds outstanding, mainly in the unlabelled climate-aligned bond universe. So plenty of opportunities around for investors.

——— The Climate Bonds Team includes Sean Kidney, Tess Olsen-Rong, Beate Sonerud, and Justine Leigh-Bell. 
 The Climate Bonds Initiative is an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

July 12, 2015

CAFD: Don't Let The Joke Be On You

Tom Konrad CFA

Sunpower and First Solar are indulging in nerd jokes. 

Their YieldCo, called 8point3 Energy Partners had its initial public offering on June 19th. The name is an astronomy nerd joke and a reference to the time it takes the sun's rays to reach the Earth, 8.3 minutes. Last week, we found out that its ticker symbol is CAFD, a "financial nerd joke" because it stands for "cash available for distribution." 

CAFD is an important YieldCo metric, but it's not a perfect one. If you're not a financial nerd but are interested in investing in YieldCos, here's what you need to know to make sure the joke isn't on you.

What is CAFD?

Cash available for distribution (CAFD) is a YieldCo's estimate of how much of the cash from its assets is available after it has paid the cash expenses necessary to keep the company running. Such expenses mostly consist of interest and principal payments on debt and maintenance of facilities. Cash spent on new investments is also deducted, but this deduction is typically net of equity or debt financing.

CAFD is a "non-GAAP" measure, meaning it is defined by generally accepted accounting principles (GAAP), and so is not always comparable between YieldCos, as their definitions may vary slightly from the one above. Some YieldCos also use other names, such as "adjusted earnings per share" by NextEra Energy Partners (NEP) or "core earnings" used by Hannon Armstrong (HASI).

YieldCos are designed to return as much cash as they can to investors without compromising the company's sustainability. Since there is no GAAP measure of how much cash a company can return to investors, they had to invent one. This is also a common practice among other income-oriented classes of securities such as REITs ("adjusted funds from operations").

Strengths and weaknesses

Like any metric, CAFD has strengths and weaknesses. Its greatest strength is observability. Unlike GAAP measures like earnings, there is no need to estimate the likely life of an asset for purposes of depreciation, and no need to accrue expected future costs. Such estimates are intended to help earnings and other GAAP measures to reflect the true economic results of a company, but the very complexity of the rules often obscures as much as it reveals.

CAFD's greatest weakness is that it is short-term in nature. While most YieldCo businesses are fairly stable, nothing is forever. Most YieldCo assets are long-lived, but even solar panels degrade slowly over time, and most wind turbines are designed to last around 20 years. Further, many YieldCo assets had been operating for some time before they were acquired.

Perhaps more important are the power-purchase agreements (PPAs) under which YieldCos sell the power they generate. These agreements typically have another 15 to 20 years to run, but many YieldCos seem to assume that they will be renewed on similar or even more advantageous terms when they expire.

Rules of thumb

Investors who want to choose between YieldCos should pay attention to CAFD per share and YieldCo CAFD per share growth targets, because dividends closely follow CAFD per share. But CAFD should not be the sole focus. They also need to understand how CAFD's short-term nature will bias the comparisons between YieldCos.

Beyond higher current and future CAFD, investors should prefer

  • YieldCos with longer-term PPAs
  • Longer-lived assets (hydropower lasts longer than solar, which lasts longer than wind)
  • Better-credit-quality power purchasers
  • PPAs that sell power for close to the market price (because these are more likely to be renewed on favorable terms)
  • Technologies which are not getting cheaper rapidly, or unique assets
  • Dispatchable generation technologies
  • Technologies that require fewer inputs (fossil fuels, water, biomass) that might cost more in the future
  • Technologies that produce less pollution and are subject to potential regulation

PPA pricing risk

The problem for YieldCos that own assets which are getting rapidly cheaper lies in the prospects of PPA renewal. For example, solar photovoltaic system prices are universally expected to continue to decline (see chart below).

Today, a new utility-scale solar facility costs about $2,000 to $2,500 per kilowatt. It will produce about 1.2 megawatt-hours to 2 megawatt-hours per year per kilowatt, depending mostly on the local climate. Suppose we have a new solar facility that produces 1.5 megawatt-hours per year per kilowatt and which cost $2,250 per kilowatt to build. If various incentives cover half the cost, the facility would require a PPA at $67 per megawatt-hour to achieve a 9 percent CAFD yield.

Now consider what will happen in 15 years when the PPA expires. The facility will have degraded somewhat, reducing its output by 5 percent, maybe a little more. A new solar facility next door will be much cheaper, but will likely also qualify for far fewer incentives. If we assume that the new facility will cost $1,000 per kilowatt after (much-reduced) incentives, it would need a PPA at $59 per megawatt-hour to achieve the same to 9 percent CAFD yield. $1,000 per kW is a very conservative estimate for installed commercial solar costs in 2030 given that First Solar's (FSLR) CEO expects that his company can hit that target by 2017.

If the customer can sign a PPA with a new solar farm at $59 per megawatt-hour, why would they sign a PPA with the old farm for more? After the 5 percent degradation and slightly higher maintenance costs for the older solar facility, a $59 per megawatt-hour PPA will only result in a 7.5 percent CAFD yield from a renewed PPA.

Hence, PPA prices for electricity from technologies like solar with rapidly declining costs are likely to fall as well. Since this effect may be partially offset by falling subsidies, YieldCos which own subsidized facilities may have an advantage if those subsidies are removed for future, competing facilities.

The weather-dependent nature of solar and wind is likely to exacerbate this problem. It used to be that solar production was well aligned with peak load on sunny summer afternoons. Now, locations with high solar penetration are beginning to experience a “duck curve,” with power prices dropping when solar production is at its peak.

In 15 years, when solar and wind PPAs will need to be renewed, it seems unlikely that utilities will be queuing up to purchase power that arrives when they need it least. Parts of the grid with high wind penetration already see zero or negative electricity prices at times of high wind and low electric demand, although grid expansion can alleviate this problem.

Such weather-related effects favor dispatchable technologies like natural-gas generation, but this advantage is offset by regulatory risk, because gas is a fossil fuel. 

Technologies like hydroelectric and geothermal are likely to have the most durable pricing power. Not only do hydroelectric power plants usually last for 50 years, they typically have longer-term PPAs. They also have very little competition from new hydroelectric or geothermal plants nearby, because the best sites are already taken. Both hydro and geothermal have some potential for dispatchability, also reducing their long-term pricing risks, although resource risks from geothermal reservoir depletion and changing weather patterns should not be ignored for either.

Incentive distribution rights and dividend

Normally, a YieldCo's dividend is directly linked to its CAFD because it will distribute all its cash available for distribution. Incentive distribution rights (IDRs) change this, because they allow for a larger share of CAFD to flow back to the YieldCo sponsor. YieldCos with IDRs include NextEra Energy Partners, TerraForm Power, Brookfield Renewable Energy Partners, and now 8point3. 

CAFD is a great metric in that it gives investors a quick guide to what sort of dividend to expect in the short term. Given its short-term nature, this may be all that short-term investors and traders need. Income investors typically have a longer-term outlook. For them, it makes sense to look at the many factors detailed above which will affect a YieldCo's dividend over the long term. 

All clean energy technologies have risk, and we do not know which will be most important over the long term. Hence, it makes sense to diversify some of this risk away by including YieldCos which own less common clean energy technologies, such as geothermal, hydropower and energy efficiency.

There is not yet any publicly traded YieldCo which owns any geothermal assets, but both U.S. Geothermal and Alterra Power own geothermal assets, and could benefit if YieldCos seek to buy such assets to diversify their portfolios. Unfortunately for income investors, neither pays a dividend.

Both Brookfield Renewable Energy and Canadian power producer Innergex Renewable Energy own mostly hydroelectric facilities and pay healthy dividends. Alterra Power also owns hydroelectric facilities.

The unique sustainable infrastructure financier Hannon Armstrong has the most diverse portfolio, and is currently the only YieldCo with significant energy-efficiency investments.

 ***

Tom Konrad is a financial analyst, freelance writer, and portfolio manager specializing in renewable energy and energy efficiency. He's also an editor at AltEnergyStocks.com.

Disclosure: Long Hannon Armstrong, Brookfield Renewable Energy Partners, Alterra Power, Innergex Renewable Energy, First Solar.

Note: The author of this article will be an instructor at EUCI's "The Rise of The YieldCo" workshop on July 30-31. This article was first published on GreenTech Media and is reprinted with permission.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. 

July 10, 2015

How Much Can YieldCo Dividends Grow?

Tom Konrad CFA

U.S.-listed YieldCos seem to offer the best of two worlds: high income from dividends, combined with high dividend per share growth.

YieldCos are listed companies that own clean energy assets, and like the real estate investment trusts (REITs) and master limited partnerships (MLPs) they are modeled after, they return almost all the income from their investments to their shareholders in the form of dividends. Unlike REITs and MLPs, however, U.S.-listed YieldCos have management targets to deliver double-digit per-share dividend growth.

Historic and target growth

YieldCos shown are NRG Yield (NYLD), Abengoa Yield (ABY), TerraForm Power (TERP), NextEra Energy Partners (NEP), Hannon Armstrong (HASI), Pattern Energy Group (PEGI), Brookfield Renewable Energy (BEP), and TransAlta Renewables (TSX:RNW, OTC:TRSWF).

Historic growth rates are not shown for some YieldCos because they have only been paying dividends for less than a full year. Dividend growth targets are not shown for TransAlta Renewables because the company's management has not issued explicit targets. The data shown is drawn from company financial filings.

In contrast, growth rates above 10 percent for REITs and MLPs are virtually unheard of, but they are the norm for U.S.-listed YieldCos. 

Sources of dividend growth

Companies can achieve per-share dividend growth in a number of ways: normal increases in income from existing business; reinvesting money generated by the business; and investing money from new share issuance.

In the case of YieldCos, income from existing clean energy facilities can increase because of inflation escalators built into the power-purchase agreements (PPAs), or if the YieldCo invests to increase power production. PPA escalators tend to be low (2 percent or less.)  

Aside from the natural increase in cash flow from escalators in existing PPAs, a YieldCo can raise its cash flow available for distribution (CAFD) per share by increasing invested capital per share. Companies often increase invested capital per share by investing some available cash flow. This increases future dividends at the expense of current yield. Since most YieldCos distribute nearly all of their available cash flow, this is not a significant contributor to dividend growth.

Instead, YieldCos typically issue new shares to pay for new investments. Because most YieldCos have seen significant price appreciation since their IPOs, new shares can be sold for higher prices than previous shares.  Share issues always provide more capital for a company to invest. When those shares are sold at higher prices, they also increase the per-share capital.

The following chart shows how the three oldest U.S. YieldCos have been able to increase the issue price of secondary offerings over time.

Yieldco Share Issuance

By selling new shares to the public, many YieldCos have been able to achieve the high per-share dividend growth rates shown in the first chart.

High dividend growth

In theory, as long as their share prices keep rising, YieldCos will be able to maintain their historic high dividend growth rates forever. 

In fact, recent price rises mean that dividend growth can continue for some time even without further share appreciation. The chart below shows the expected per-share dividend increase which would arise from investing the proceeds of a share issue at the current stock price, along with the YieldCos' stated growth targets. 

In the chart, a “percentage share increase” means issuing a number of shares, which is the percentage of the shares currently outstanding. For instance, if a YieldCo has 10 million shares outstanding, issuing 2 million shares would be a 20 percent increase, 5 million new shares would be a 50 percent increase, and 10 million new shares would be a 100 percent increase.

The effects of larger-percentage stock issues are not shown in the chart if the YieldCo is already so large that the new issue would exceed $2 billion. This is because investors would not be willing to buy so much new stock quickly, and the YieldCo would have trouble finding so many attractive projects to invest in quickly.

The $2 billion number is arbitrary, but I chose it because the largest YieldCo acquisition to date was TransAlta Renewables purchase of $1.78 billion worth of assets in Western Australia from its parent company TransAlta. Most YieldCo acquisitions are much smaller, and no YieldCo has bought more than $2 billion worth of assets during its history as a public company.

Yieldco distribution growth

As you can see in the chart above, the U.S.-listed YieldCos NRG Yield, Abengoa Yield, TerraForm Power, and NextEra Energy Partners have the greatest potential for percentage increases in their per-share dividends. 

The U.S.-listed REIT Hannon Armstrong, which is very similar to the YieldCo despite its REIT structure, and the dual-listed YieldCos Pattern Energy Group and Brookfield Renewable Energy Partners also have good potential and target percentage growth rates. From the perspective of growth potential, the Canadian-listed YieldCo TransAlta Renewables is far behind. It also lacks specific per-share growth targets.

Not high yield

These impressive per-share growth rates disguise the vulnerability of relying on new share issuance for new investment. The share price increases necessary to perpetuate rapidly growing distributions also reduce the yield.  This is because yield is simply distributions per share divided by the share price.

Unless the share price falls, the amount of invested capital from share issuance will never exceed the share price, and so the dividend yield will remain below the YieldCo's cash-on-cash returns from new investments. 

As we have seen here and in the chart below, YieldCos' new investments have cash-on-cash returns in the 7 percent to 9 percent range.

Despite the potential for rapid percentage dividend growth, the 7 percent to 9 percent range for YieldCo returns on investment will also cap future yields. No YieldCo can have a higher distribution yield unless its price falls, or it starts to reinvest some of its cash flow into the business, which would cause its yield to fall in the short term.

This final chart is similar to the Model Growth In YieldCo distributions chart above, except that here the dividends are shown as a yield on the current share price.

From the perspective of current and potential future yield at the current share price, the U.S.-listed YieldCos suddenly seem much less impressive. In fact, the previous apparent laggard, TransAlta Renewables, already has a current yield as high as the yield which the best other YieldCos hope to achieve after two more years. 

Even if their impressive dividend growth rates continue, the U.S.-listed YieldCos are many years from achieving yields comparable to TransAlta Renewables' yield today.

More bad news

The illusion of rapid dividend growth is not the only bad news. TerraForm Power, NextEra Energy Partners, and Brookfield Renewable have incentive distribution rights (IDRs) which give the YieldCo's parent company (General Partner) a growing percentage of distributions when those distributions exceed certain levels per share. TerraForm's IDR will begin to take effect when the quarterly dividend hits 34 cents per share (it's currently 32 cents), and it will rise to 50 percent of distribution increases when it hits 45 cents.

NextEra Energy Partners' IDR Fee will begin to take effect when quarterly dividends reach 21.6 cents (currently 19.5 cents).  It will rise to half of distribution increases when dividends reach 28.1 cents.

Brookfield's incentive distributions are currently in effect, with the parent Brookfield Asset Management currently receiving 15 percent of quarterly distributions in excess of 37.5 cents. This incentive will soon rise to 25 percent when quarterly dividends exceed 42.25 cents per share. Dividends are currently 41 cents, so the 25 percent threshold will likely be met soon.

YieldCos' parent companies justify IDRs because they supposedly align the parents' interests with the YieldCos' shareholders. Since the parents have complete control, and are often the sellers of the clean energy facilities which YieldCos buy, this is not an unreasonable argument. On the other hand, as long as YieldCos are using new share offerings at ever higher prices to increase distributions, IDRs are essentially an incentive to just do more deals using other people's money.

IDRs would do a much better job of aligning the parties' interests if they were defined in terms of distributions as a percentage of the average price at which shares had been issued.  As it is, IDRs create a perverse incentive to issue more shares whenever the stock price is high relative to previous issuance.

IDRs will reduce potential yields at these three YieldCos.

Conclusion

Investors have been seduced by rapid percentage dividend growth targets at the U.S.-listed YieldCos NRG Yield, NextEra Energy Partners, TerraForm Power, and Abengoa Yield. 

It is likely that these YieldCos will continue to meet, and sometimes exceed, these impressive targets; the growth will be fueled in large part by new share issuance at higher prices. Such share issuance allows dividends to rise while placing a cap on yield. In the case of YieldCos with IDRs, it also allows the YieldCos' parents to “earn” an incentive by spending other people's money.

Investors considering the purchase or sale of a YieldCo today should care more about current and future yield than they do about yield growth rates. Another way to think of yield is as the number of dollars of annual income for each $100 you invest in the YieldCo. Assuming distribution growth targets are met, the following chart shows how much income each YieldCo will produce over the next three years.

(Since TransAlta Renewables does not publish dividend growth targets, the corresponding numbers are the modeled dividend growth from issuing 20 percent and 50 percent more shares.)

If the investment objective is long-term income, it is clear which YieldCos are the most attractive.

Invest accordingly.

***

Tom Konrad is a financial analyst, freelance writer and portfolio manager specializing in renewable energy and energy efficiency. He's also an editor at AltEnergyStocks.com.  He will be an instructor at EUCI's "The Rise of The YieldCo" workshop on July 30th and 31st.  This article was first published on GreenTech Media and is reprinted with permission.

Disclosure: Tom Konrad and/or his clients have long positions in PEGI, HASI, RNW, and BEP. They have short positions in NYLD-A.

Disclosure: Long 

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 08, 2015

Are YieldCos Overpaying for Their Assets?

Tom Konrad CFA

YieldCos buy and own clean energy projects with the intent of using the resulting cash flows to pay a high dividend to their investors. 

Several such companies, often captive subsidiaries of listed project developers, have listed on U.S. markets since 2013. So far, YieldCos have been a win-win: The developers that list YieldCos have gained access to inexpensive capital, and income investors have gotten access to a new asset class paying stable and growing dividends. 

So far, they have also gained from significant stock price appreciation. The seven U.S.-listed YieldCos are up between 21 percent for Abengoa Yield (ABY) and 136 percent for NRG Yield (NYLD) since they were listed.

However, some experts believe YieldCos are overpaying for projects. “We've seen them purchasing at prices we think don't make sense," said Chris Francis, the founder of Seven Waves Corporation.

Francis describes Seven Waves Corporation as a private YieldCo. Like its publicly traded cousins, Seven Waves invests in solar projects. The publicly traded YieldCos are his direct competitors, and their access to cheap capital “has made us adjust the prices” that Seven Waves pays for projects. 

Seven Waves has to meet the return objective of its investors, and the competition from YieldCos has made it “a very slim business, with not much meat left on it.” It is still possible for Seven Waves to acquire projects. It has had to adapt to a much more difficult environment, but Francis expects to close on the purchase of a 76-megawatt solar farm in the next few weeks.

What they are paying

Francis, like most financial professionals, evaluates the value of a solar project using the metric internal rate of return. IRR gives an interest rate or yield, which allows a project with cash flows that vary over time to be compared to a simple-interest-bearing investment like a CD or a bond.

Not all public YieldCos announce their acquisitions, and none of the ones that do have disclosed the IRRs for the projects they are investing in. TerraForm Power's recent announcement of its purchase of 23 megawatts of solar from Integrys is typical. 

It says, “These plants are expected to generate average levered CAFD of approximately $5 million annually over the next 10 years. The equity consideration to be paid for the acquisition is $45 million. In addition, TerraForm Power will assume $10 million in project debt. This represents an expected levered cash-on-cash return of greater than 9%.”

“Levered cash-on-cash return” is a lot less useful than IRR, in the same way that “payback” is a less-than-ideal way to evaluate the value of an investment in solar for your home. Payback is just the inverse of cash-on-cash return. In this case, payback is 11 years ($55 million cost / $5 million CAFD, also equal to 1 divided by the cash-on-cash return). Both payback and cash-on-cash return fail to account for inflation, depreciation, project lifetime, or anything that happens after the payback period. 

In the case of TerraForm's announcement above, we are told, “The assets were placed into operation between 2008 and 2013, and are contracted under long-term power-purchase agreements (PPAs) with a variety of commercial and municipal entities having a weighted-average credit rating of Baa2. The contracts have a weighted average remaining life of 15 years.” 

But the payback and cash-on-cash return would be the same if the projects had just been built and had PPAs that had a remaining life of 20 years or more, making them more valuable. Cash-on-cash return would also not change if the PPAs only had 10 years to run, and the solar farms were at the end of their useful lives.

Despite the weaknesses of the metrics cash-on-cash return or payback, these measures do not require assumptions about the long-term value of a wind or solar farm, and the truth is, no one really knows what that is. We don't know what the electricity market will be like in 15 years.

Will TerraForm be able to sign new PPAs at that time, and at what price? Francis says that YieldCos seem to be “very aggressive” about their assumptions about future electricity prices. Historically, electricity prices typically have always risen, and YieldCos seem to be assuming that they will continue to do so. Francis, on the other hand, thinks that the large-scale deployment of renewable energy will cause prices to fall, at least in the middle of the day when solar is operational, and at times of strong wind in areas that have significant wind penetration.

He says he sees YieldCos getting 4 percent to 6 percent IRRs. That corresponds to the range of IRRs I compute from the 7 percent to 10 percent cash-on-cash returns from YieldCo announcements (see charts below). The TerraForm acquisition referenced above is one of the better ones; it has an IRR between 5 percent and 7 percent depending on the assumptions made about revenue after the PPAs expire. 

The following chart shows a compilation of cash-on-cash returns gathered from YieldCo announcements where they can be calculated. Note that these numbers are not strictly comparable from one YieldCo to the next because of slightly different assumptions about how to treat assumed debt and what expenses are deducted from the project's expected cash flow. 

TERP's Integrys acquisition is shown at 11 percent, not the 9 percent cited in the press release, because I judged that removing the assumed debt from the purchase price made it more comparable to previous TERP announcements.

According to Francis, some unannounced acquisitions have even worse IRRs. One had an IRR of 1 percent when evaluated using Seven Waves' assumptions. He thinks that such purchases could only be justified if the buyer assumes a 10 percent to 15 percent increase in electricity selling prices for the second PPA, with ongoing 2 percent annual price increases after that. 

Such assumptions imply that utilities would be willing to pay far more for a PPA with an old solar farm than they would have to pay to construct a new one, given the widespread consensus that the price of new solar installations is likely to continue to fall, not rise. Francis observes that we have already seen some utilities trying to get out of PPAs in court. That does not bode well for their willingness to sign even more generous PPAs in the future.

Trends

Despite widespread talk that the market for clean energy projects is getting more competitive, I was not able to find a long-term trend of cash-on-cash returns over time. While some YieldCos such as TerraForm and Pattern Energy Group (PEGI) seem to be getting better returns than other YieldCos, most of the highest returns are on the smallest investments, as shown in the chart below. The labels and bubble sizes show the size of the purchase, not including assumed debt.

What we can see is that the pace of deals has been picking up. More of the deals shown in the chart closed in the first half of 2015 than in all of 2013 and 2014 combined.

Francis believes that this level of frenetic deal-making may soon come to an end. He thinks that when the federal Investment Tax Credit (ITC) falls at the end of 2016, it may lead to a short burst of deal-making as project developers leave the industry and sell off their existing farms. Some developers will continue to build farms, but at a more sedate pace, because it will be less lucrative without the ITC.

The effects on YieldCos

YieldCos can only raise dividends by acquiring more projects, or making the projects they have more productive. Both require cash to invest. Paying high prices (and getting low IRRs) for projects means that they have little or no money to invest after they pay their dividends. 

So far, rising share prices and secondary stock offerings have provided the funds for these investments, but this will only work if investors' giant appetite for YieldCo shares continues. That appetite for YieldCo shares depends on their expectations for continued dividend increases. 

Anything that disrupts either investor demand or rising YieldCo dividends will feed back to disrupt the other in a vicious cycle. Stagnating dividends will attract fewer new investors, and fewer new investors will be able to fund fewer of the acquisitions the YieldCos need to keep raising their dividends. 

In recent weeks, rising interest rates have begun to dampen investor demand for YieldCo shares. Will that or some later event like the ITC's sunset trigger the vicious cycle? We will only know in hindsight. 

As for Francis, rather than continuing to try to compete with YieldCos' cheap stock market capital, he's hoping that he can get access to some of his own by possibly taking Seven Waves public through a reverse merger with a listed company.

***

Tom Konrad is a financial analyst, freelance writer and portfolio manager specializing in renewable energy and energy efficiency. He's also an editor at AltEnergyStocks.com.  He will be an instructor at EUCI's "The Rise of The YieldCo" workshop on July 30th and 31st.  This article was first published on GreenTech Media and is reprinted with permission.

Disclosure: Tom Konrad and/or his clients own shares of Pattern Energy Group (PEGI) and TransAlta Renewables (TSX:RNW), and short positions in NRG Yield (NYLD).

Disclosure: Long 

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

May 26, 2015

My Yieldco Raised Its Dividend With This Weird Trick

Tom Konrad CFA

Clean energy yieldcos buck the general trend by paying out a large proportion of cash flow to investors, and rapidly increasing their dividends at the same time.  The key to this trick has been their rapidly appreciating stock prices.

High yield companies generally grow slowly, while high growth companies have low dividend yields.

Normal companies grow by investing some profits in new business opportunities.  Early stage growth companies typically retain all their earnings to invest in new business.  More mature companies have fewer opportunities, and so share a larger proportion of profits with their shareholders.  Mature companies tend to grow more slowly: they return more of their earnings to shareholders in the form of dividends, and the investments they do make tend to be less transformative and more incremental. 

New investments can also be financed by selling more shares to the public.  In this case, the company's overall income will grow because it has more investments, but income per share can only increase if the new investments produce more income per share issued than the company's existing investments. 

The Strange Case of Yieldcos

Yieldcos are subsidiaries of clean energy project developers.  They buy clean energy projects from their parent companies or other developers, and pay out nearly all of the income the projects produce as dividends to shareholders.

In finance jargon, the percentage of profits reinvested in the business is the "Retention Rate."  "Return on Investment" is a measure of how lucrative or transformative a business opportunity can be.  Financial theory says that, if all new investments come from retained earnings, its growth rate will be the product of Retention Rate and Return on new investments. 

By design, yieldcos' retention rates are very low, yet all have been regularly increasing dividends, and most have targets for continuing to increase dividends per share at an extremely rapid rate.

According to the financial theory outlined above, yieldcos should only be able to accomplish this if their new investments are much more lucrative than their existing investments.

Skipping the math for clarity, the following chart looks at the three oldest yieldcos, chosen because they have more data available than other yieldcos.  The three yieldcos shown are NRG Yield (NYSE:NYLD, NYLD-A), Pattern Energy Group (NASD: PEGI) and TransAlta Renewables (TSX:RNW, OTC:TRSWF).

The chart shows recent Retention Rates (amount of cash flow available for distribution which they do not pay out) in blue.  It also shows recent dividend growth (red) and dividend growth targets (yellow and green.)  The brown bars are return on investment from each company's most recent publicly announced acquisition, while the light blue bars show what each yieldco's calculated implied growth rate would be if the only source of growth were from investing retained earnings in the announced projects.  The data is derived from company financial statements and press releases.

Yieldco growth rates.png

The Mystery

Without retained earnings or great returns on investment, how are yieldcos raising their dividends?

As you can see, the implied growth rates (1% to 2%) are far below actual and target dividend growth rates.  This would normally lead us to the conclusion that yieldcos have extremely attractive opportunities for new investments.  We would guess that money raised from the sale of shares to the public is invested these extremely attractive opportunities, and all shares would see a cash flow and dividend boost because the very high returns on new investments more than compensates for the dilution of the new shares.

As you can see in the following chart the returns on the yieldcos' recent investments have been fairly low, and have not been rising significantly. 

Yeildco ROI
I show a rough measure return on investment for those acquisitions from the same three yieldcos where there was sufficient information disclosed for me to make the calculation.  The measure shown is estimated annual cash flow divided by the equity invested.  A more technically accurate measure would also take into account how annual cash flow changes over time, but that information is not available in the press releases. 

As an aside, since these returns are based on estimates from company management, inter-company comparisons may not be meaningful.  In particular, the fact that Pattern's returns on investment have been higher than those of NRG Yield or TransAlta Renewables may be a product of different management assumptions, rather than a true economic advantage.

The mystery remains: Without retained earnings or great returns on investment, how are yieldcos raising their dividends?

The Weird Trick

Although yieldcos are not getting better returns on dollars invested, they are getting more money for the shares they sell.

For example, NRG Yield raised $11 per split adjusted share in its July 2013 IPO.  In its July 2014 secondary offering, it sold shares at a split-adjusted $27 per share.  Every dollar invested in the Energy Systems Company acquisition in 2013 produces 6.7¢ of annual cash flow.  At $11 per share, that is 73¢ cash flow per share.   In contrast, NRG Yield's 2015 investment in the second group of Right of First Offer (ROFO) assets from its parent, NRG, produces a very similar 7.3¢ per dollar invested.  But the shares it sold in July produce $1.97 of cash flow per share when invested in the ROFO assets. 

While NRG Yield's return on invested cash has barely budged since 2013, its return on each new share sold has grown almost three-fold.
The key to NRG Yield's massive dividend per share growth is not better investment opportunities.  The key to its dividend per share growth is selling stock to the public at ever increasing prices.  Many other yeildcos are projecting per share dividend growth based on similar share price growth.

When Will It End?

As long as yieldcos can increase their invested capital per share by selling stock at higher prices, they should be able to continue increasing their per share dividends quickly.  But given many yieldcos' low current yields, the stock prices will only continue to rise as long as investors expect dividends to continue to grow rapidly.  

So far, most yieldcos have enjoyed the benefits of a virtuous cycle of rising share prices and rising dividends.  Rising share prices allow more cash flow per share sold, which in turn allows large dividend increases.  Large dividend increases excite investors, who drive up stock prices, and the cycle repeats.

To keep the cycle going, yieldcos are on a treadmill which requires them to make ever larger purchases of new assets. This growing demand for renewable energy assets, will raise the prices of such assets and lead to declining returns on investment.  This, in turn, is undermines future dividend growth, which in turn will undermine stock price growth. 

At some point, the virtuous cycle will turn vicious.  Failure to meet dividend growth expectations may lead to declining share prices, and lead to further declines in dividend growth, and so on.  Or flat stock prices may make increases in cash flow per share harder to achieve, and this will lead to low dividend growth rates, leading investors to sell the stock.

What Can Investors Do?

Yieldco investors who wish to avoid getting caught in this vicious cycle should focus on those yeildcos with prices that are based more on current dividends than on future dividend growth.  These are easy to identify: they are the yeildcos with the highest current yields.

TransAlta Renewables (TSX:RNW, OTC:TRSWF) currently tops the list, with a 6.6% yield at the current (Canadian dollar) share price of C$12.68 and 7¢ Canadian monthly dividend.  It also has the advantage of slightly higher retained earnings than the other yieldcos, which should allow it to produce a little more conventional dividend growth than the others.

Note: The author of this article will be an instructor at EUCI's "The Rise of The Yieldco" workshop on July 30th and 31st.

Disclosure: Long PEGI, TSX:RNW.  Short NYLD, NYLD-A

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

April 27, 2015

Green Bond Market Heats Up After Slow Start To 2015

$7.2 billion of green bonds issued.  Market shows signs of maturity, including more currencies, and non-investment grade bonds.  Emerging market green bonds are ramping up, while green munis are booming.

by Tess Olsen-Rong, Climate Bonds Market Analyst

The first three months of 2015 (Q1) have seen 44 green bond deals totalling $7.2bn of issuance. After relatively low issuance in January the amount of green bonds issued has been climbing each month, with March three times bigger than January. This year will be the biggest year ever for green bonds: there’s a healthy pipeline of bonds in the works and we expect Q3 and Q4 in particular to be strong in the lead up to the UN COP.

From a slow Q1 2015 start green bond issuance is climbing

To grow a deep and liquid green bond market we need to not only scale issuance but we also need diversification of currency and ratings. This was starting to show in Q1 with 11 different currencies and ratings ranging from AAA to B-.

The big story in Q1 was the growing interest in green bonds in emerging markets shown by the increasing commentary on potential green bonds from the Middle East, China and South Asia. However, it was India who made the headlines, with the first Indian green bond issued in February.

The US municipal green bond market continued to grow with water and green buildings dominating the use of proceeds. One big difference between US municipal green bonds and other green bonds, however, is the low uptake in second opinions: none of the Q1 green muni issuances chose to get a second opinion.

Finally, if you think the role of the development banks in the green bonds is petering out, think again! In addition to contributing with benchmark issuances, many are increasingly supporting the green bond market through more specialised issuances in different currencies and structures, as well as on the investment side of the market.

Emerging markets: India’s first two green bonds, beating China to the punch

Low-carbon and climate resilient finance needs to grow fast in emerging markets with huge levels of investment required by 2050. The good news is that green bonds offer a potential solution. We had thought that China would be first of the largest emerging economies to enter the green bond market, but India beat them to the punch with a corporate green bond from Yes Bank. The INR 10bn ($161.5m) bond will finance renewable energy projects.

Hot on the heels of Yes Bank was the Export Import Bank of India, with a larger $500m green bond. The bond will finance renewable energy and low carbon transport projects – although not in India, but in neighbouring Bangladesh and Sri Lanka. Policy support for the low-carbon transition may have been influential in encouraging these Indian green bonds: India has a target of creating 165 gigawatts of new renewables by 2022. According to Yes Bank, $70bn of debt investment is required to achieve this goal – meaning ample opportunities for green bonds! After some lobbying, the Indian government has become supportive of the use of green bonds as a tool to meet India’s green financing needs; they have apparently been asking Indian Government agencies and development banks to start issuing green bonds. Expect to see more of green bonds out of India this year.

But let’s not forget about China. We now expect the first Chinese green bond mid-year, heralding a rush of green issuance.

Currency diversity allows more investors to gain exposure in green bonds

Green bonds need to be available in a range of currencies to give a wide range of investors the opportunity to invest. The bulk of green issuance continues to be in USD and EUR, but the development banks have been increasingly issuing smaller green bonds in a range of currencies including Turkish Lira, Brazilian Reals and Indian Rupees — in Q1 green bonds were issued in 11 different currencies. Australian investors were also able to buy the KfW’s Kangaroo green bond in local Aussie dollars, which proved incredibly popular. Outside of the development banks, some corporates also appealed to local investors, such as the Wallenstam and Vasakronan green bonds in Swedish Kronor. Creating a deep and liquid green bond market requires currency diversity and in the past three months we’ve started to see that.

Green bonds were issued across 11 different currencies in Q1 2015 showing the growing depth in the market – however the USD and EUR issuance continued to dominate

Non-investment grade: Greater diversity as green bonds move down the ratings

We’ve also seen more high-yield bonds in the market — another important indicator of depth. Two of the largest green bonds (Terraform’s and Paprec’s) in the first quarter were non-investment grade; and they came from different types of issuers, respectively a yieldco and a corporate.

Terraform Power Operating (BB-) yieldco hit the market early in January with a sizeable $800m green bond to finance the acquisition of renewable energy assets. The bond followed the successful yieldco green bonds last year from NRG Yield and Abengoa Greenfield. French recycling company Paprec then issued its inaugural bond; a whopping (EUR 480m) $523m bond split across two tranches of EUR 185m/$201m (B-) and EUR 295/$321 (B+).

US munis ramp up issuance, but stay clear of second opinions, leaving green credentials more difficult to determine

Four US states saw green bond issuance during Q1: Washington (Tacoma), Massachusetts, Arizona and Indiana. Proceeds from the green muni bonds are funding a wide range of projects, but are mainly centred on clean water and low-carbon buildings.

The State of Indiana joined Chicago and Iowa in issuing a green water bond; in fact, they did two separate green water bonds within a month. Now, the green credentials of a water bond can be a tricky subject: for example, if the investments funded involve long-term water infrastructure, has exposure to physical climate change impacts and the necessary adaptation measures been accounted for? What is the energy intensity, and therefore emissions impact, of the water infrastructure (this can be very high)? Clean water provision that involves building infrastructure that ignores expected changes to rainfall patterns and intensity is frankly foolish – yet still all-too common. Ditto investments that rely on increased energy when other options are available, like demand management.

To be confident a water investment will deliver positive environmental benefits, investors need to have access to this kind of information. We saw an important recognition of this issue in the recent update of the Green Bond Principles when the water category was changed from ‘clean and drinking’ water to ‘sustainable’ water. Now we need more detailed criteria and an independent review model breaking into the green water municipal markets.

There’s also a growing trend amongst US universities to follow in the footsteps of MIT in refinancing their low-carbon buildings through green bond issuance. This quarter, both the University of Virginia and Arizona State University jumped on the bandwagon with a $97.7m and $182m issuance, respectively. Great news – but similar to the green muni water bonds, we‘d like to see an independent review of these bonds or at least a commitment to improve and report on the buildings’ energy efficiency during the tenor of the bonds.

US munis have tended to avoid independent review, and their dominance in Q1, along with some un-reviewed Indian issuance, has meant more than half the Q1 bonds were un-reviewed

Development Banks: Playing from both sides by providing issuance and investment in green bonds, as well as pushing the envelope on reporting frameworks

Development banks have continued to hold their dominant market position in Q1 2015. They maintained a 46.2% share of total issuance - the same as their 2014 share. Development banks continue to be green bond pioneers, and are now finding ways to support the market other than simply issuing large USD denominated green bonds. For example, this quarter KfW – already a repeat green bond issuer - announced it would also participate in the market on the asset side of the business and invest in a broad range of green bonds through a EUR 1bn green bond portfolio. Similarly, IFC, the private sector arm of the World Bank, supported emerging market issuance by committing $50m of cornerstone investment to India’s first green bond from Yes Bank.

Q1 2015 green bonds have been issued by a variety of types of issuers

The development banks also continued to provide demonstration issuance and liquidity through benchmark-sized issuance. The World Bank issued both its largest-ever green bond of $600m and its longest dated green bond (40yr) in the same week, yet again proving its strength as a green bond powerhouse.

The development banks are pushing the envelope on green bond processes as well; for example, the EIB launched an upgraded green bond impact report in late March. Development bank reporting practices, however, are costly. Lower costs will be needed for the corporate green bond sector to grow, plus some levels of disclosure are difficult, such as when a bank is including in it’s green bond pool syndicated loans that are subject to confidentiality clauses in the syndication contracts. We believe that clear standards around green assets and around reporting methodologies, combined with audit-style certification, can keep the cost of verification suitably low while still providing confidence in the green credentials of a bond.

Energy and low-carbon buildings account for the largest share of use of proceeds of Q1 green bonds

To provide an indication of the types of projects to be financed by the Q1 2015 crop of green bonds we split the proceeds of each issuance into the declared eligible green project categories and pooled together. On first glance it shows that renewable energy is the biggest proportion, with the top three biggest bonds of the quarter — Terraform Power Operating, World Bank and Vestas — all financing renewables.

Proceeds from Q1 2015 green bond issuance have gone to a range of project types

Green buildings and water are the second and third biggest categories, largely through US green munis. Transport appeared largely because the EXIM of India bond finances rail and bus transport as well as renewable energy.

Investor interest in green bonds remains high, even as they become more vocal on expectations of green

It’s no surprise to close followers of the green bond market that the investor appetite for green bonds has continued in Q1 2015. This shows through in the upsizing of green bonds as a result of strong demand –the World Bank’s retail green bond in January, for example, was upsized from $15 to $91m; KfW’s kanga green bond intended to be AUD 300m ended up ballooning to AUD 600m; and Yes Bank doubled its green offering from INR 5bn to INR 10bn ($161.5m).

Another indicator is the continued high levels of oversubscription. An example from Q1 is the latest Kommunalbanken Norway’s (KBN) green bond issued in March, which received $700m orders for a $500m issue. Of course, oversubscription is a common feature of bond issuances generally in the current market environment; but green bonds seem to be seeing higher rates of oversubscription than non-green ones.

A more diverse set of investors are getting involved in the green bond market. There have been many public commitments over the quarter to invest in green bonds including €1bn from Deutsche Bank treasury – in addition to the mentioned EUR 1bn commitment from KfW. The number of green bond funds/mandates are also growing: during the first quarter Swedish insurance company SPP announced a green bond fund following in the footsteps of Nikko Asset Management, BlackRock, State Street, Calvert and Shelton Capital Management. Plus Norwegian investment powerhouse Norges Bank Investment Management (with over $800bn of assets under management) also disclosed it has established a green bonds mandate.

Investors are also becoming more involved in structuring green bond products to fit their specific requirements. For example, the World Bank issued a green bond with longer tenor of 30year ($34m) specifically for Zurich Insurance, who wanted to match long-term liabilities with a green bond. Partnerships such as this will be important as demonstration issuances to show off green bonds in new markets.

Another development is the launch of an investor statement of expectations for the green bond market from a group of key green bond investors, brought together by Ceres Investor Network on Climate Risk. The investors’ main ask is for greater transparency and reporting, especially quantitative reporting where possible, on the green credentials and impacts of green bonds. The report states: “this will minimise ‘greenwash’ concerns and reputation risk to issuers and investors”. The 26 signatory investors are: Addenda Capital, Allianz SE, AXA Group & AXA IM, BlackRock, Boston Common AM, Breckinridge, CalPERS, CalSTRS, Colonial First State, Community Capital Management, Connecticut Retirement Plans, Retirement System of the State of Rhode Island, Everence, Mirova, NY State Comptroller Thomas P. DiNapoli, North Carolina Retirement System, Pax World Investments, PIMCO, RBC Global Asset Management, Standish Mellon Asset Management, California State Treasurer John Chiang, Trillium Asset Management, UN Joint Staff Pension Fund, University of California, Walden Asset Management and Zurich Insurance.

--

So, interesting start to 2015 — slowish start but the market is now heating up, and growing both in size and diversity. We expect strong growth in Q2 and we’re not the only ones expecting 2015 to be a big year: In Q1 we have seen S&P forecasting $30bn of corporate issuance alone in 2015; SEB is predicting the total 2015 issuance to reach $70bn and Bloomberg’s Michael Liebreich said in New York last week they are expecting $80bn. The race is on!

There were $60bn of green bonds outstanding at the end of March 2015

——— Tess Olsen-Rong is a market analyst at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

March 30, 2015

Why This German Solar Executive Is Skeptical About American YieldCo Assumptions

by Tom Konrad CFA

Ever since the first YieldCo, NRG Yield (NYSE:NYLD), went public in 2013, it and other similar YieldCos have been reshaping the market for operating renewable energy assets, especially wind and solar PV farms. 

A YieldCo is, to put it simply, a publicly traded subsidiary of a developer and operator of clean energy farms that uses the cash flow from its assets to return a high current dividend to shareholders. Most large, publicly traded clean energy developers have already launched or are preparing to launch a YieldCo. The current crop includes NRG Yield, Pattern Renewable Energy Partners (NASD:PEGI), NextEra Energy Partners (NYSE:NEP), Abengoa Yield (NASD:ABY), TerraForm Power (NASD:TERP), and TransAlta Renewables (TSX:RNW, OTC:TRSWF). First Solar (NASD:FSLR) and SunPower (NASD:SPWR) are jointly planning the IPO of a YieldCo to own PV farms to be called 8point3, after the time it takes the sun's rays to reach the Earth.

This rush to launch YieldCos is unsurprising, given that investors can't seem to get enough of them. Since their IPOs, the YieldCos listed above have advanced between 15 percent (Abengoa Yield) and 127 percent (NRG Yield), while at the same time paying dividends and selling large amounts of stock in secondary offerings to fund their growth plans and raise cash for their sponsors.

The new kids on the block

YieldCos were not the only, or the first, publicly listed companies to use clean energy assets and pay a dividend. Long before they came along, there were the Canadian Income Trusts, many of which were focused on clean energy. The tax advantages that first made Canadian Income Trusts a tax-favored structure have since been changed, but several of these trusts survive in a similar form, the most notable being Brookfield Renewable Energy Partners (NYSE:BEP / TSX:BEP.UN), which differs from the YieldCos only in that it develops some projects internally, rather than buying them from a sponsor.

Another is Capital Stage AG (XETRA:CAP), the largest operator of solar PV parks in Germany. Capital Stage also has large holdings of PV in Italy and France, and wind in Italy and Germany, and is in the process of acquiring PV parks in the United Kingdom. It bought its first PV project in 2009.

German skepticism

In an interview, Felix Goedhart, Capital Stage's CEO, expressed mixed feelings about the YieldCo phenomenon. “We like having peers,” especially highly valued peers like the YieldCos, but they are also competitors for buying PV and wind projects. Many such projects do not even make it to the market, since they are sold directly by developers to their captive YieldCos. 

Goedhart is confident, however, that Capital Stage will continue to find attractive deals at after-tax internal rates of return well in excess of what is available to “anyone with a pot of money” who takes part in solar and wind mergers and acquisitions. 

He says that his firm's experience and reputation for reliability allow it to find special situations that less experienced players are not able to touch. When Capital Stage finds such deals, it can act quickly because it does due diligence internally, and can handle “complex situations” such as the current acquisition of solar in the U.K. 

He said some investors new to the business would have backed away from that deal because it looked complex. Capital Stage, on the other hand, knows “basically everything” about the deal and has “seen so many things [that] we know what to do to take on these challenges.”

Goedhart's skepticism of YieldCos centers on their accounting practices, and the inherent conflict of interest when they purchase assets from their sponsors. He asks, “Are you worried by the fact that [developers] and some 'independent' decision-making body decides which asset goes at which price?”

This conflict of interest has not worried investors yet, but it will doubtless begin to worry them if purchasing overpriced assets from their sponsors keeps YieldCos from producing the long-term dividend growth they currently expect.

A kind of Ponzi scheme?

Goedhart's other point of skepticism lies around the source of YieldCo dividends. He contrasts Capital Stage's own dividend, which is “paid out in cash, not paper, not on a business plan, [but] real money operationally earned. Not in a kind of Ponzi scheme where you're raising real funds and taking parts of the funds to pay out a dividend which you haven't earned operationally.”

Do YieldCos pay out dividends in a kind of Ponzi scheme as he claims?

In 2014, NRG Yield produced $223 million in cash flows from operations (CFO), and paid out $122 million in dividends to shareholders and distributions back to its parent, NRG. Cash flow from operations is a very broad measure, and does nothing to account for cash needed to replace its assets at the end of their useful lives. Actual income, which does include depreciation, was only $16 million, far below what would be needed to pay its current level of dividends and continue as a viable business beyond the useful life of its current assets.

Other YieldCos operate in a similar fashion. Abengoa Yield paid $24 million in dividends, created $44 million in CFO, but produced a net loss in 2014. Although their track records are short, most YieldCos seem similar: they have cash flow from operations to comfortably pay their dividends in the short term, but insufficient earnings to both pay a dividend and invest for the future.

Is Capital Stage any different? The company has not yet released its 2014 results, but in 2013, it earned €14 million from which it paid €7 million in dividends in 2014. Its dividend is easily covered by both earnings and cash flow. 

Summing up

YieldCo dividends are not supported by earnings, and so they are not sustainable in the long term unless the companies continue to raise capital to re-invest. Further, there are reasonable questions about the conflicts of interest when YieldCos purchase assets from their controlling sponsors.

While the YieldCo model is valuable in that it matches the strong cash flow producing characteristics of operating clean energy projects with the cash flow needs of income oriented investors, dividends from YieldCos are not directly comparable to dividends from operating companies which have earnings, not just cash flow, sufficient to replace their assets over time. 

Instead, investments in YieldCos should be viewed as amortizing assets. Over the 15- to 30-year typical remaining life of YieldCo assets, the value of those investments will slowly be paid out as a dividend, causing the share price to fall when aging assets are no longer able to support the dividend, or because early investments become diluted by the capital needed to invest in newer assets.

That does not make YieldCos any sort of Ponzi scheme, but it does mean that YieldCo dividends is not worth as much as dividends from operating companies that can fully cover their dividends with earnings.

***

Tom Konrad is a financial analyst, freelance writer, and portfolio manager specializing in renewable energy and energy efficiency. He's also an editor at AltEnergyStocks.com.

Disclosure: Tom Konrad and/or his clients have long positions in PEGI, FSLR, ABY, RNW, BEP, and a debt investment in GridEssence, a private company which Capital Stage AG is in the process of buying. They have short positions in NYLD and TERP.

This article was first published on GreenTech Media, and is republished with permission.

January 30, 2015

Terraform Power Issues $800m High Yield Green Bond

by the Climate Bonds Team

This week the yieldco TerraForm Power (TERP) issued a huge high-yield green bond; seeing more high-yield bonds is a sign that the green bond market is continuing to mature. In addition to TerraForm, more green bonds from repeat issuers OPIC, World Bank, IFC and Credit Agricole have been announced and will be closing in the coming weeks. For today, let’s dig deeper into the latest green high-yield offering.

The US-based renewable energy company TerraForm Power Operating has issued US$800m of senior unsecured green bonds (debentures), making it the largest green bond of 2015 so far. TerraForm Power Operating is a subsidiary of TerraForm Power Inc, a yieldco, spun out from the renewable energy developer SunEdison (SUNE), meaning its fully focused on operating renewable energy assets.

The bond has 8-year tenor and fixed coupon of 5.875%. The bond issuance is sub-investment (junk) grade, with Moody’s rating the offering as B1 and S&P rating as BB-. The lead underwriters were Barclays Capital, Bank of America Merril Lynch, Citi, Goldman Sachs, Macquarie Securities and Morgan Stanley.

Terraform will use the proceeds in part for the acquisition of wind and solar power generation assets from First Wind. Proceeds will also service existing debt used to purchase or develop other renewable energy projects. The acquisition from First Wind will make the asset base 2/3 solar and 1/3 wind, totalling 1503MW - mainly located in the US, but also in Canada, Chile and the UK.

TerraForm provides a good level of transparency as a yieldco disclosing asset level information on their existing portfolio and the First Wind acquisition on their website. It would be good to see a commitment to report on use of proceeds of the bond, though investors can take comfort in knowing that all TerraForms assets are renewable energy.

Great to see that pure play renewable energy companies decide to add the green bond label on to their issuances. The larger investment universe provided by the green label is beneficial both for discovery and liquidity in the market. The potential for pure plays to label their bonds as green is still massively untapped: we estimated in June last year that the total outstanding bond issuances for climate solutions stands at US$502.6bn - a magnitude of difference from the labelled green market. So, here’s a challenge for the pure plays out there - get on labelling your bonds as green.

——— The Climate Bonds Team includes Sean Kidney, Tess Olsen-Rong, Beate Sonerud, and Justine Leigh-Bell. 
 The Climate Bonds Initiative is an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

January 14, 2015

$37B 2014 Green Bond Issuance Triples Market

by Tess Olsen-Rong

Following a landmark green bond growth year in 2013, the labelled green bond market has once again experienced a year of incredible growth in 2014: by year-end there had been $36.6bn of green bonds issued by 73 different issuers – that’s more than a tripling of the market! The final figure was boosted by a late flurry of green municipal bonds.

This exponential growth takes the total amount of green bonds outstanding to $53.2bn by the end of 2014.

So, what happened to cause this tripling of issuance? Well, corporate and municipal bond issuers joined the green party - big time - while development banks continued to be the backbone of green bond issuance. Let’s go through them each in a bit more detail.


Development banks continue to dominate green bond issuance, led by the EIB

True to form the big development banks still account for the majority of issuance with 44% ($16bn) of total green bond issuance in 2014. This is split amongst new green bond issuers and the veterans (EIB, EBRD, World Bank and IFC).

New entrants to the market were mainly national development banks that had been waiting in the wings for the right moment to issue a green bond. These include banks such as Germany’s KfW, France’s AFD and Netherland’s NWB Bank.

In addition to new issuers, we saw a diversification in product types with the World Bank issuing a series of retail investor focused green bonds, as well green bonds across 6 different currencies. EIB continued to be a prolific issuer of green bonds (although they call them Climate Awareness bonds) and ended the year on top of the issuer table, across all issuer types, with $5.6bn green bonds issued in 2014.

Overall top 10 green bond issuers of the year (by amount issued in USD):

First green asset-backed securities brought to market by Toyota

A new type of green bonds also came to the market; Toyota (TM) kicked the year off with a bang with a $1.75bn green asset-backed bond in Q1. This bond showcased how proceeds from a bond backed by car leases and loans can be earmarked for future green vehicles.

Green corporate bond issuance was the biggest catalyst for the market explosion

Green corporate “earmarked” bonds helped create depth in the green market. Not only did the corporates bring scale, accounting for $12bn issuance, but they also offered a range of currencies -both great for liquidity in the market.

The largest corporate deal of the year was GDF Suez’s $3.4bn green bond (split into a EUR 1.2bn and EUR 1.3bn tranches) with proceeds going towards renewable energy and energy efficiency projects.

As the corporate green bond market matured, we also saw a move down the ratings with NRG Yield (NYLD) (rated Bb1 by Moodys) and Abengoa's (ABGB) Greenfield SA subsidiary (rated B by S&P) bringing high yield green bonds to the market in Q3.

Banks leveraged their green loan portfolios to ramp up green bond issuance to US$1.2bn

For example, Credit Agricole CIB used their green loan book to back $478m green retail bonds for Japanese investors over the year. This is great, as banks play a crucial role in the capital pipeline by providing loans and project financing to green issuers and projects.

After a successful inaugural bond, NRW, the German regional bank, chose to get a second opinion on its next offering, which proved its green credentials. NAB (National Australia Bank) took it a step further with its inaugural green bond having certification against the Climate Bond Standard.

US municipal green bonds drove the muni market share of green bond issuance to 12%

Green city bonds became popular mid-year with issuances from the Swedish City of Gothenburg and South Africa’s City of Johannesburg. Gothenburg was a trailblazing green city issuer with repeated green issues through the year, while Jo’burg was the first to show how green bonds can work for emerging market issuers.

We also had other types of municipal issuers: In the first two quarters of 2014, Ile de France brought EUR 850m ($1.3bn) of green bonds to market. But it was first in the second half of 2014 when the green municipal market really started to heat up with Ontario and 11 different US States bringing a wide range of green bonds to market.


Ending the year on a high

Not to be missed: A bunch of unlabelled project and ABS bonds funding green assets

Now, Bloomberg New Energy Finance’s 2014 green bond total is $38bn but it includes unlabelled ABS or project bonds. If we include CBI’s list of project bonds, which total $2.5bn in 2014, to our green labelled figure we make it $39bn! Amazingly close to our $40bn prediction for 2014.

This difference in the end total is likely to be around how we carve up the numbers. CBI uses the Bloomberg announcement date for inclusion in the 2014 figures.

Here are the top 5 unlabelled project and ABS bonds with proceeds for green from 2014:

So, that’s 2014 done...on to 2015! This year we are expecting the same level of market growth in order to get $100bn green bond issuance by December 31st 2015. Let’s get started then!

Notes on the figures:

  • Currency exchange rates are taken from the last price on the date of issuance.
  • Some issuances fall on the cusp of the year in which case we use the announcement date as recorded on Bloomberg to determine its quarter.
  • Additional taps of bonds are included dependent on tap announcement date
  • $36.6bn is the labelled green bond total – this means that the issuer has self-labelled the bond as green in a public statement or bond document.

——— Tess Olsen-Rong is a market analyst at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. Sean Kidney and Beate Sonerud also contributed to this post. 

January 13, 2015

A Flurry Of Green Muni Bonds

by Tess Olsen-Rong

Green municipal bonds are set to take off in 2015 after a flurry of issuances in the latter half of 2014. With interest rates at an all time low, this is the time to finance the vast backlog of infrastructure upgrades and developments needed – and to green that infrastructure. This, according to the Financial Times, is especially so in the US.

With green muni growth has come a growing diversity in the use of proceeds. Some green municipal bonds are using proceeds for projects where the green credentials are more complex to analyse than say a wind or solar plant. Recent bonds have used proceeds for heat recovery from natural gas generation, biomass power plants, car parks and clean water. Things are getting complicated.

Jefferson County NY $20.1m biomass-to-energy – this really needs feedstock certification

Let’s start with a renewable energy green muni bond issued by Jefferson County in the State of New York. Proceeds from the $20.1m bond will go to a 60 MW capacity biomass power plant. The plant was coal-fired until 2013 when it was converted by ReEnergy Black River LLC. Biomass, like almost all green categories, is not automatically a green project. Unsustainable sourcing of biomass can lead to deforestation and therefore have a negative effect on carbon emissions. Fortunately Jefferson County “primarily burn sustainably harvested biomass residues and other waste fuels” – great! But investors should be looking for accreditation from a suitable feedstock standard to confirm that the issuers’ definition of “sustainably harvested” really does fit the bill. In this case the majority is derived wood with the remaining 20% recovered wood (i.e. chippings).

Another area of concern with biomass is the air pollution generated in the burning process. Jefferson address this in part by committing to reporting on the annual air emissions (and water use) of the plant. Watch out for the public consultation for the Climate Bonds Bioenergy Standard in February that will address these issues.

Mass State College $91.4 … mostly sort of pale green … but a car parking station? Really?

Green munis in Massachusetts were coming thick and fast in 2014 with bonds from Massachusetts state and MIT. Not wanting to miss out on the fun, Massachusetts State College Buildings (MSCB) joined the club with an inaugural $91.4m green bond. The bond is split across multiple tranches with tenor ranging from 2 to 20 years and a credit rating of AA from S&P.

Proceeds will go to the renovation of a campus center, and construction of: a science building, a residential hall, a design-media center and a car park. We have previously discussed the need for green property standard; here the buildings will be Silver LEED rated – a good start.

However, this is the first time we have seen a green bond used for an indoor car park,based on energy efficiency measures. This threw us a bit, especially as LEED certification does not apply for car park structures. The (new) car park will achieve bronze level “Green Garage Certification” under a scheme run by the Green Parking Council — we’ve tried to find out what that actually means and are still in the dark. Of course, if the whole parking station was an electric car charging station ….

Hartford County in Connecticut goes for green (water) bonds

Next, water. Florida’s East Central, Spokane and Connecticut all issued green water municipal bonds in the last quarter of 2014. Hartford County in Connecticut also joined the ranks with a $140m bond across 24 tranches with tenor ranging between 1-23 years and AA/Aa2 rating (SP/Moodys).

Proceeds from the bond will go to stormwater projects, pipe repair and replacement, and waste water (pollution) control. Now these are pretty standard project types when it comes to the water bonds we have seen so far. Adaptation to climate change requires water infrastructure to be ready to deal with, for example, bigger surges of stormwater. The treatment of waste water, when there is no energy, is not necessarily green because of the environmental footprint it creates. This is why a thorough second opinion on the green credentials of a water bond is essential. However this is currently missing from the green muni market; Spokane did lead the way with a second opinion; but its review did not cover the green credentials of the bond, only adherence to Green Bond Principles.

In 2015 we need to see a green review for water that takes all these topics into account to provide investors with an insightful analysis of the topics.

Utah power $21.39m – not sure about the gas aspect

Finally, Utah Associated Municipal Power System’s (UAMPS) $21.39m green bond was issued across 20 tranches in November 2014. Tenor ranged from 3 to 20 years across the tranches and achieved an A- rating from S&P.

Alarm bells started ringing when we saw natural gas in the offering document. But our fears were somewhat alleviated because proceeds are not going to gas; instead the bond is funding a project to recycle excess heat energy created by the gas turbine. Once completed the heat recovery power plant will generate up to 7.5 MW and has the potential to remove 737,000 tonnes of CO2 (when replacing gas-fired power generation) over its 30 year life.

When taken in isolation (from the gas turbine) it can be described as a “green” project – but its entire process is dependent on gas, where the jury is still well and truly out about what you could call “green”. The project could be compared to a refurbishment or energy efficiency project in a gas power plant which would elongate the life of the gas generator. Hmm ... not quite convinced on the green credentials of this one yet, although we do appreciate there’s a complex argument about gas as a transition investment in some countries – but that needs careful analysis as it doesn't always stack up.

(He amusingly quotes a banker: “The markets are very like sheep – if one sees a rival doing something they immediately look at it and think should we do the same.” That BTW is one of the rationales for promoting a green bonds market.)

——— Tess Olsen-Rong ia an analyst at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. Sean Kidney and Beate Sonerud also contributed to this post. 

November 21, 2014

Northland Power's Solar-Backed Bond

By Beate Sonerud

Canada’s Northland Power (TSX:NPI / OTC:NPIFF) issued an asset-backed bond (ABS) last month through a SPV (Northland Power Solar Finance One LP). The amortising bond was a private placement of CA$232m with 18-year tenor. Semi-annual coupon is 4.397% and DBRS (Canadian credit rating agency) rated the issue BBB.

It is Northland’s first bond backed by renewable energy projects.  Since the bond is asset-backed the recourse is to the solar projects instead of to Northland Power. This allows Northland to move operational-phase renewable energy assets off their balance sheet, freeing up space for new renewable energy investments. The specific assets are six “Ground-Mounted Solar Phase I projects”, with each operating a 10MW solar facility that sell all electricity to the Ontario electricity grid.

Stable revenue streams for the duration of the bond are provided by the 20-year feed-in tariff contract between Northland’s solar projects and the Ontario grid. This is a good illustration of how policies providing price signals for green in the real economy can enable climate bond issuance. That the bond has achieved a BBB investment-grade rating without further credit enhancement is exciting: As feed-in-tariffs are in place in many countries, there are vast opportunities for other utilities to copy Northland’s model for ABS issuance backed by renewable energy assets that have their less risky operational phase.

Proceeds from the bond “will be transferred via intercompany loans to the six Ground-Mounted Solar Phase” and to Northland for “general corporate purposes”. Now, at first we were a bit worried about the latter, as Northland Power operates facilities for natural gas as well as wind, solar and hydro - meaning general corporate use of proceeds would have excluded the bond from our climate bonds universe.  However, we were happy to include it after Northland confirmed that the proceeds of the bond that are not used for the solar projects has been earmarked for the purchase of a large offshore wind project (Nordsee One) due to close early next year.

So why is that so exciting? Essentially the bond is an ABS version of the corporate use of proceeds bonds (such as Verbund) where proceeds are earmarked for specific green purposes. This matters as the bond not only refinances the underlying projects (that we would expect) but also enables Northland Power to grow its green portfolio - this additionally is what so many investors are looking for.

Now, Northland’s bond is not actually labelled green, but as we clarified that proceeds are aligned with a low-carbon economy, the bond issuance does fall into our unlabelled climate bonds universe. While we are happy to include the bond in our non-labelled climate bonds universe, future similar bonds could benefit from being labelled green. If Northland had decided to monitor and report on proceeds (and ideally gained a second opinion on green) we could easily have welcomed it to the green labelled universe.

Overall, exciting issuance structure – we hope to see it replicated by other utilities and renewable energy developers. Great work, Northland!

———  Beate Sonerud is Policy Researcher at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

October 27, 2014

Will Investors Flock to SunEdison’s Emerging-Market YieldCo?

by Tom Konrad CFA

SunEdison is proposing something entirely new: a YieldCo with a focus on projects in Africa and Asia, but it's a long way between an S-1 filing with the SEC and and IPO.

The June launch of SunEdison's (SUNE) first YieldCo, TerraForm Power (NASD:TERP), transformed the parent company's prospects. Now it wants to repeat the performance with a first-of-its kind YieldCo that will focus on investment in Africa and Asia.

A YieldCo is a publicly traded company that is formed to own operating clean energy assets that produce a steady cash flow, most of which is returned to shareholders in the form of dividends. Like many other renewable energy developers, SunEdison formed TerraForm Power in order to appeal to a pool of income-oriented investors who would never consider owning the company's common stock. Such investors look for reliable income streams generated by existing businesses, and often won't even consider buying stock in a company that does not pay a regular dividend. 

The low interest rate climate over the past few years has made income-oriented investors, many of who rely on dividend payments to support current expenditures, increasingly desperate for yield and much more willing to enter new asset classes in order to find it. YieldCos and the renewable energy developers that formed them have been direct beneficiaries. 

Arguably, no energy developer has benefited more from forming a YieldCo than SunEdison. Unlike large utilities that have formed YieldCos, includng NRG Energy, NextEra, Abengoa SA and TransAlta Corp., SunEdison does not have a history of profits and dividendimg

These utilities' YieldCos, NRG Yield (NYSE:NYLD), NextEra Energy Partners (NYSE:NEP), Abengoa Yield (NASD:ABY), and TransAlta Renewables (TSX:RNW), appeal to investors who might have been interested in the parent companies' stock, but like the higher yield and relatively greener assets offered by the YieldCo subsidiaries.

YeildCo Sponsor earnings.png

In contrast, SunEdison has never paid a dividend, and has not been profitable under generally accepted accounting principals (GAAP) since before 2011. On an adjusted basis (in which items deemed to be one-off by management are eliminated), the small profits in 2011 and 2012 were more than wiped out in 2013, and analysts expect losses to continue at least through 2015 (see the chart above).

While the lack of earnings and dividends makes SunEdison's stock unattractive to income investors, they have rushed to buy the stock of TerraForm Power. According to one estimate, investors are effectively paying $5 per watt for TerraForm's projects when they buy the stock. When such projects are sold in private transactions, they typically fetch only $3 per watt, so TerraForm investors are willing to pay a 67 percent premium over the going market price.

SunEdison has a huge appetite for investor capital.  According to its cash flow statements, the company has raised an average of $1.2 billion in debt and equity in each of the last three years. So it's not surprising that after seeing the appetite of income investors for the mostly developed-market assets owned by TerraForm Power, SunEdison is hoping income investors will also be interested in projects in Asia and Africa.

To date, YieldCos hold a majority of their assets in the developed world, especially the U.S., Canada, and Europe. The reasons for this are simple: income investors consider the safety of a company's income stream to be extremely important, and developed electricity markets offer long-term contracted power-purchase agreements.

In contrast, electricity markets and grids in Asia and Africa range from the state-controlled to the unreliable and even the nonexistent. The lack of reliable grid infrastructure in some Asian and African countries means that renewable power is often competing with electricity from diesel generators on price. The following slide is from a 2012 presentation by Christian Breyer of the Reiner Lemoine Institut. The green and yellow areas on the map denote places where the economics of displacing some diesel power generation with solar during the daytime is highly economical, even without subsidies. These areas have expanded as solar prices have fallen over the last two years.

PV displacing diesel.png

 

Clearly, sub-Saharan Africa and Asia's interior are both excellent prospects for solar from a purely economic standpoint, without any subsidies whatsoever. Indeed, the slide above shows that diesel subsidies serve to limit the number of countries in which replacing diesel with solar generation makes economic sense.

One problem is that these parts of Asia and Africa are better known for outbreaks of disease and terrorism than for the stable political and economic conditions that usually give rise to businesses producing reliable long-term dividends.

Perhaps SunEdison intends to focus on more stable parts of Asia and Africa, but that will make its projects more dependent on local political support to produce the reliable returns that income investors expect. 

Either way, SunEdison is proposing something entirely new. From the perspective of using the power of markets to fight climate change, it's entirely welcome. What remains unclear is if income investors are ready for the idea. If the new YieldCo can pay a dividend high enough to attract such investors despite the risks, it will be a big win for the planet -- and for SunEdison's current shareholders.

***

Disclosure: Long RNW, Short NYLD.

This article was first published on GreenTech Media, and is republished with permission.

October 26, 2014

Solar Bonds and Other Green Income Investments Compared

by Tom Konrad CFA

Clean-energy stocks’ performance over the last couple of years proves that it’s possible to do well – sometimes very well – while doing good. Unfortunately, it’s also possible to lose a lot of money.

Case in point: solar installer SolarCity’s stock (SCTY) price has more than quintupled since its 2012 IPO, but has fallen 40% since the start of the year. Swings like these are just too wild for many investors to stomach.

So the news that California-based SolarCity launched the first public offering of solar bonds last week likely piqued the interest of sustainability-minded investors seeking more stability. But how do these bonds really stack up against other sustainable investment options?

SolarCity’s bonds, which are available to retail investors in all 50 states, represent energy projects across the country. They start at $1,000, mature in one to seven years, and pay up to 4% interest. Buyers face no price risk – unlike volatile stock values, the bonds pay a fixed amount – but the bonds are backed only by the company’s ability to pay.

This could be a problem for skittish investors: as the bonds are not currently traded on any market, investors will not be able to redeem or sell them if they suspect the company will have financial difficulties before the bonds mature. And given that SolarCity is itself only eight years old, investing in a seven-year bond could be a little unnerving.

While SolarCity’s bonds are a significant innovation, they are hardly the first green investment on the market. Aside from directly investing in companies via stock, there are clean-energy mutual funds, certificates of deposit (CDs) and even home improvements. As with all investments, these options involve tradeoffs between risk, liquidity and income.

With that in mind, here’s a look at the costs and benefits of five of the most promising green investment options:

Solar bonds

While SolarCity’s bonds are the first such product to be nationally registered, Mosaic has been offering very similar state-registered bonds in California and New York since April 2013. Like SolarCity’s bonds, Mosaic’s are not traded and must be held to maturity. However, they are available in smaller increments – the least expensive cost as little as $25 – and often offer higher interest rates. Most offerings have been priced to yield 4.5%, although they often have longer maturities as well.

Asked to comment on the differences between SolarCity and Mosaic’s offerings, Tim Newell, SolarCity’s vice president for financial products, highlighted the advantages of his product’s diversification: SolarCity’s bonds are being backed by the cash flows from its solar leases around the country.

In reality, this is both an advantage and a disadvantage. While SolarCity can draw on the income from a large number of solar leases to repay its bonds, none of these leases are specifically dedicated to repaying the retail bonds. For example, there is nothing to prevent SolarCity from using the cash flows from its existing leases to back new issues of commercial asset-backed bonds. The company has issued $327.1m of such bonds since November 2013.

For Mosaic’s bonds, on the other hand, the greatest weakness is their lack of availability. Currently, the site is not funding any projects or offering any new bonds, which means that interested investors are – currently, at least – out of luck. When Mosaic does have investments available, they sell out quickly. The new bonds from SolarCity may help fill the demand by providing an alternative.

Green CDs

The safest sustainable income investment remains a CD from a sustainable bank. Some of these banks are Certified B Corporations, which shows a commitment to the environment and promoting social good. Beneficial State Bank, Capital Pacific Bank, New Resource Bank and Virginia Community Capital Bank all offer FDIC-insured CDs.

But while CDs are safe, they come with a trade-off: income. As the chart below shows, the interest rates on CDs are anemic when compared to SolarCity bonds with similar maturities.solar bond and CD rates.pngSolar power systems

One of the most reliable, consistent and non-volatile sustainable investments is a home solar power system. Like a more traditional income investment, a solar power system produces a monthly cash flow; of course, rather than putting money into your account, it works the opposite way – cutting expenses by reducing the cost of your utility bills. Even better, these savings don’t count as income, so they aren’t taxable.

To give a concrete example, I recently installed solar on my house in New York. Even assuming that electric rate increases are only enough to compensate for maintenance, the equivalent tax-free interest rate for the investment comes to approximately 11%. Improving a home’s energy efficiency can produce even higher returns, although those returns can be much harder to measure.

New York has excellent solar incentives and high electricity prices, but a solar installation in any state is likely to be a much better investment than SolarCity’s bonds. When Newell was asked to compare the interest rate on MyPower, the company’s solar loan program, he avoided the question, saying the two products were like “apples and oranges”.

His reluctance is understandable: SolarCity’s profits come from the difference between the rates at which it lends (or the embedded rates in its power purchase agreements) and the rates at which it borrows. It’s not diplomatic to highlight the large gap between them, especially when talking to small investors or potential customers.

Admittedly, the economic benefits of home solar are largely limited to homeowners. For renters and homeowners without suitable roofs, however, some states have passed legislation to enable community solar, also known as Solar Gardens. These are commercial scale solar farms in which local individuals can invest and get benefits similar to those of a solar system.

Preferred stock

Buying stock in green companies is one of the most common types of sustainable income investments. But while these investments have recently produced very attractive returns, they’re highly volatile. To make matters worse, few clean energy stocks produce any income at all.

Preferred stocks, a hybrid between stocks and bonds, offer a bit more security. Holders have rights to a “preferred” dividend before common shareholders, but have fewer rights than bondholders in a bankruptcy.

One example of this is Power REIT (PW), a real estate investment trust that owns railway track and invests in the land under solar farms. The company’s Series A Preferred shares (PW-PA) yield 7.75% at $25 and trade on the NYSE MKT. Although they have a higher risk of loss than bonds, they also have a much higher yield – and can be held in an IRA. Perhaps best of all, they offer a much greater deal of freedom. Unlike bonds, which lock in purchasers, Power REIT’s preferred shares can be bought and sold on a daily basis.

Yieldcos

Yield-oriented companies, or “yieldcos” are designed to produce a stable cash flow by separating a company’s volatile day-to-day activities from its operating assets. Put another way, a company that is involved in generating energy could partially insulate its investors from risks caused by regulatory changes by sequestering its stable assets in a separate, income-generating business.

Over the last two years, seven yieldcos owning renewable energy and energy efficiency projects have listed on US markets. All can be traded and held in IRAs, but they’re more volatile than any of the investments listed above. Given the nature of their assets, most have lower risk of bankruptcy than SolarCity or Power REIT. The following chart shows 14 yieldcos and similar companies listed on US, Canadian, and UK stock exchanges.

Unlike other income investments, yieldcos have the potential to increase their dividends over time. All things being equal, this would also result in a higher stock price.  The yieldco with the highest yield is currently Hannon Armstrong Sustainable Infrastructure (HASI) at 7.3%, followed by Brookfield Renewable Energy Partners (BEP), Pattern Energy Group (PEGI), Terraform Power (TERP), NRG Yield (NYLD), Abengoa Yield (ABY) and NextEra Energy Partners (NEP).

Ultimately, SolarCity’s new solar bonds fill an important niche in the sustainable investment market. They are easy to buy and have much higher interest rates than similar bank CDs; at the same time, they are also riskier and cannot yet be sold or held in self-directed retirement accounts.

On the other hand, they are safer (but have a lower yield) than preferred stocks and yieldcos. In this context, they’re ideal for small investors who cannot invest in clean energy for their own homes, or who want more solar income investments.

Tom Konrad is a freelance writer and portfolio manager specializing in clean energy and income investments.

Disclosure: Tom Konrad and his clients own shares of Power REIT (both common and preferred) as well as Hannon Armstrong, Brookfield Renewable Energy, Pattern Energy Group. He also has a short position in the shares of NRG Yield.

Disclosure: Tom Konrad and/or his clients have long positions in HASI, BEP, PW, PW-PA, and short positions in NYLD.

This article was first published on The Guardian, and is republished with permission. Further reprints require permission from The Guardian.

October 17, 2014

Solar Bonds For Small Investors

By Beate Sonerud

SolarCity (NASD:SCTY) is issuing US$200m of asset-linked retail bonds, with maturities ranging from 1-7 years and interest rates from 2-4%. Wells Fargo is the banking partner. While the bonds are registered,SolarCity expects the bonds to be buy and hold, and not traded in the secondary markets.

The bond is issued for small-scale investors, with investment starting at US$1000, giving this bond issuance a crowdfunding aspect. Choosing such a different structure allows SolarCity to diversify their investor base – the company stresses that small-scale investors are a complement, not substitute, for large-scale institutional investors. While this is the first public offering of solar bonds in the US, in the UK, such small-scale retail and mini-bonds in the solar and wind sectors have been popular for some time.

SolarCity is the largest installer of residential solar in the US, and this is not the first time they are pioneering in the green bond space. In November last year, SolarCity was the first US company to issue asset-backed securities for solar. Since then, it has issued another two rounds of ABS backed by power-purchase agreements from their customers. All of these issuances have been private placement offerings.

SolarCity’s securitisation offerings have shown a steady decline in coupon, providing the company with cheaper funding. The company’s first issuance was rated BBB+ with coupon at 4.80% - right off the bat achieving investment grade rating with no credit enhancement. In April this year, the second issuance, US$70.2m, was also rated BBB+, but achieved a better coupon at 4.60%. In July 2014, the third issuance, for US$201.5m, achieved a lower coupon still. The upper tranche of this issuance achieved rating of BBB+, and a coupon of 4.026%, with the lower BB tranche getting 5.45%, providing an overall coupon of 4.32%.

In September, SolarCity also issued US$500m of 5-year convertible bonds, with a 1.625% coupon. We like the wide range of different structures of green bonds they are using.

In terms of the green credentials, we consider SolarCity a pure-play company aligned with a climate economy, although it’s worth noting that their bonds are not labelled green bonds. We do think there is room for labelling also for solar companies like SolarCity, mostly because it would make it easier for investors to identify the company’s bond issuances as green. Although easy investor identification is less relevant for this specific retail bond, it is something to consider for future issuances. It is also a much simpler process to label solar than non-pure play companies - check out our solar standards for details of what we’d expect from a labelled solar bond.

We look forward to see what SolarCity will do next as a green bonds pioneer. The company seems to just be getting started, as SolarCity states that: “(…) this is the first of fairly continuous offerings”. Great stuff!

———  Beate Sonerud is a policy analyst at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

October 02, 2014

Trina Solar's Second Convertible Bond

By Beate Sonerud and Sean Kidney

China’s Trina Solar (TSL)is issuing US$100m of convertible bonds with 5-year tenor and 4% annual coupon, with semi-annual payments. An extra US$15m could be raised, as Trina has given the underwriters a 1-month window to buy additional bonds. Guess they are waiting to gauge demand. Underwriters are Deutsche Bank, Barclays, and Credit Suisse, with Roth Capital Partners as co-manager.

The bonds can be converted to shares (American Depositary Shares, meaning they are listed in the US) at an initial price of US$14.69 per share. Currently, Trina’s shares are trading at US$11.40, after falling sharply due to concerns that Japan, the world’s second largest solar market, will reduce subsidies to solar – which would mean reduced business demand for Chinese solar companies, including Trina. So shares will have to rise substantially before it’s attractive for bondholders to convert the bond.

Trina Solar is a leading manufacturer and service provider in PV solar – therefore we consider it a pure-play company aligned with a climate economy. However, this bond, as their previous offerings, are not labelled green bonds and consequently there is no second party review on the green credentials of the use of proceeds (Trina reports that the proceeds will be used for general corporate purposes, which may include development of solar power projects, expansion of manufacturing capacity and working capital). We do think there is room for labelling also for solar companies like Trina, as it would make it easier for investors to identify the investments. It is also a much simpler process to label solar than non-pure play companies - check out our solar standards for details of what we’d expect from a labelled solar bond.

This is Trina’s second convertible bond offering so far in 2014, following a previous issuance of US$150mn in June. Convertible bond issuances have been a popular financing choice for solar companies this year. We are including them in our climate bond universe because, although they are more complicated than vanilla bonds, they are still bonds until converted.

———  Beate Sonerud is Policy Researcher and Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

August 18, 2014

Hannon Armstrong's Strong Q2 Keeps It In My Top Picks

By Jeff Siegel

Hannon Armstrong (NYSE:HASI), one of my top picks for 2014, just made me very happy.

Yesterday, the company announced its Q2 Core Earnings of $4.7 million or $0.22 per share. On a GAAP basis, the Company recorded net income of $2.9 million.

Here are some other highlights. . .

  • Raised approximately $70 million in April, 2014 in a follow-on offering.
  • Increased the flexibility and expanded the capacity of its existing credit facility by $200 million.
  • Completed more than $200 million worth of transactions, including the acquisition of a $107 million portfolio of land and leases for solar and wind projects.

CEO Jefferey Eckel commented on earnings, saying. . .

April 23, 2014, marked the first anniversary of HASI's initial public offering (IPO) and we are pleased to continue our success with the accomplishments of the second quarter of 2014. Since the IPO, we have completed nearly $1 billion of transactions. For the quarter, we generated and paid a $0.22 dividend, completed a follow-on equity raise and closed more than $200 million in transactions. This includes acquiring a portfolio of long-duration lease streams for solar and wind projects as well as the rights to finance additional transactions from this new platform client. As we have demonstrated over the past few quarters, we continue to execute on high credit quality transactions that should translate well into dividend growth for our shareholders.

Opportunities for HASI continue to be robust. The recently announced Presidential initiative calling for an additional $2.0 billion of federal energy efficiency projects and the EPA proposed regulations to cut carbon emissions from existing power plants will encourage more investments in energy efficiency and clean energy throughout the country. HASI is well positioned to capitalize on these opportunities and will continue to seek projects generating attractive risk-adjusted yields.

Hannon Armstrong remains one of my top long-term picks in the alternative energy space. With top-notch management in place, continued demand for alternative energy financing, and a solid 6% dividend, this is a must-own stock for any savvy energy investor.

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Jeff Siegel is Editor of Energy and Capital, where this article was first published.

August 10, 2014

Convertible Solar Bonds: Trina, SunPower Stoke Fire; Ascent Descends

by Sean Kidney

Trina’s $150m 3.5% 5yr convertible solar bond

In June Chinese solar manufacturer Trina announced the private placement of $150m of 5 year, 3.5% convertible bonds to “institutional investors” (no details provided). Trina weren’t clear how they would use the proceeds, but they are planning to build 400-500MW of solar plants over the rest of this year. Book-runners were Deutsche Bank, Barclays, J.P. Morgan and Goldman Sachs (Asia), with co-manager HSBC.

SunPower issues $400m 7yr 0.875% (!) convertible solar bond

That same month SunPower announced a private placement of $400 million, 7 year, 0.875% senior convertible bonds. What a great interest rate! Being 60% owned by Total may have helped; and then Total bought $250m of the bonds. Proceeds were for debt paydown, working capital and projects.

Then $32m Ascent 8% convertible solar runs into problems

Two weeks ago US thin-film solar developer Ascent Solar Technologies [ASTI] announced it was issuing $32 million of 8% convertible loan notes via private placement with institutional and other investors. Ascent is also owned by a Chinese company, TFG Radiant; it used to be controlled by Norsk Hydro.

A week later they announced it wasn’t happening after all – they’d been unable to get the permissions of one of their lenders and had to instead go for a much smaller ($4m) stock placement deal. Bummer!

Solar Power Inc issues a small convertible bond, but it’s converted 3 wks later. Hmmm.

In mid-July US PV developer SPI Solar (Solar Power Inc), a subsidiary of China’s troubled LDK Solar [LDKSY], one of the world’s largest solar PV companies, announced it had made a private placement of “common stock and convertible bond” for an aggregate $21.75 million to four investors. Proceeds to be used as working capital and to pay down debt.

We noted this as we generally count convertible bonds in our broader “Bonds and Climate Change” universe. At the time SPI didn’t specify the breakdown of stock and bond; but today it announced one of the investors had already converted their bond - a mysterious Hong Kong shelf company Robust Elite Limited. Geez, that was quick. Perhaps it’s something to do with LDK Solar’s re-structuring with the help of a company part-owned by China’s Xinyu City Government – where LDK is based in fact.

------------------------

Environmental-Finance’s Peter Cripps reports that more convertibles look likely.

(He amusingly quotes a banker: “The markets are very like sheep – if one sees a rival doing something they immediately look at it and think should we do the same.” That BTW is one of the rationales for promoting a green bonds market.)

——— Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

August 06, 2014

No Longer Just Growth: Investing in Renewable Energies for Yield

by Robert Muir

Given the determined investor quest for yield as the Federal Reserve maintains the benchmark Federal Funds rate at zero, and the resurgence of attention being paid to alternative energy generation, mainly solar, and to a lesser extent wind and hydro, it’s no wonder Yield Co’s have gained so much investor interest lately. In the near to mid-term, the enthusiasm may be justified. Supported by Power Purchase Agreements, energy infrastructure financing and leasing contracts, and electricity transmission and distribution concessions, all with credit-worthy counter-parties, Yield Co’s are designed specifically to pay out a large portion of their EBITDA to shareholders in the form of dividends. By virtue of their steady cash flow and above market yields, these companies are often viewed by investors as relatively safe and stable, similar to high yielding traditional utilities, and their shares tend to trade with low volatility and beta.

Structured as they are to generate and pay out cash flow to investors these firms are to a large extent valued on both current yields and their anticipated ability to maintain and increase future dividends. Therefore vigorous deal flow and a robust acquisition pipeline are key. I'm most in favor of Yield Co’s that are direct spin offs and by contract have Right of First Offer (ROFO) on any projects developed by the parent. The other very important factor I consider is financing. I like to see structured debt financing at attractive rates that is properly engineered into the financial metrics of the acquisition. I tend to avoid Yield Co’s that finance development projects and acquisitions with the issuance of new equity.

Green Alpha Advisors holds Yield Co’s in some of our portfolios. One I particularly like is Pattern Energy Group (PEGI). PEGI has the ability to expand it MW production capacity, and therefore grow its revenues and cash available for distribution, through a solid pipeline for identified projects from Pattern Development on which it has ROFO, while also being able to consider beneficial third party project acquisitions. It will benefit through 2016 from the Federal Renewable Electricity Production Tax Credit. PEGI currently holds only wind capacity generation in its portfolio but management is open to adding solar as well. The company has a stated goal of increasing its cash available for distribution by 10-12% annually and increasing its dividend by 12% annually over next 3 years. With a current yield of 4.10%, and an annual dividend of $1.31, PEGI is currently fairly priced at around $32.00. Its forward performance estimates are trending nicely, with estimated full year revenue growth of 25.5% in 2014 and 35% in 2015 and estimated full year EPS growth of 32.8% in 2014 and a whopping 133% for 2015. Both its Price to Book and Price to Cash Flow are estimated to trend lower in 2014 and 2015. Its EV/EBITDA valuation ratio is high, but not relative to its superior EBITDA, and its EV/EBITDA vs. EBITDA ratio is markedly more attractive than many of its competitors. PEGI seeks to pay out 80% of EBITDA, and if the company performs as estimated it should be able to meet both that benchmark and its dividend growth targets. If the company does meet those growth targets its annual dividend in 2017 will be $1.67. All things being equal, if the yield were to remain at 4.1% that would potentially make for a 2017 price of $40 a share. Inversely, if the price were to stay close to $32.00, the 2017 yield will have ballooned to 5.2%.

     While acknowledging many positives, I do see some risk in owning shares in these firms. Firstly, Yield Co’s stock valuations, like traditional dividend paying utilities, often considered bond proxy’s, or any high yield investment instrument for that matter, have negative exposure to a rising interest rate environment. A seven, six, or even five percent yield might seem extremely attractive when the Ten Year U.S. Treasury Note is yielding just 2.52%, but if or when benchmark interest rates return to more historical norms income investors may not be willing to pay today’s prices for shares with those same yields. To offer some context, in 1995 the Fed Funds rate was 5.5%. In the minutes from the most recent Federal Reserve meeting, released on July 9th, FOMC members anticipated the fund rate will be at 1% in 2015, 2.5% in 2016, and 3.75% in the longer term. To preserve share prices in a rising interest rate environment Yield Co’s will need to be able to increase their dividends commensurately.

Also, as the number of publicly listed renewable energy Yield Co’s has risen, the demand from these firms to secure renewable electricity generation projects has also spiked, leading to less attractive pricing and revenue metrics on third party, competitive bid acquisitions.

Another potential risk that Yield Co’s face, albeit in the longer term, is the threat to the traditional “Hub and Spoke” electricity generation and distribution model. This is far and away the model of the majority of the holdings in Yield Co portfolios. As the generation and storage technologies that will bring about distributed and eventually autonomous energy production advance this utility model will become increasingly less economically viable. I know of only a handful of Yield Co’s at this time, NRG Yield Inc. (NYLD), Hannon Armstrong Sustainable Infrastructure Capital, Inc. (HASI), and TerraForm Power, Inc. (TERP), that have distributed solar assets in their current portfolio of holdings. This is clearly a longer term concern and doesn’t affect my near term analysis of the space or any individual companies. However, it is something I will continue to monitor.

In my view Yield Co’s clearly have a role to play in any diversified equity investment model, particularly one designed to generate dividend income.
                                                                                                                      
Disclosure and Sources:

Green Alpha Advisors is long PEGI and HASI, and has no position in NYLD or TERP.  Data on PEGI is sourced from Thomson Reuters as of 08/05/2014.  This information is for information purposes only and should not be construed as legal, tax, investment or other advice.  This information does not constitute an offer to sell or the solicitation of any offer to buy any security.  Some of the information contained herein constitutes “forward-looking information” which is based on numerous assumptions and is speculative in nature and may vary significantly from actual results.  Green Alpha is a registered trademark of Green Alpha Advisors, LLC.

About The Author

Robert Muir is a Partner and Senior Vice President at Green Alpha Advisors, LLC. He is a member of the Shelton Green Alpha Fund (NEXTX) Investment Committee.  An earlier version of this article was first published on Green Alpha's Next Economy blog.

July 22, 2014

Fifteen Clean Energy Yield Cos: Where's The Yield?

Tom Konrad CFA

 In the first article of this survey of yield cos, I noted that many of the recent yield co IPOs have risen so far as to "lend the very term "yield co" a hint of irony" because rising stock prices are accompanied by falling annual dividend yields.

Yield Co Worries

Because yield cos invest in clean energy infrastructure such as wind farms and solar facilities, conservative income investors may worry about the durability of the technology.  Will solar panels still be producing power twenty years from now?  Others have brought up the credit quality of utility counter parties, and the untested nature of residential solar leases.

All of these concerns are real.  Some solar panels will fail sooner than expected, and possibly many at a single solar farm.  Utilities in Europe are already struggling financially, in part due to regulatory policies which were designed to promote renewable power.  The residential solar lease model is only a few years old.  Many solar leases contain inflation escalators which cause the price of solar power to rise by a few percent a year.

If electricity prices fall with the cost of power generated from wind and solar, what will homeowners do if they find they are suddenly paying more for electricity from their solar panels than they would for grid electricity?  Might populist politicians pass laws declaring solar leases invalid because the lessees feel like they've gotten a raw deal?

While all of these risks are real, most can be dealt with by diversification.  Falling prices of solar panels will make it cheaper to replace ones that fail prematurely.  Both electricity prices and politics are local, meaning that geographic diversification can do much to manage these risks. Technological risks can be dealt with by diversifying between technologies.  See the second article in this series for details on the types of power generation owned by each yield co.

The Biggest Risk

While all these risks are real, they are fairly standard investment risks, and can be dealt with through portfolio diversification: Don't own just one yield co (especially the smaller ones that own only a few facilities), and don't focus all your holdings on wind or solar. 

The biggest risk, and the one that can't be diversified away is the risk of paying too much.  For yield cos, which are designed to pay healthy dividends, not paying too much means getting a decent yield, now or in the near future.  For me, "decent" means at least 2% more than long term government bonds.  Even 2% is a fairly thin margin to compensate for the risks discussed above.  The ten year US Treasury note currently pays 2.5%, and the 30-year bond pays 3.3%, so anything below a 4-5% dividend yield is too little to be taken seriously, unless we are very confident that dividend growth can continue at a rapid pace for many years to come.

High Expectations For Growth

Most US-listed yield cos have outlined aggressive plans for dividend growth.  NRG Yield (NYLD) is the most ambitious, and expects to grow its dividend by 15% to 18% for five years.  In order of decreasing ambition, Terraform Power (TERP) aims for 15% growth for 3 years, NextEra Energy Partners (NEP) expects 12% to 15% growth for three years, Hannon Armstrong Sustainable Infrastructure (HASI) expects 13% to 15% growth for two years, Pattern Energy Group (PEGI) aims for 10% to 12% for three years, and Abengoa Yield is aiming for relatively modest 6.5% growth over the next 12 months.  Canadian yield cos, like TransAlta Renewables (TRSWF or RNW.TO) and Brookfield Renewable Energy Partners (BEP, BEP-UN.TO) have not laid out specific dividend growth targets, but do have reasonably aggressive growth plans which are likely to boost distributable cash flow and dividends over time.

The three London-listed yield cos, The Renewables Infrastructure Group (TRIG.L), Greencoat Wind (UKW.L), and Bluefield Solar Income Fund (BSIF.L) are less aggressive, and aim simply to increase distributions in line with inflation.

Sources Of Growth

Investing Cash Flow
Since yield cos return most of their investable cash to shareholders, most expected future dividend growth cannot come from re-investing earnings, as we would expect from traditional growth companies.  Hence, dividend growth will have to come either from issuing debt and using that to buy assets, or from buying assets (with debt or new equity) at low prices which make those assets significantly accretive to cash flow per share.

Debt
If debt is used to buy new assets, this will generally increase the dividend, but it will also increase overall risk to shareholders.  There is also a natural limit to debt, because there will come a point where lenders will become unwilling to provide additional funds.  Because of the increased risk inherent in using debt to buy assets and boost the dividend, I do not ascribe much value to dividend increases arising from increasing debt.

Developing Assets In House
In contrast, the ability of a company to obtain clean energy assets such as wind and solar farms at low prices has real value.  With the exception of TransAlta Renewables, the Canadian yield cos including Brookfield Renewable Energy, Primary Energy Recycling (PENGF, PRI.TO), Innergex Renewable Energy (INGXF, INE.TO), and Capstone Infrastructure (MCQPF, CSE.TO) have a tradition of developing projects in house as well as purchasing them from other developers when such projects are available at attractive prices.

In contrast, the US listed yield cos rely on others to develop projects for them.  Hannon Armstrong is fairly unique in this regard, because it is an investment bank which has relationships with a number of blue chip companies that develop energy efficiency and other sustainable infrastructure projects for which it obtains the financing.  Before Hannon Armstrong's IPO, it financed these projects by bundling the debt and selling it to institutional investors like pension funds. Now, while it still creates packages of investments for pension funds, it also keeps some such projects on the books.

I expect that Hannon Armstrong's position as the leading investment bank for such projects as well as its existing relationships should continue to enable the company to invest at attractive prices and continue increasing its dividend.

ROFOs
The other yield cos (NRG Yield, NextEra Energy Partners, Terraform Power, Abengoa Yield, Pattern Energy Group, and TransAlta Renewables) are relying on "Right Of First Offer" or ROFO agreements with their parent companies to obtain projects at attractive prices.  The parent companies are all experienced project developers, and those parents with large portfolios assets and concrete road maps for dropping them down to their yield co offspring have been rewarded with the highest yield co share prices and the lowest current yields

The highest yield among the US-listed ROFO yield co is Pattern Energy Group.  Its parent, Pattern Development is a private company with only a handful of projects that it is currently developing. The other ROFO yield cos all have publicly listed parents which already own significant clean energy assets, and are developing new ones as well.  They have low yields and high stock prices to match. 

The one exception is TransAlta Renewables, which trades at a 6.5% yield, compared to the 2% to 4% yields available on US listed ROFO yield cos.   Its low price and high yield are due in part to the fact that its parent, TransAlta Corp (TAC), has not explained precisely which assets it plans to sell to TransAlta Renewables, and at what prices.  TransAlta Renewables' lack of a US listing is also likely to be part of the reason for its high yield, but even given these factors, I consider TransAlta Renewables to be massively undervalued compared to the other ROFO yield cos.

Finite Growth

The flood of new capital which current and expected future yield cos are bringing to the market is likely to have significant effects on the price clean energy projects sell for.  Most such projects take years to develop, and so the short term supply is limited.  A large source of new capital chasing a finite number of projects is likely to boost the value of those projects on the market. 

As project prices rise and ROFO agreements expire, we can expect that they will be renewed only with prices which are less attractive to the yield cos. Yield cos which develop projects in house will also find that their costs rise as other developers enter the market in order to sell projects into a robust market fueled by cheap yield co money.

Hence, while yield cos many be able to hit their aggressive short term dividend growth targets, this growth must slow over the longer term.  I personally am only willing to believe current projections one to three years into the future.  To reflect that, I have put together the following chart of the 15 yield cos current yield and expected yield growth over the next two years.


Yieldcos by yield.png
The horizontal lines show current yield, the x-axis shows how much yield is expected to increase over the next two years, and the diagonal lines combine these two to show expected yield in two years.

The Best

Paying a high price for a yield co not only reduces its current yield, it also reduces the effect of even very aggressive dividend growth targets.  The chart reflects NRG Yield's extremely aggressive dividend growth target (15% to 18%) with an assumed annual dividend growth of 16.5%.  Because NRG Yield has such a high price, its current yield is only 2.8%, and two years of compounded 16.5% growth bring it up to only 3.8%. Pattern Energy Group may have a less impressive (but still proven) parent in Pattern Development, but it offers a 3.8% yield today. With that sort of head start, it will have no trouble staying ahead of its US-listed ROFO yield co brethren.

Looking at the upper right hand corner of the chart, we see Hannon Armstrong and TransAlta Renewables.  These offer current yields of 6.1% and 6.5% respectively.  NRG Yield would have to grow its dividend at 16.5% per year for five years just to get to where Hannon Armstrong is today.  NextEra Energy Partners, TerraForm Power, and Abengoa Yield would require even longer to get there.

In short, a dividend today is worth more than years of potential dividend growth.  Among the current crop of yield cos, I consider TransAlta Renewables, Hannon Armstrong, Capstone Infrastructure, Brookfield Renewable Energy Partners, Primary Energy Recycling, and Innergex Renewable the most attractive, in that order.  The London listed yield cos are also attractive, especially for geographic diversification, but are extremely difficult to buy for US based investors.  The only one I've been able to purchase is The Renewables Infrastructure Group (TRIG.L).

This ranking of yield cos is almost entirely based on current and future expected yield.  Primary Energy gets a slight boost in the rankings because of the real possibility of a takeover offer in the near future.  In the last article, I looked into how each of the yield cos were structured.  There, I noted that some (especially Abengoa Yield, NextEra Energy Partners, and Terraform Power) have structures which don't completely align management incentives with the interests common shareholders.  That said, the most of the yield cos with the highest yield also have the best alignment of management and shareholder interests.  My analysis of yield co structure only served to re-enforce my preference for those yield cos with the highest current yields.

In the end, is there any fairer way to evaluate yield cos than on the basis of yield?  Without yield, the term "yield co" is just PR.

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 20, 2014

Fifteen Clean Energy Yield Cos: Company Structure

Tom Konrad CFA

In the first article of this survey of yield cos, I looked at the possible reasons for the seemingly endless enthusiasm for US-listed clean energy yield cos.  Here, I'll take a look at how these yield cos are constructed, and why investors should prefer one structure over another.

Who's Your Daddy?

Most yield cos have been created by clean energy project developers in order to create a ready, low-cost buyer for those projects.  With the recent string of very successful IPOs, the capital available for such projects may prove to be even lower cost than anyone expected.  Terraform Power's (TERP) on July 18th only makes it more certain that other developers and owners of operating clean energy projects will be rushing new yield cos to market.

A yield co's parent company is often its largest shareholder, and the relationship may work either to the advantage or disadvantage of other shareholders.  On the plus side, many yield cos have a "Right of First Offer" (ROFO) for projects the parent develops.  While the details of ROFOs may vary among yield cos, a ROFO will always be a potential source of value for the yield co because it may provide access to a pipeline of projects at favorable prices, or at least the benefits of dealing with a familiar party such as lower due diligence costs for project acquisitions.  Since a ROFO is a "right," not an obligation to buy projects, having a ROFO with an established developer is an advantage for a yield co, and is likely to be a greater advantage if the parent has a large pipeline of projects.

On the other had, many yield cos' cozy relationships with their parents could easy lead to choices which are not in the best interests of other yield co shareholders.  A ROFO may give the yield co the right to buy a project, but this right is of no value unless the project in question is sold at an attractive price. In some cases, the parent may use its effective control of yield co decisions to obtain above-market prices for unwanted projects, doing harm to other yield co shareholders.

Conflicts of Interest

I expect that it will be virtually impossible for most yield cos to escape the influence of their parent companies.  In order to mitigate the risk that the parent uses its influence to the detriment of other shareholders, it's very important that the parent's interests be completely aligned with those shareholders.  For this purpose, I like the parent company to own a large stake in the yield co composed of the same class of shares as common shareholders. 

Another red flag is "Incentive Distribution Rights" or IDRs.  IDRs allow parent company to receive an increasing percentage of distribution increases.  Advocates of IDRs say that they provide the parent with an incentive to increase the distribution as quickly as possible.  However, if the parent already owns a large stake in the yield co, the distributions themselves should provide adequate incentive for this purpose. 

IDR are also asymmetric  incentives: they pay off for the parent when distributions increase, but do not inflict a penalty for a decrease in distributions.  Because of their asymmetric nature, IDRs may incentivize increased risk taking, such as using higher levels of debt to increase the dividend.  I prefer yield cos without IDRs, or IDRs at low percentages. 

Corporate Structures

Most yield cos are organized as corporations, but a few are partnerships.  The partnership structure facilitates the use of IDRs, but I consider the corporate form of a partnership to be less important than the existence and level of any IDR. 

15 Yield Cos

Six US-Listed Yield Cos

Name (Ticker)
NRG Yield (NYLD)
Hannon Armstrong Sustainable Infrastructure (HASI)
Annual dividend (Management dividend growth target) $1.45 (15-18%, five years)
$0.88 (13% to 15% for 2 years)
Parent (Ticker)
NRG Energy (NRG)
None
Parent's retained interest
65.5% voting with complex share structure.
n/a
Relationship with parent
ROFO. Parent earns management fee based on assets.
Management has significant stake in common shares; insiders mostly buying in public market.
Assets
Solar, Wind, Thermal (facility heating and cooling)
Energy efficiency (performance contracts), Wind, Solar, Geothermal, water, telecommunications and other sustainable infrastructure all of which must contribute to reductions in GHG emissions.

Name (Ticker)
Pattern Energy Group (PEGI)
Terraform Power (TERP)
Annual dividend (Management dividend growth target) $1.29 (10% to 12% for three years)
$0.9028 (15% for 3 years)
Parent (Ticker)
Pattern Development (private)
SunEdison (SUNE)
Parent's retained interest
35%
71%
Relationship with parent
ROFO. Parent will not compete for projects.
ROFO, IDR starting at 0% but increasing to 50%.
Assets
Wind
Solar

Name (Ticker)
NextEra Energy Partners (NEP)
Abengoa Yield (ABY)
Annual dividend (Management target dividend growth) $0.75 (12% to 15% over 3 years)
$1.04 ( 6.5%, 12 months)
Parent (Ticker)
NextEra (NEE)
Abengoa SA (ABGB)
Parent's retained interest
79.9%
66.8%
Relationship with parent
ROFO, IDR starting at 0% but increasing to 50%
ROFO. Parent provides line of credit.  Will have interal management after 1 year.
Assets
Wind, Solar
Solar, Wind, Transmission, Conventional generation (gas)

 Four Canadian Yield Cos and One Dual-Listed Yield Co

Most of the Canadian "yield cos" have existed much longer than the term "yield co," which was coined last year.  With the exception of TransAlta Renewables, these were former Canadian Income Trusts, a structure which lost its tax benefits 2011.  The ones I have chosen to include here are the ones with the highest proportion of clean energy assets.

Name (Canadian Ticker, US OTC Ticker)
TransAlta Renewables (RNW.TO, TRSWF)
Capstone Infrastructure Corp: (CSE.TO, MCQPF)
Annual dividend (My estimate of future growth) C$0.77  (8% to 15%, 2-3 years)
C$0.30 (0%, 2-3 years)
Parent (Ticker)
TransAlta Corp (TAC)
None
Parent's retained interest
70.3%
n/a
Relationship with parent
ROFO, managed by parent for management fee based on EBITDA; Parent also supplying line of credit.
Develops projects in-house.
Assets
Wind, Hydro
Combined Heat and Power, Wind, Hydro, Solar, Water utility, district heating

Name (Canadian Ticker, US OTC Ticker) Innergex Renewable Energy (INE.TO, INGXF) Primary Energy Recycling (PRI.TO, PENGF)
Annual dividend (My estimate of future growth) C$0.60 (2% sustained)
US$0.28 (0%, 2-3 years)
Parent (Ticker)
None
None.
Relationship with parent Develops projects in-house. Develops projects in-house. 
Other notes

The company has stated that it may be for sale.
Assets
Hydro, Wind, Solar Waste Heat Recovery, Combined Heat and Power


Name (US Ticker, Canadian ticker)
Brookfield Renewable Energy Partners (BEP, BEP-UN.TO)
Annual dividend (Historical dividend growth) $1.55 (12%)
Parent (Ticker)
Brookfield Asset Management (BAM)
Parent's retained interest
65%
Relationship with parent
Develops projects in-house.  IDR at 15% of future increases eventually rising to 25%
Assets
Hydro, Wind, Combined Heat and Power

Three UK Listed Yield Cos

These are organized as investment companies, and securities laws make them difficult if not impossible for US based investors to purchase.  Because of this, I'm including the UK based yield cos mostly for comparison purpose.

Name (Ticker)
The Renewables Infrastructure Group (TRIG.L)
Greencoat Wind (UKW.L)
Bluefield Solar Income Fund (BSIF.L)
Annual dividend (Target dividend growth) 6p (with inflation)
6.16p (with inflation)
7p (with inflation)
Parent (Ticker)
The RES Group (private)
none
none
Assets
Wind, Solar
Wind
Solar

Yieldcos by fuel

Up Next

The final article in this series will discuss which I consider the most attractive investments, and why.

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 16, 2014

Fifteen Clean Energy Yield Cos, Created Unequal

Tom Konrad CFA

Renewable Energy Investing Grows Up.

In January I predicted 2014 would be the year "renewable energy finance comes of age."  Here's how Jennifer Runyon quoted me on Renewable Energy World:

Konrad believes that 2014 will be a great year for renewable energy finance, he said.  He said that we saw the beginning of it in 2013 with the securitization of a bond by Solar City (SCTY) and pointed to Hannon Armstrong’s (HASI) securitization of an energy efficiency bond in late December 2013 as another indicator that renewable energy financing is on track to take off in 2014.

“I think that we will see a few publicly traded ‘yield cos’ (yield companies) in solar listed in 2014,” he said.  A yield co is a publicly traded company that is oriented towards income as opposed to growth.  This type of investment opportunity is a major switch, said Konrad.  “Any stock you have ever written about pretty much has been a growth stock,” he explained.  “Tesla (TSLA) is a growth stock.  People buy Tesla because they think they are going to keep on gaining market share,” he clarified.

“Now there are some new income stocks that came public last year: Hannon Armstrong, Pattern Energy Holdings (PEGI), NRG Yield (NYLD) and Brookfield Renewable Energy (BEP), so there are four, I would say, renewable energy income stocks on U.S. exchanges.”

...Once renewable energy assets are operating efficiently, they generate payback for their investors.  Now that the technology has matured enough to gain the trust of some of the more reticent, risk-averse investors like corporations and banks, expect to see lower cost of capital for projects and greater interest in renewable energy stocks, bonds and mutual funds.

Renewable Energy Investing's Awkward Teens.

It now looks like just "a few" yield cos may be an underestimate. Last month, Abengoa (ABGB) and NextEra (NEE) launched yield co spin-offs Abengoa Yield (ABY) and NextEra Energy Partners (NEP), respectively.  Both IPOs were oversubscribed and priced at the top end of their expected range.  Along with NRG Yield (a spinoff of alternative energy assets from NRG Energy (NRG) from last year) and Pattern Energy Group (PEGI), launched by privately held Pattern Development, these are all up substantially (38% for ABY to 131% for NYLD) from their offering price.  In fact, they are up so substantially that their yields have fallen so far as to lend the very term "yield co" a hint of irony. 

The only real US-listed exceptions are Hannon Armstrong Sustainable Infrastructure (HASI) and Brookfield Renewable Energy Partners (BEP,) which still offer yields of 6.6% and 5.5%, respectively.  I suspect their relatively high yields arise from two factors, a rational one having to do with tax treatment and an irrational one having to do only with investor perception (or lack thereof.) 

With regards to tax, BEP is organized as a partnership and HASI is organized as a REIT, meaning that distributions from HASI are taxed as income, not at the lower rate for qualified dividends, and some investors may not want to bother with the added complication of receiving an annual K-1 from BEP.  Certain institutional investors such as many index funds also avoid there less usual corporate structures. 

While differential tax treatment of dividends can have a significant impact on high income investors, possible investor aversion to the partnership structure has not put investors off NextEra Energy Partners' stock because that company will be taxed as a corporation.  At most, these factors might justify a 20% to 40% discount for HASI, and a 10% to 25% discount for BEP.  Yet even after such discounts, they both trade at about two-thirds of the prices which would put them on par with the typical US-listed yield co.

I think the part of the discounts on BEP and HASI which is not accounted for by their tax structures can be ascribed to the immaturity of yield co investing.  To extend my coming of age metaphor, renewable energy income investors are acting like teenagers: they're a little new to the dating scene, and are more concerned about getting a date for the prom (yield co investment) than they are about the long term viability of the relationship.

Finding An Adult Relationship

I've been managing money professionally as long as many teenagers have been alive, and at this point I'm more interested in a stock's long term potential for total return than dating stock market prom queens. This article is the first in a series which will compare the fifteen publicly traded stocks in the US, UK, and Canada which meet my definition of yield co: a company which owns primarily clean energy assets for the purpose of generating income which is mostly returned to investors in the form of distribution.

For a taste, the following chart shows the types of assets and the portion of the market capitalization not currently owned by the company's sponsor ("market float.")  The numbers for Terraform Power (TERP) are based on the assumption that, like ABY and NEP, the offering will price at the top end of its range ($21) and that the underwriters exercise their full over allotment option.

UPDATE: The next two installments are here and here.

Yieldcos by fuel.png

Disclosure: Long HASI, BEP, PEGI, RNW, CSE, INE, PRI, TRIG.  Short NYLD Calls.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 25, 2014

Is Clean Water Always Green? Why I <3 NY

By Bridget Boulle and Sean Kidney

Helping to push along the green muni space, the New York State Environmental Facilities Corp (EFC), rated AAA, has issued a USD 213 million green / water bond. There were 30 bookrunners on this bond with JP Morgan and LOOP Capital Partners co-leads - see prospectus.

The proceeds will be used to provide financial assistance to local governments to finance and refinance drinking water projects as well as to refund certain bonds previously issued. They expect to support 128 drinking water and wastewater infrastructure projects across the State.

Qualifying projects will be chosen based on their adherence to various state water and pollution legislation. Although the third party verification was not supplied, EFC promised to post semi-annual updates regarding such projects on their website.

Water is a complex area for green bonds as projects can have conflicting environmental and social outcomes. For example, the provision of clean water has obvious social benefits, but there are lots of good and bad choices that can be made towards that end. Water-provision investments can range from building a new reservoir and long aqueducts for transporting water, to reducing pipeline leaks (which can be vast in old and leaky city systems) and introducing better demand management measures.

The wrong decisions can end up over-using limited water resources in areas beginning to suffer decreased or more volatile rainfall as a result of climate change - and can lead to spikes in energy consumption just as we need to cut back to reduce emissions. Water infrastructure is a huge consumer of electricity - for example 17% of California's electricity is used to shift water around the State. Yes, that's right, 17%!

Water investments that don't take into account climate and energy issues can end up being positively harmful, even as they deliver nice clean water.

From a creditworthiness perspective, as our friends at Ceres have shown, the level of climate-preparedness in water utility and water-dependent companies should be seen as a key risk signal.

That means it would be foolish to see water projects as green by default. At minimum investors should be asking for evidence that asset management and capital expenditure plans have robust climate adaptation and mitigation thinking behind them.

The good news is that we know New York has done this! It makes me love New York. For EFC's next bond we would ask that relevant plans be specifically linked to the projects in the bond.

On the broader issue of being able to better recognize good and not so good water investments from a climate change perspective, we're working with Ceres, the World Resources Institute and CDP to make it easier for investors by developing clear criteria for water related investments. They will become part of the Climate Bonds Standard.

——— Bridget Boulle is Program Manager and Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

June 23, 2014

Vornado Realty Green Bond Boosts US Market, But Lacks Ambition

By Bridget Boulle and Rozalia Walencik

Last week BBB-rated Vornado Realty (NYSE:VNO) became the second US real estate investment trust to issue a corporate green bond, following the Regency Centres (NYSE:REG) bond late last month. The 5 year, $450 million bond was structured by Bank of America Merrill Lynch. Pricing was in line with non-green bonds.

Investors included asset managers, pension funds, insurance companies and governments, of which some were regular investors and others had a specific green interest. Some non-US investors also came in.

According to the prospectus, the proceeds will be used to fund buildings and retrofits that meet the following criteria:

  1. New building developments: LEED Silver, Gold or Platinum certification
  2. Existing buildings: any LEED certification level
  3. Tenant improvement projects: any LEED certification level
  4. Capital projects that “enhance energy efficiency, at buildings which currently are LEED certified at any level”
  5. Capital projects at buildings not yet certified by LEED but “which improve, based on a third-party engineering study, the operating and energy efficiency of a building by a meaningful amount.”

So where does it sit on the green spectrum? It’s certainly a good start - but perhaps we need a little more ambition to have a real impact.

A green building is one that’s “environmentally responsible”, which generally means resource-efficient in terms of energy, water, and other resource usage and in waste management.

What we’re especially concerned about is energy and emissions. The most important environmental reason to cut energy use in buildings is to reduce greenhouse gas emissions from fossil-fuel-based power grids (we’re not as concerned, for example, if energy consumed is 100% on-site solar).

The International Energy Agency (IEA) allocates some 40% to emissions avoided from reduced energy consumption; buildings are the largest consumers of energy worldwide and so the biggest contributors to emissions from energy.

The IEA tells us that deep cuts in building emissions are needed to head off catastrophic climate change, and that: “Deep renovation of inefficient existing buildings is a crucial way to achieve a much more sustainable future.” However, only “about 1% of buildings are renovated each year … the overwhelming majority of these renovations do not lead to deep energy-use reduction”.

Impact investments, from our perspective, are those that lead to those needed deep cuts in emissions.

LEED certification is a flexible environmental standard that provides many ways to achieve certification, with energy efficiency one of many priorities.

But using LEED basic ("any LEED Certification") as a criteria is not contributing much to emissions reduction. In terms of greenhouse gas emission reductions, the USGBC actually recommends that a 30% energy efficiency design goal relative to its ASHRAE 90.1, as used in LEED v2009.

As we wrote in a commentary on the recent Regency green property bond, because a retrofit only happens every few years, a “shallow” or low-ambition retrofit may mean we put off, for many years, the opportunity to make the sort of deep emission cuts we need to get out of buildings if we’re to achieve deep emission cuts. Yes that’s right: shallow retrofits can save energy and money, but may be counter-productive in terms of addressing climate change. If every building in the world aimed for LEED basic certification, we wouldn’t stay within 2 degrees global warming.

In the absence of a more comprehensive energy standard at the time of issuance, targets for % reduction in emissions/energy should demonstrate actual reductions. This could be where clause v. on the use of proceeds in of Vornado’s prospectus comes in (that's the one quoted above). We’re not exactly enthused with their use of the term "meaningful amount" (talk about "open to interpretation"), but if a percentage were specified and applied across retrofits, this could be a good way on ensure both the energy efficiency and the wider environmental benefits of LEED.

Vornado haven’t done this at this stage, but it’s possible that it will be part of the comprehensive annual reporting that they have committed to (which includes detailing LEED certification of projects funded and annual updates on a dedicated page of the website). If a third party has been used to review the bond, such an approach may have been recommended.

In summary: good start, but we need to up the ambition by raising the bar on those lower level retrofits currently allowed.

The issues we’re raising here are of course why we’ve just released new Climate Bonds Green Property definitions. These were developed with an international expert group that included folks from the US Green Buildings Council (who developed LEED). The definitions are now open for public consultation - read more here.

———  Bridget Boulle is Program Manager and Rozalia Walencik is Communications Officer at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. Bridget has worked in sustainable investment for 6 years, most recently at Henderson Global Investors in the SRI team.  Rozalia an holds MA in Public Relations from University of Westminster and BA in Journalism and Mass Communication from Jagiellonian University in Cracow. 

April 26, 2014

Unlocking Solar Energy's Value as an Asset Class

James Montgomery

2014 is predicted to be a breakout year for solar financing, as the industry eagerly pursues finance innovations. Many of these methods aren't really new to other industries, but they are potentially game-changing when applied in the solar industry.

Not all options are ready to step into the spotlight, though. Master limited partnerships (MLP) and real estate investment trusts (REIT) promise more attractive tax treatment than securitizations or yieldcos, but they require some heavy lifting and difficult decisions at the highest levels: MLPs need an act of Congress even for an infinitesimal language tweak to remove a legislative exclusion to solar and wind, while REITs involve a touchy reclassification of assets from the IRS that could have broader and undesirable tax consequences. Yet another model gaining traction is a more institutionalized version of crowdfunding, led by Mosaic (technically they call it "crowdsourcing"), but crowdfunding is awaiting more clarity from the Securities and Exchange Commission about what rules must apply.

And so, while patiently waiting for Paleozoic movement out of Washington, the industry is turning its attention and anticipation toward ushering in two other new financing models: securitizations (converting an asset into something that is tradable, i.e., a security) and “yieldcos" (publicly traded companies created specifically around energy operating assets to produce cash flow and income). Their build-up actually began last year: in the fall SolarCity (SCTY) finally launched the first securitization of distributed-generation solar energy assets, with a pledge to do more and significantly larger ones in the coming quarters, and throughout 2013 several companies (NRG, Pattern, Transalta, Hannon Armstrong) spun off yieldcos with varying levels of renewable energy assets in their portfolios.  These were NRG Yield (NYLD), Pattern Energy Group (PEGI), TransAlta Renewables (RNW.TO), and Hannon Armstrong Sustainable Infrastructure (HASI).

Just weeks into 2014 we're already seeing an uptick in activity. While the industry awaits SolarCity's next securitization move, in the meantime the company has acquired Common Assets, which had been building up a Web-based platform for managing financial products (most especially renewable energy investments) for individual and institutional investors; the first SolarCity-backed products are expected to start rolling out by this summer. We're also hearing rumors of up to half a dozen other securitization deals working through the pipeline, referencing unidentified large players with long histories of building out projects — some names frequently invoked as potentially fitting those criteria include familiar residential-solar companies such as Vivint, Sunrun, Sungevity, and several others.

On the yieldco front, in mid-February SunEdison announced plans for its own "yieldco" IPO aimed at unlocking more value within its solar energy assets. Pricing wasn't announced at press time, but earlier reports suggested it could generate a $300 million payday. SunPower also recently has been talking about doing a yieldco in a 2015 timeframe, likely to feature its 135-MW Quinto project and possibly its 120-MW Henrietta project. Others reportedly eyeing the yieldco model include Canadian Solar, Jinko Solar, and First Solar.

What Capital Markets Can Do For Solar Companies

What's coming together to bring these two financial innovations into the arena right now? Put simply, it's the confluence of plunging PV prices and blistering installation growth which are achieving a scale and maturity that outstrips the capacity of traditional tax-equity sources -- but it also means they can now entertain large-scale financial instruments, explains Joshua M. Pearce, Associate Professor at the Michigan Technological University's Open Sustainability Technology Lab, who recently published a study of solar securitizations. Look at it from a macro level: even conservative growth estimates for U.S. solar energy capacity additions point to 20 GW coming online by the time the investment tax credit (ITC) is planned to run out in 2017, notes NREL energy analyst Travis Lowder, author of another recent report. At an average of $3/W that's $60 billion in assets, of which a third or even half could generate securitizable cash streams for solar developers. Spin that equation around: a single $100 million securitization deal could support 72 MW of residential solar assets, 100 MW of small commercial solar, or 133 MW of larger commercial/industrial projects.

Number of PV Systems (by Market Sector) Potentially Financeable Through a Single Securitization Transaction. Credit: NREL

What does that mean for individual companies? In its 3Q13 financial results SunEdison calculated its current business model of building and selling solar projects yields about $0.74/Watt, but those assets' true value could jump as high as $1.97/W if the company could find ways to lower its cost of capital, apply various underwriting assumptions, and factor in residual value in power purchase agreements. That's a startling 2.6x increase in potential value creation that SunEdison thinks it can unlock, by choosing to hang onto its projects vs. simply selling them off. In its mid-February quarterly financial update the company revealed more value-creation calculations: it captured an additional $158 million during 4Q13 through those retained assets, with a resulting metric of "retained value per watt" at $2.02/W. By applying most of the 127-MW on its balance sheet with an estimated $257 million in "retained value" to its proposed yieldco, the company says, it now has sufficient scale to unlock the true value of those solar assets.

The ability to lower the cost of capital deserves extra emphasis. SolarCity's securitization last fall had a 4.8 percent yield, only slightly higher than a 30-year fixed mortgage and with twice the payout on current 10-year treasury bonds, which is great for investors — but for the company it represented roughly half the cost of capital vs. what can be obtained currently for distributed solar PV financing, noted Rocky Mountain Institute's James Mandel.

"This trend is transformative for the solar industry" because of how it can unlock so much more value and generate more returns, explained Patrick Jobin, Clean Technology Equity Research analyst with Credit Suisse. (Disclosure: SunEdison is one of his top picks specifically for that reason.) "We're probably in the first or second inning of the public capital markets appreciating what this does for the industry."

Securitization vs. Yieldco: The Good, Bad, And Unknown

Both securitization and yieldcos increase access to lower-cost financing by pooling solar assets into an investment vehicle, separating the more reassuring elements of them (payments from operating energy assets under a power contract) from the riskier ones (project development). Both of them promise returns, though yieldcos come as dividends that vary with the company's performance while securitizations are fixed-income meaning investors get locked-in payments for a set period. And most importantly to the solar industry, they offer a lower cost-of-capital compared to the usual funding sources: debt, tax equity, and sponsor equity.

Generalized solar securitization transaction. Credit: NREL

One key difference: yieldcos own both the energy producing assets and the contracts, which means they can monetize federal investment tax credits. An equity owner can't use power-purchase agreements to create a securitization and also take the tax benefits. The real challenge, says Yuri Horwitz, CEO of boutique financial services firm Sol Systems, will be building a yieldco that has income-producing assets that create tax liability, coupled with solar projects that have tax benefits. NRG's yieldco last year did that, and he thinks they have a leg up because of it. Moreover, yieldcos will go out into the market to compete aggressively with other options such as specialty financing that offer similar returns. The hope is that as yieldcos mature and more operating assets are added in their competitiveness will improve.

Defining what assets are best securitized and best spun out into yieldcos exposes a gap that neither properly addresses. Larger projects are good candidates for yieldcos; securitizations typically involve residential solar assets. (An exception: MidAmerican used debt securities/project bonds for its 550-MW Topaz solar farm, as did NextEra (NEE) for its two 20-MW St. Clair solar projects in Canada.) In between is the commercial/industrial segment which presents a more complicated financing challenge. "[Securitizations and yieldcos] don't really work in the center," Horwitz said. A different class of securitizations, "collateralized loan obligations," are more applicable to the commercial sector where less diversity in assets means more risk in making ensuring offtakers' credit-worthiness, suggests NREL's Lowder.

Something else that successful securitizations and yieldcos have in common: the more scale and diversity the better. But that's also a limiting factor: not everyone can pool a wide distributed portfolio of solar assets to mitigate risk, or a smaller portfolio of larger ones. And the more diverse it is, the harder it is to evaluate them as a whole, value them, and get underwritten.  By definition, they require someone who can offer up a large pool of assets as de-risked and diversified as possible, and backed by a brand-name sponsor, pointed out Tim Short, VP of investment management at Capital Dynamics. "There's plenty in the wings that will never make it," he said. "There's not a whole lot of people to bring all the ingredients together."

One other factor to account for in any solar-backed financial models is the externality of policy changes. While investors appreciate the value in a solar offtake contract, but they need to factor in potential risk of any retroactive policy changes, such as is on the table in the net metering debates raging in several states. If net metering policies end up being reduced or even repealed, "solar contracts may default and reducing predicted income streams," Pearce said. "Ensuring policy stability and communicating that stability to investors will be key to the on-going attractiveness of solar assets."

The Need to Standardize

What will be critically important as more of these financing innovations emerge, and more solar companies try to take advantage of their promise, is pinpointing ways to standardize how the process works, in specific areas and as a whole. "The number-one priority is standardization, especially moving forward with vastly more distributed-generation assets coming online, said Haresh Patel, CEO of Mercatus. That's the glue that will hold these offerings together with both developers and investors — and it needs to be embedded in developers' DNA from the very beginning, so their solar assets can be evaluated and bundled repeatedly and reliably. 

Addressing the databasing of solar asset performance metrics are NREL and SunSpec with their open-source OSPARC database. One "Gordian knot" issue: who owns the data and are they willing to share it? That pathway of data ownership can get muddled because not all issuers outright own their systems, and it gets worse by adding a tax equity layer. Figuring out that chain of data ownership protection and security is hugely important., notes Mike Mendelsohn, senior financial analyst at NREL. That's part of OSPARC: anonymizing and rolling up data into a friendly fashion so it's easy for solar companies to present to investors, and for them to digest. "We need to build confidence that those issues are adhered to," he said.

Startup kWh Analytics is similarly targeting aggregation and benchmarking of information about solar asset performance, which is crucial because it tells institutional investors about the soundness of the collateral (the system and the leasee). What are individual PV panels and inverters doing compared with other options; are the customers with FICO scores in the 650-700 range paying off their bills? Developers also want to know how their chosen systems are performing comparatively — and increasingly so with the emergence of these new investment vehicles, where the developer retains those assets as a financing tool.

Mercatus, meanwhile, wants to address the whole package, assessing everything from system components to permitting. "What entities look for is consistency for which they can reduce risk," said Haresh Patel, CEO of Mercatus, which is tackling that problem with its own platform: quickly process and synthesize projects' data so they can be more easily pooled for investors -- and in the same language project after project, especially as new assets come into the pool. Establishing a mechanism to organize this on a repeatable basis is "the biggest friction point," he said.

Project summary view inside Mercatus' 2.0 “Golden Gate" platform. Credit: Mercatus

Standardizing offtake contracts "is the best place to start as this problem impacts every step in the process," Pearce suggested. "Uniform contracts facilitate comparison, reducing asset evaluation costs and promotes pooling.  They also simplify data collection and analysis. Uniform contracts will better facilitate data collection and analysis, asset comparisons and pooling, all of which means reducing costs. 

As part of SolarCity's securitization last fall, Standard & Poors (which rated it BBB+) revealed some interesting background info about the assets being offered, including an impressively high FICO score for residential system owners (and strong mostly investment-grade ratings for the nonresidential ones). There is no solar version of FICO scores, which took decades to become the standard for credit ratings and lending. Addressing this particular pain point is the truSolar Working Group, formed a year ago by 15 solar companies and organizations, trying to develop uniform standards similar to a credit score for measuring the risks associated with financing solar projects, explained Billy Parish, founder/president of Mosaic and a truSolar founding member.

"Standardization will happen much sooner than people think," Patel said. "Standards drive velocity." He invoked the efforts of the DoE-NREL multi-year project Solar Access to Public Capital (SAPC), which folds in well over a hundred organizations with activities from standardized PPAs to installation techniques, "mock pools" of solar assets to rating agencies, and collecting performance data.at involving groups with touchpoints all along the solar energy chain from panel suppliers to banks.

Message to the Masses

As solar companies come around to how much extra value they can unlock, part of that process is coming up with new metrics to calculate that value potential, such as "net present value per watt" or "retained value per watt," and then educating investors who might persistently adhere to the traditional metrics like earnings per share. Issuers including SolarCity and SunEdison and the investment banks go out and do their part with investor roadshows, but also out in the field helping educate about solar asset-backed investments is SAPC is out pounding the pavement too, engaging both sell-side investment banks and buy-side capital market managers to get everyone more comfortable with how these vehicles will work.

"We are now in a positive feedback loop," said Michigan's Pearce. "By successfully accessing lower-cost capital, the solar industry can fund high rates of growth in the future, continuing the current momentum of eliminating antiquated and polluting conventional electricity suppliers."

Jim Montgomery is Associate Editor for RenewableEnergyWorld.com, covering the solar and wind beats. He previously was news editor for Solid State Technology and Photovoltaics World, and has covered semiconductor manufacturing and related industries, renewable energy and industrial lasers since 2003. His work has earned both internal awards and an Azbee Award from the American Society of Business Press Editors. Jim has 15 years of experience in producing websites and e-Newsletters in various technology.

This article was first published on RenewableEnergyWorld.com, and is reprinted with permission.

April 09, 2014

SolarCity's Second Solar Lease-Backed Bond Closes Thursday

SolarCity is on the road with a $70.2m, 8yr, BBB+ rooftop solar leases securitization; closes Thursday

SCTY residential solar.pngSean Kidney

US company SolarCity (NASD:SCTY) has priced a solar bond backed by cash flows from a pool of 6,596 mainly residential solar panel systems and power purchase agreements in California, Arizona, and Colorado. Expected bond figure is $70.2 million, but the bond doesn’t close until Thursday this week. Interest rate is 4.59%. Credit Suisse is structurer and sole bookrunner.

This is SolarCity’s second solar securitization in six months. Their previous (ground-breaking) bond was for $54.4 million with an interest rate of 4.8% – but 13 year tenor.

——— Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

April 05, 2014

Record-Breaking $9bn Green Bonds Issued in Q1

Bridget Boulle

It’s been another ground breaking quarter for green bonds – the biggest yet with just under USD9bn issued ($8.997bn). It seems our initial estimate of $20bn for the year will be met much sooner than we thought so we’ve revised it to $40bn (there are no rules).

There have been new issuers, new currencies, new underwriters, new areas of issuance and, for the first time, a green bonds index. All good things, here is a summary…

The development banks led the way for the quarter but not by too much: development banks = USD4.9bn while corporates = USD4.03bn (it may seem quite a big gap but the first corporate bond was only issued in Nov 2013 while the Development bank market has been going since 2007).

Firsts

  • New development bank: Canadian Export Development Bank
  • Four new corporate issuers: Toyota, Unilever, SCA, TD Bank
  • Transport sector green securities: Toyota with an ABS linked to electric and hybrid vehicles
  • New currencies: GBP, CHF
  • Green Bond Index released by Solactive (a Climate Bonds Partner). It includes mostly labelled issuance as well as some project bonds.

Top 5 issuers for the quarter

  • EIB = $2.9bn
  • Toyota = $1.75bn
  • World Bank = $1.3bn
  • Unibail-Rodamco = $1bn
  • TD Bank = $452bn

EIB has continued to prove its worth as the hero development bank by being by far the largest issuer, almost double Toyota. They issued six times (some taps of existing bonds) in 5 currencies – CHF, EUR, ZAR, GBP and SEK.

Demand

Demand has been very strong particularly with new issuers:

  • Canadian Export Development Bank: $500m orders on $300m bond in 15 min
  • Unibail Rodamco: 3.4x oversubscribed
  • Toyota: upsized from $1.25 to $1.75
  • Unilever: 3x oversubscribed
  • SCA: 50% oversubscribed
———  Bridget Boulle is Program Manager at the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. Bridget has worked in sustainable investment for 6 years, most recently at Henderson Global Investors in the SRI team. 

March 17, 2014

Toyota's Asset Backed Green Bond: This Is Big

Sean Kidney

Toyota Motor Corp. (NYSE:TM) will close mid-next week on what will be the world’s first green bond backed by auto loans – electric vehicle and hybrid car loans to be specific. And what a kickstart for that market, at $1.75 billion.

According to a report in International Financing Review (IFR), the bond will be in multiple tranches, each at a different ratings level: A2 tranche, A3 and A4 (Moody’s ratings).

First thing to know: they told the media a week ago it would be a US$774.675 million bond. Rumour has it that initial investor interest was up to three times that. On Tuesday IFR was reporting that the bond would be $1.25 billion; by yesterday someone had told Bloomberg that it would be $1.75 billion. That’s looking like a very successful bond.

Was it because it was green? I mean, people are going to buy a Toyota bond anyway, aren’t they? Citigroup (NYSE:C), who structured the bond, certainly felt it was worth the extra effort to pick up new investors; but we won’t know details until after close next Wednesday. By the way, co-lead-managers with Citi are Bank of America Merrill Lynch (NYSE:BAC) and Morgan Stanley (NYSE:MS). BNP Paribas, Credit Agricole, JP Morgan and Mizuho are co-managers.

Most “labelled” green bonds (see our explanation of this in our review of green bonds in 2013) have been “asset-linked” corporate green bonds, where the investor has no exposure to the underlying asset.

This is different; the different tranches of the bond are apparently fully backed by the cash flows of the auto loan portfolio – which is great for Toyota because they get they original lending capital back and can plough it into a new pile of loans, which all helps to sell more low-carbon cars).

Asset-backed securities are still relatively new to the “labelled” green bonds theme: Hannon Armstrong (NYSE:HASI) kicked this off with a $100 million bond in December backed by energy efficiency and renewable energy cash flows. (Mind you do there are a few asset-backed renewable energy bonds around that we include in our broader Bonds and Climate reporting, such as MidAmerican’s Topaz, last year’s groundbreaking rooftop solar lease securitization from SolarCity (NASD:SCTY) as green, and 2010′s Italian Andromeda bond).

The size of Toyota’s bond signals the start of a major new stage in the green theme. We think it’s safe to expect more.
Two reasons why this is important:

1. It establishes transport as green for the purposes of bonds issuance. Yes yes yes!

Transport is responsible for 23% of global energy emissions – reducing those emissions is vital. Of course the question is then what really is green. Are hybrids really green or is true that they have higher emissions than diesel cars if you drive them intercity? What about a Hummer hybrid, is that good (yes there was one)? And don’t we want to get everyone out of cars and on to trains instead?

It just so happens we have a Low-Carbon Transport Working Group of international experts in the area tackling these issues at this very moment; all under the Climate Bonds Standard and Taxonomy. We expect to be publishing agreed criteria for low-emission vehicles later in April, along with criteria for metro rail, bus rapid transit systems and the like.

From what little we know so far, the Toyota bond looks like it will meet the criteria currently being discussed; they’ve said cars will “be required to meet standards of energy efficiency in regulations set by the California Environmental Protection Agency’s Air Resources Board". We’ll know more about exactly what level later next week and whether they’ve had a credible sign off on the green credentials.

2. Asset-backed issuance is incredibly important to getting increased capital into the green investment pipeline.

Being able to issue asset-backed bonds allows banks and companies to sell green loans and assets to the huge pool of investors looking for low-risk bonds and quickly recycle the capital they raise into new investments.

The more easily and quickly they can sell a mature portfolio, the more project investment and lending they can do with a limited amount of capital.
This is a big moment for the green bonds and climate bonds market.

——— Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

March 02, 2014

Solar Investing Grows Up

Tom Konrad CFA

Disclosure: Long HASI, BEP. Short PEGI calls, NYLD calls.

When I was asked in an interview last month what I thought 2014 would hold for green tech finance, I said 2014 would be the year that “renewable energy finance comes of age.”

What I mean is that a new type of renewable energy investment is proliferating.  Solar, other renewables, and energy efficiency investments are no longer limited to risky growth plays like Tesla Motors (NASD:TSLA.)   There are now a number of yield focused investments available to small investors.  As of last year, there was a mostly hydropower partnership: Brookfield Renewable Energy Partners (NYSE:BEP), an energy efficiency focused Real Estate Investment Trust (REIT): Hannon Armstrong Sustainable Infrastructure (NYSE:HASI), and a wind power focused “Yieldco”: Pattern Energy Group (NASD:PEGI.)  There is also a solar crowd funding platform, Solar Mosaic.

In that same interview, I predicted: “I think that we will see a few publicly traded ‘yield cos’ (yield companies) in solar listed in 2014.”   In other words, I predicted that 2014 would bring IPOs for two or more companies investing in solar and offering attractive dividend yields.  On Wednesday, SunEdison Inc. (NYSE:SUNE) submitted  a draft registration for what is likely to become the first US IPO of a solar yieldco.  Other groups such as Grid Essence and CleanREIT Partners are currently raising funds for solar yieldcos to be listed in Canada.

The rapid increase of green yield vehicles in the US and abroad has made it possible to build a high-yield diversified equity mutual fund for investors frustrated with the growth-only character of the existing green mutual funds. I’m working with Green Alpha Advisors on launching just such a strategy (currently available to individual clients of Green Alpha in separate accounts.)  We hope to follow this with a fossil free mutual fund following the same strategy if there is sufficient demand.  I personally think that the yield, which is near 5%, is likely to stimulate that demand.  When such mutual funds and exchange traded funds (ETFs) are available, it will create a new source of funding for green infrastructure companies, and further stimulate the growth of the sector.

Relative Pricing 

Another aspect of an industry growing up is more rational relative pricing between stocks.  I’ve highlighted the relative mispricings I saw among the current crop of green yieldcos on January 29th and the beginning of convergence on February 10th.  The last week and a half has seen continued convergence, as you can see in the updated graph below, with data from 1/29 (palest circles), 2/10, and 2/19 (darkest):

green infra cos 3.png

The only significant move came from Hannon Armstrong, which was initiated by FBR Capital at Outperform.  The analyst, Aditya Satghare, was quoted:

“We expect Hannon Armstrong to lead the industry in new financing structures in its core energy efficiency asset class while rapidly diversifying its portfolio into on-site renewable generation and other infrastructure-type assets.  In our opinion, the convergence of energy efficiency and on-site generation should effectively double the company’s potential addressable market, and we estimate that this, coupled with an under-levered balance sheet and expanding net interest margins, should drive annual dividend growth of 20% over the next three to five years. Energy efficiency as an asset class is still in the very early stages of development, offering low loss rates and limited interest rate risk, and we believe that Hannon Armstrong should provide a strong diversification benefit to both specialty finance and other yield-oriented investors.”

He was even more bullish than I am, and set a price target of $20.

Conclusion

Solar has always been the poster boy for green energy.  When SunEdison or another company successfully lists a solar yieldco in the US, green energy investing will finally have come of age.  It will no longer only be for risk-tolerant stock jockeys, but will also have a place in the most conservative income portfolios.

This change should also benefit the clean energy industry.  The lower interest rates unlocked by the access to retail capital should make renewable energy’s trade-off of higher capital cost for zero fuel cost increasingly attractive.

This article was first published on the author's Forbes.com blog, Green Stocks on February 20th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

March 01, 2014

Green Dividend Yield Portfolio

By Harris Roen

There is a new and growing interest in the world of alternative energy investing, the search for high-quality dividend yield among green investments. To this end, the Roen Financial Report has created a Green Dividend Yield Portfolio, a select group of high-yield alternative energy stocks. Together, this selection of companies can produce a steady stream of income for the alternative energy investor. [Ed. note: The Roen Financial report uses a data provider that does not cover Canadian stocks.  These include many of the highest yielding green stocks.  The potential for global high yield green investing is even greater than discussed in this article. That data provider also missed the fact that PW has suspended its dividend, which is why the stock is included in the second graph.]

A New Source for Dividend Yield

green_div_yield_portf_20140225[1].jpg

The Green Dividend Yield Portfolio is a collection of high-yield stocks that are in the alternative energy business. Companies that fall in the “sweet-spot” of dividend yield are included, which I consider to be between 3.5% and 7.0% yield. Anything lower and the yield is not meaningful enough to be of interest, anything higher and the risks are just too great. By having a range of yields from a variety of alternative energy stocks in this sweet spot, a significant yield can be achieved with reduced risk to stock price fluctuation. Subscribers to the Roen Financial Report get access to a list of all companies in the Green Dividend Yield Portfolio along with their ranks, dividend quality rating, exclusive company reports and monthly updates.

The 15 companies currently in the Green Dividend Yield Portfolio have yields ranging from 3.5% to 6.2%. The average yield of the Green Dividend Yield Portfolio is 4.4%, which is a better than going all the way out to the 30 year U.S.Treaury. Even for lower investment grade corporate bonds (A rated), an investor would need to go to 10 years to get an equivalent yield.

Ranked Dividend Yield Stocks

Alternative energy companies in the Green Dividend Yield Portfolio are evaluated on many criteria important in determining the quality of dividend yield that a company puts out. These include dividend growth, earnings per share, free cash flow, return on equity and yield to debt risk. Companies are then compared to each other and given a dividend quality rank of 1 to 5, with 1 being the highest. This ranking gives dividend yield investors a simple yet powerful way to gauge the likelihood that a stock will be able to offer consistent or growing yields into the future.

Dividend Yield Quality

yield_to_quality_20140225[1].jpg The top 25 yielding alternative energy companies that the Roen Financial Report tracks are shown in the graph. Stocks determined to have higher quality yield are on the left, and those with lower quality yield are on the right. Though it is not a perfect fit, the stocks do graph along a clear trend line. A statistical way to determine the validity of a trend line is to look at its R2 value. This trend line has an R2 value of 0.4, which implies a significant correlation.

For many investors, owning a diversified basket of high-yield stocks is a very good strategy as part of a well-balanced portfolio. As a word of caution, though, there are dangers to weighting a portfolio too heavily in high dividend yield stocks. This is especially true in a rising interest rate environment, so be aware of the risks. Having said that, owning a collection of these high-yield alternative energy stocks can be a very attractive way to add income to a green investor’s portfolio.


DISCLOSURE

Individuals involved with the Roen Financial Report and Swiftwood Press LLC owned or controlled shares of PW. It is also possible that individuals may own or control shares of one or more of the underlying securities contained in the Mutual Funds or Exchange Traded Funds mentioned in this article. Any advice and/or recommendations made in this article are of a general nature and are not to be considered specific investment advice. Individuals should seek advice from their investment professional before making any important financial decisions. See Terms of Use for more information.

About the author

Harris Roen is Editor of the “ROEN FINANCIAL REPORT” by Swiftwood Press LLC, 82 Church Street, Suite 303, Burlington, VT 05401. © Copyright 2010 Swiftwood Press LLC. All rights reserved; reprinting by permission only. For reprints please contact us at cservice@swiftwood.com. POSTMASTER: Send address changes to Roen Financial Report, 82 Church Street, Suite 303, Burlington, VT 05401. Application to Mail at Periodicals Postage Prices is Pending at Burlington VT and additional Mailing offices.
Remember to always consult with your investment professional before making important financial decisions.

February 20, 2014

Power REIT's Preferred Stock Offering: A Hedge That Pays 7.75%

Tom Konrad CFA

Disclosure: I am long PW, and have subscribed to the offering of preferred shares.

Several smart money managers I know are excited by the heads-I-win, tails-I-win big opportunity offered by Power REIT’s (NYSE:PW) attempt to foreclose on its railroad lease with Norfolk Southern Corporation (NYSE:NSC) and Wheeling and Lake Erie Railway (WLE).  I know this because I’m one of them, and I’ve talked to others about it.  Others aren’t quite so sure.  Despite the fairly obvious merits of its case, as a tiny company, Power REIT is massively outgunned when it comes to fancy lawyers.  NSC, for one, does not seem at all concerned about its prospects: The civil action has not even made it into the company’s disclosure of legal risks in its annual report in either of the last two years.

Now there’s a way to hedge that risk.

The Offering

This article is not about the legal opportunities.  See the links above and the company’s most recent litigation update to learn about those.  It is about an overlooked opportunity in Power REIT’s ongoing Preferred Stock offering.

Why do I say this opportunity is overlooked?  Because, until I asked Power REIT’s CEO David Lesser about it yesterday, he had not even thought about it himself.  Nor is it mentioned in the offering documents or presentation.

This is the opportunity: If Power REIT loses the civil action, the value of the preferred should increase.

Preferred stock is usually a hybrid between the characteristics of equity (common stock) and debt (bonds.)  This preferred offering is closer to the debt end of the range.  The upside for investors is collecting the 7.75% dividend payments, since the preferred can be redeemed at any time after 2018 at par.  Like bond interest, preferred dividends are much more secure than dividends on common stock.  With a “cumulative” preferred issue like this one, preferred dividends are not lost  if the company is temporarily unable to pay.  They will accrue until the company is able to resume dividend payments.  All accrued and current dividends on the preferred must be paid before the company pays any common dividends.

The company intends to pay preferred dividends currently.  If it were to suspend preferred dividends at some time in the future, those accrued dividends would have to be paid as soon it started making a profit.  That’s because 90% of REIT profits must be paid out to shareholders in order to maintain REIT status, and preferred dividends (both current and accrued) must be paid before common dividends.

While Power REIT is not currently profitable, this is due to the legal expenses from fighting a civil action against two much larger companies.  One reason Power REIT can pay its preferred dividends despite these legal expenses is because its law firm has agreed to accept payment only when the company is able to pay.  (Few law firms would accept such terms, but Lesser’s wife is a partner at this particular firm.  While the related party transaction has caused some prospective investors to pause, the extended payment terms and the firm’s willingness to allow Lesser to do much of the work which would normally have been done by paralegals would not be available from a firm without this relationship.  I also understand that a certain about of uncompensated legal advice arrives in the form of pillow-talk.)

If PW loses, preferred dividends will become tax-free.

All of that explanation was a prequel to why the preferred is an excellent hedge for the risk that Power REIT might lose the civil action.  A “loss” in the civil action would basically mean WLE and NSC get everything they want: a return to the status quo.

  1. PW could not foreclose on the railway lease, and rent would remain at $915,000 annually.
  2. NSC and WLE  indebtedness of at least $16.6 million (plus accumulated interest) under the lease would not be due.
  3. NCS and WLE would not have to pay PW’s legal expenses.

A win, of course, could see the opposite result on all these accounts, which could mean a cash infusion larger than the current market value of the company.  That is why common investors are excited.

Preferred investors, on the other hand, only get the upside in the payment of their 7.75% dividend.  This dividend will be more secure if PW wins on any of the above counts.  If PW loses, however, the dividend will be a tax free return of capital.  That is because PW will be able to write off the $16.6 million indebtedness mentioned in item 2, off-setting PW’s next $16.6 million of profits for tax purposes.  If the company were to resume its former $0.10 per share dividend on the common, and the full preferred offering is subscribed, that $16.6 million would be enough to turn all those dividends into a tax-free return of capital for the next 32 years.

Conclusion

If PW loses its civil case on every count, it should be able to continue paying its preferred dividends, but those dividends will become a tax-free return of capital.  While PW’s common stock may decline without the prospects of a big pay-off, the value of the preferred should increase given the new, tax-free status.  If PW wins, the payment of the dividends will be backed by cash, which should also help the value of the preferred by reducing risk.

Hence, PW’s preferred stock (NYSE:PW-PRA) should be a perfect hedge for any legal risk embodied in the common stock (NYSE:PW.)

The 7.75% annual dividend is nice, too.

This article was first published on the author's Forbes.com blog, Green Stocks on February 7th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

December 27, 2013

The Pros Pick Three Green Income Stocks For 2014

Tom Konrad CFA

bigstock-green 2014.jpg
Green 2014 image via BigStock
Disclosure: I am long ACCEL, SBS, and HASI

For the second year in a row, I’ve asked my panel of green money managers for their top green stock picks for 2014.  You can see how their 2013 picks did here.

This year, I asked them for three picks each.  This is the first of a series of articles discussing those picks.

Green Income Stocks

Green investing began to mature in 2013, with a number of income-oriented green investments becoming available to retail investors.  Until recently, it had been impossible to build a diversified portfolio of clean energy stocks suitable for an income investor.  That is now changing, and I’m working with Green Alpha Advisors to launch a fossil-fuel free equity-income strategy for separately managed accounts, potentially followed by a mutual fund using the same strategy if there is sufficient demand.

As investors become aware of this new type of green investing, and especially as income funds focusing on the sector are launched, I expect valuations to rise, so the next couple years are likely to be an opportune time to invest in the best green income stocks.  You can be sure there will be several green income stocks in my annual list of “Ten Clean Energy Stocks for 2014″ which will be published around New Year’s on AltEnergyStocks.com. For now, here are the three income picks from my panelists.

Jan Schalkwijk CFA is a portfolio manager with a focus on Green Economy investment strategies at JPS Global Investments in Portland, OR.  I co-manage his JPS Green Economy Fund.  Schalkwijk had two green income picks this year.   Here’s what he has to say about them:

Accell Group NV  (Amsterdam:ACCEL, OTC:ACGPF) is a bicycle company located in The Netherlands. It is reasonably cheap at 12.4x earnings and paying a 4.7% dividend. What has kept a lid on Accell is the seemingly perpetual European economic malaise, unfavorable weather conditions during the bike buying seasons in the last couple of years, and lack of analyst enthusiasm. In my view, Europe is likely to follow in the footsteps of our slowly improving economic recovery, which should bode well for European stocks and consumer spending. Additionally, Accell is well positioned for the continued electrification of the bike in northern Europe.

Companhia de Saneamento Basico do Estado de Sao Paolo (NYSE:SBS), is a mouthful, but also a very interesting water utility and waste water treatment company in Brazil. It had been on a tear until early 2013, when the regulated water rate increase disappointed the market. There is a good chance that come February/March, the company will get a more favorable rate reassessment. Meanwhile the stock is trading at 7.7x earnings, pays a 4.6% dividend, and might have a chance to ride the wave of investor interest that is likely the accompany the Brazilian World Cup in 2014 and Olympics in 2016.

Shawn Kravetz 2013.jpg

Shawn Kravetz is President of Esplanade Capital LLC, a Boston based investment management company one of whose funds is focused on solar and companies impacted by the emergence of solar.  Last year, his top pick last year was Amtech Systems (NASD:ASYS.)  It’s up 137% in the 12 months since he picked it. His income pick this year is Hannon Armstrong Sustainable Infrastructure, (NYSE:HASI) one of the new income investments I mentioned above that IPOed in 2013.

HASI is a “broken” IPO, meaning that it has been trading almost exclusively below its issue price of $12.50, but it has touched $12.50 several times over the last few days.  Kravetz says that HASI

Provides and arranges secured and generally senior debt and equity financing for sustainable infrastructure projects (e.g., clean energy generation and energy efficiency).  Established as a REIT pre-IPO, this 32 year-old firm is headed by veteran management team.  We see them ramping to a $1.17 annualized dividend early in 2014, nearly a 10% dividend at today’s stock price.  At a peer multiple, the stock should command a price of at least $17, implying at least 40% upside.

Conclusion 

Will Kravetz have the top pick in 2014 as well as this year?  It’s quite possible, but I hope it’s not with Hannon Armstrong.  Although I personally own all three of these stocks, it’s not because I expect 100%+ gains, but because they have the potential for appreciation, but are much safer than the growth stocks which dominate the available green investments.

If any of these three picks is the top pick for 2014, it will be because other green stocks will have had terrible year, and these advanced in a flight to safety.

Broad market valuations are high, so there is a real risk of a broad market decline in 2014, and this would probably affect green stocks as well.  Even without a broad market decline, it would be unreasonable to expect another spectacular year like 2013 for green stocks.  Nevertheless, there are still a large number of green stocks that did not participate in this year’s rally and remain great values.

My panel of managers have picked fifteen of their favorites.  You can read about the other twelve in my next few articles.

This article was first published on the author's Forbes.com blog, Green Stocks on December 17th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

December 24, 2013

Christmas Climate Bond From Hannon Armstrong

Sean Kidneyhannon armstrong logo

Out Monday: a very interesting bond from US listed sustainable infrastructure investor, Hannon Armstrong Sustainable Infrastructure (NYSE:HASI): a $100 million asset-backed securitization of cash flows from over 100 individual wind, solar and energy efficiency installations, all with investment grade obligors. They’re calling them “Sustainable Yield Bonds”; Climate Bonds for us. Coupon is 2.79%. This first bond was privately placed - but they’re planning lots more.

Hannon Armstrong have taken the high ground on emissions and built in quantitative annual reporting of greenhouse gas emission reductions, measured in metric tons per $1,000 of par value. The assets underlying the bond are “estimated to reduce annual … emissions by 0.61 metric tons per $1,000 bond”. The company says the annual estimated 61,036 metric tons carbon savings are ”the equivalent of taking approximately 12,700 cars off the road”. Investors will get emissions reporting data project by project, although individual projects won’t be named ”for competitive reasons”.

We like the blended portfolio approach – that’s how we’re going to get to scale in the fragmented climate investments market – with emissions reduction reporting giving us comfort on the building energy efficiency portions.

Being asset-backed means it’s real, extra, money being raised against the cash flows, freeing up capital for Hannon Armstrong to move on to the next crop of projects. That’s the ideal role for bonds in the capital pipeline.

Great work from Hannon Armstrong.

——— Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

November 25, 2013

Capstone Infrastructure: How Bad Is The Worst Case?

Tom Konrad CFA

Disclosure: I have long positions in MCQPF and AQUNF.

Capstone Infrastructure Corporation (TSX:CSE, OTC:MCQPF) has been trading at a significant discount to its peers because of a  power supply agreement which expires at the end of 2014.  Capstone is seeking a new agreement with the Ontario Power Authority for its Cardinal gas cogeneration facility, a process which has taken much longer than management expected.

The cardinal Cardinal plant currently accounts for about a third of Capstone’s revenue and a quarter of earnings before interest, taxes, and depreciation (EBITDA), but two-thirds of distributible income.  The high fraction of distributible income is because Cardinal’s debt has been paid down over the term of the expiring power supply agreement.  This makes income from Cardinal (and the terms of a new power supply agreement) crucial to maintaining Capstone’s dividend.

Cardinal.png
Capstone Infrastructure Corp.'s Gas Cogeneration facility in Cardinal, Ontario.

In the company’s third quarter conference call, we learned a few tidbits which point to how and when the negotiations might be resolved.

Timing

In terms of timing, the Ontario Power Authority (OPA) is expected to release its new Long Term Energy Plan before the end of the year.  It seems unlikely that the OPA would announce a new contract with Capstone before releasing the plan, so I expect that investors will have to wait until 2014 before we have any news on an actual contract.

The OPA did finalize a 20 year power supply agreement with TransAlta Corporation (TSX: TA, NYSE:TAC) for that company’s similar gas cogeneration facility in Ottawa.  That facility’s previous agreement was expiring at the end of 2013.  If Capstone’s negotiations follow a similar pattern, we would expect a new agreement for Cardinal in the middle of next year.

Likely Terms

TransAlta’s Ottawa power supply agreement is interesting in terms of its substance, in addition to its timing.  Under that deal, the plant “the plant will become dispatchable. This will assist in reducing the incidents of surplus baseload generation in the market, while maintaining the ability of the system to reliably  produce energy when it is needed.”

For similar reasons, the chance of Capstone and the OPA failing to come to any agreement seems minuscule.  The Ontario government has committed to no new nuclear and an increasing dependence on renewables and efficiency.  No new nuclear means lower overall supply, and more renewables means more variable power supplies, adding to the value of flexible plants such as Cardinal and Ottawa.

The Ottawa agreement provides for TransAltas’s plant to ramp up and down in response to the needs of Ontario’s power system.  Dispatchable plants receive two types of revenues from the utility: payment for energy produced, and a capacity payment based on the plant’s ability to respond to system needs.

Cardinal is also a flexible facility, so it makes sense that Cardinal’s power supply agreement would also provide for the plant to become dispatchable.  New capacity payments would go some way to making up for the lost revenue when Cardinal no longer operates as a baseload facility.  In 2012 and 2013, Cardinal has been generating power nearly flat-out, running at a capacity factor equal to over 90%  of its theoretical maximum.

The capacity factor of dispatchable facilities varies greatly.  ”Peaker” plants tend to be relatively inefficient facilities with high operating costs which operate for only a few hours or days each year, when load is highest and all other facilities are already operating.   More efficient cogeneration plants such as Cardinal and Ottawa are typically used to serve intermediate load.  Such plants are dispatched whenever demand is high or moderate or when renewable power production is low.  They are switched off at times of low demand or high production from renewables.  Such plants usually operate at capacity factors between 30% and 70%, with more efficient, low-cost facilities operating at higher capacity factors.  Cogeneration facilities tend to be among the most efficient.

Estimates

I modeled three scenarios for Capstone’s 2015 earnings under a new power supply agreement.  For a worst case, I assumed that Cardinal would operate at a very low 15% capacity factor.  My “expected” case would have Cardinal operating at a 55% capacity factor, and my “high” case would have it operating at a 65% capacity factor.

I then factored in moderate revenue and earnings growth from Capstone’s many development projects and capital investments to arrive at some rough estimates of Capstones future capacity to pay dividends.  The company measures this capacity with “Adjusted Funds From Operations” or AFFO, and aims to pay out roughly 70% to 80% of AFFO as dividends.

Capstone Metrics.png

Starting with Capstone’s recent share price of C$3.66, I assumed that management would maintain the current C$0.075 quarterly dividend through 2014, and pay out 80% of AFFO in 2015.

Although income and AFFO will drop with the new contract, the market is already pricing in a dividend decrease.  Capstone currently trades at a dividend yield over 8%, while the closest comparable, Algonquin Power and Utilities (TSX:AQN, OTC:AQUNF,) yields 5.2%, so I assumed Capstone’s yield would fall to 6% in 2015, given the increased certainty embodied in a new contract.

In my expected scenario, this produced a C$4.70 stock price, while my worst case scenario had the stock fall to C$3.08, and the high case produced a stock price of C$5.06.  The worst case scenario produced only a tiny net loss (less than 1%) over the next two years because of Capstone’s high dividend yield, while the Expected and High scenarios produced 45% and 55% two-year returns, respectively.

  Capstone Share
Price and Div Est.png

Conclusion

Ontario’s plans to meet its electricity needs without new nuclear power, and with the increasing use of wind, solar, and energy efficiency mean that the flexibility of Capstone’s Cardinal cogeneration power plant is increasingly valuable.  The Ontario Power Authority is likely to reach a supply agreement with Capstone to provide for Cardinal to be operated as a dispatchable facility.  Such an agreement is likely to be finalized well in advance of the expiration of Cardinal’s current agreement at the end of 2014.

Under such an agreement, Capstone’s income from Cardinal will almost certainly decline.  However, the market currently seems to be pricing in a worst case scenario under which Cardinal operates only a fifth of the time.  Under a more likely scenario, Capstone should be able to maintain its current C$0.30 annual dividend.  If that happens, the stock should appreciate for a two year total return of between 35% and 55%.

This article was first published on the author's Forbes.com blog, Green Stocks on November 15th.

Disclosue: Long CSE, AQN,NPI,BEP,INE,RDZ

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sour

November 21, 2013

Hannon Armstrong Yeild On Track For 7% in Q4 With More To Come

Tom Konrad CFA

hannon armstrong logo

After the close on Thursday, November 7th, Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI) declared third quarter earnings.  Results were in-line with my, and other analysts’ expectations: Earnings per share (EPS) of 14 cents, and a declared dividend of 14 cents as well. This more than doubled the second quarter’s 7 cent EPS and 6 cent dividend. Note: I have a large long position in HASI.

HASI remains on track to reach managements’ dividend target of “over 7% of the $12.50 IPO price” (22 cents a quarter,) and provided some additional guidance for future dividends.  Brendon Herron, HASI’s Chief Financial Officer said that investors can expect the dividend to grow between 13% and 15% for the next couple of years, based on the 22 cent fourth quarter target.

Putting some numbers to the dividend guidance, at Friday’s closing price of $11.69, a 22 cent fourth quarter dividend would equate to a 7.5% annualized yield.  13% to 15% annual dividend growth would provide an annualized yield of  8.5% to 8.6% in Q4 2014, and 9.6% to 10% in 2015, assuming the share price does not increase.

Why The Decline?

Despite delivering on the company’s promises, the stock fell 5% from its Thursday $12.30 close, returning to levels it had last seen in mid-October, as it recovered from early-October lows.  I attribute those lows to investor worries about the federal government shut-down.  (Incidentally, I was buying in early October.  While much of HASI’s business is with the federal government, federal cost cutting is more likely to be a driver of HASI’s money-saving investments than a drag in the long term.  In the short term, federal projects may be delayed, but the company can make up the difference from other sectors in its vast pipeline.)

The most likely reason for the decline was selling by IPO investors.  Approximately 2 million, or 13% of outstanding shares, became eligible for sale in October.  Many of these IPO investors have doubtless been disappointed that the company has been consistently trading below the $12.50 IPO price, and were hoping the fourth quarter earnings announcement would provide an exit.

With an average share volume of less than 100,000 shares, it would not take much selling by short term IPO investors to drag the stock price down for several weeks.  In contrast. the long term income investors who are likely to be attracted by HASI’s future yield tend to move more slowly.  I expect they will eventually bring the price back up as they recognize the value of HASI’s current 4.8% annualized yield and forward 7.5%+ yield, but we can’t expect this to happen overnight.

Note that company insiders are still restricted from selling.  However, I don’t expect them to sell many shares when they are released from lock up.  According to SEC filings, company officers (most notably the CEO, Jeffery Eckel) have purchased over 50,000 shares since the IPO at prices between $10.99 and $11.76.  I would not be surprised if they are buying today.

Conclusion

Hannon Armstrong’s fall on Friday was most likely due to selling by IPO investors who were released from lock-up restrictions in mid-October.  If only a fraction of these investors try to sell their shares over the next few weeks, it could easily drive the stock down further given HASI’s low trading volume.

Long term investors and traders willing to hold a position for at least six months should take note.  Given the extremely reliable nature of its investment income, buying Hannon Armstrong at any price below $12 is not only likely to produce some capital gains as they reach their full dividend, but the 14 cent thirdquarter dividend should provide a floor for the stock price.  At $12, its annual yield is  4.7%, which is already in line with comparable US-listed stocks.  If selling by short term IPO investors is driving the stock down, it is a buying opportunity, not a reason to panic.

This article was first published on the author's Forbes.com blog, Green Stocks on November 15th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

November 18, 2013

Solar Rooftop Lease Securitization A Ground-Breaking Success

SCTY residential solar.pngSean Kidney

Last week we blogged that  SolarCity (SCTY) and Credit Suisse were about to issue a new $54.4 million, climate bond – a rooftop solar lease securitization. It’s out: BBB+, 4.8%, 13 years. The long tenor is interesting – and great. And S&P’s BBB+ rating suggest those credit analysts may be beginning to understand solar.

This bond has been long-awaited by the green finance sector, who are hoping it’s the harbinger of things to come.

I did get the chance to look at the S&P opinion. Their rating reflected, as they put it, their views on over-collateralization (62% leverage; that’s how companies do credit enhancement), SolarCity's track record and the credit quality of the household borrowers.

They also noted that “because this asset class has a limited operating history, we expect the rating to be constrained to low investment-grade for the near future”. Presumably that means we can expect better ratings five years away.

The asset-backed securities will be paid for with the cash flow from the SolarCity‘s rooftop solar leases. This allows SolarCity to raise fresh cash to do the next wave of deals; we think of this as supporting velocity in working capital.

I’m mentioning this because folks from the policy and carbon world sometimes feel a bit queasy about climate bonds backed by existing assets. “Shouldn’t we be focusing on new project finance”, they ask. No.

In the project space, as Citi’s Mike Eckhart is fond of reminding us, bonds only make up 5% of debt financing globally. Banks provide the rest – and that’s unlikely to change much.

The critical task for climate bonds is to re-finance – to provide an exit strategy for those folks who best understand project development risk: equity investors, energy corporates, and bank lenders. Once that project development risk has gone, climate bonds become the means to re-finance among the pension and insurance fund sector, whose risk appetite is much lower.

This is important for energy companies, allowing them to effectively offload “mature” assets (solar panels in place, leases signed, revenue flowing) and so quickly recycling capital into new projects.

It’s also vital for banks, struggling with recapitalisation pressures post-crash. If they can securitize their loan portfolios it will allow them to do more with their now reduced allocations to project lending.

It opens up a critical new financing option for companies, helping them grow faster. And boy do we need them to grow: if we’re to have a chance of avoiding climate change tipping points we need every low-carbon industry to grow at maximum rates.

SolarCity installs rooftop solar panels, typically at little or no cost to customers. The company owns the systems and its residential and commercial clients sign long-term agreements to buy the power.

Interestingly SolarCity‘s share price jumped 4.3% when the bond came out, making the largest US solar company by market cap. Confidence building? [Ed. Note: It should not be surprising that when a company gets access to a cheap new form of finance, it helps the stock.]

——— Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

November 12, 2013

Retail Renewable Energy Bonds Proliferating

by Sean Kidney
Wind solar finance.jpg
Renewable Energy Finance via BigStockPhoto

There has been a bit of interest recently about rapidly expanding options for retail investors to get involved in renewable energy projects. While we still see retail bonds as making a relatively modest contribution to the transition to a low carbon economy, they are important in engaging the public and creating awareness for green thematic investments which can only be good.

Here’s a round up of some of the activity going on in the retail bond market (please note, this is not an endorsement of and product’s credit characteristics, only their environmental ones)…

Good Energy bond 3x oversubscribed

Last month we blogged about UK-based Good Energy’s aim to raise £5m through a retail bond offering to finance investment in solar and wind energy generation. Within 3 weeks, Good Energy easily met their target, closing the book at £15m three weeks ahead of schedule!

The demand demonstrated for this bond and the earlier Ecotricity bonds is very encouraging. Question is, will this trend continue to the larger utilities? When the big utilities start issuing asset-linked climate bonds to finance their renewable energy assets, that’s when we’ll see real capital shifts.

Bonds to finance solar rooftop generation

A few days ago we blogged about SolarCity’s pending US rooftop solar lease securitization.

In the UK, CBD Energy (CBD.AX) is offering a “Secured Energy Bond” to raise finance to install solar panels for chosen UK businesses at no cost to the business but with income derived from Feed-In Tariffs. The bond is secured against the assets of the company and also has a corporate guarantee from the parent company. It will pay an annual coupon of 6.5%. The minimum investment into the bond is £2,000 for a 3 year fixed term and as the bond is non-transferable, it has to be held to maturity in late 2016.

A similar offering come from UK-based A Shade Greener which is aiming to raise £10m from small investors (min £1000) by offering 3 year retail bonds at 6% annual return, but with an interesting twist – all the interest paid upfront as a lump sum. Bizarre indeed (we’ve never seen it before) but according to the company, the decision demonstrates the confidence it has in the reliability of its income plus it wants to differentiate itself from similar offerings. The company, which has installed 25,000 solar panel systems, installs panels at no cost to the householder and collects the feed-in tariff payments. As with the CBD bond, this must be held for three years until maturity.

Canada’s largest solar co-op

Bullfrog Power and SolarShare have recently announced the completion of Toronto’s largest solar co-op project. The ‘Goodmark’ project is an 18,000 square-foot rooftop installation providing 100kW of power to a variety of companies within the building. With the successful completion of the installation, the project goes into a portfolio of PV assets against which Solar Bonds are issued and offered to SolarShare members. The bonds offer a return of 5% per year on a 5 year bond. The bonds are secured against a portfolio of solar PV assets (no construction risk), each of which has secured a 20 year Feed-in tariff power purchase agreement from with Ontario Power Authority.

Crow-source funding grows

There’s been a bit of hype recently about the potential for crowd funding as a tool for financing renewable energy. To be honest, we’ve mostly put this into the ‘great but not nearly big enough’ category. However, some recent articles have shown that, while it’s still not likely to finance all the $1trn per year needed globally to avoid catastrophic climate change, numbers are growing. In Europe in 2012, crowd funding (not just energy) grew 65% over 2011 to reach EUR735m. This is not insignificant compared to the European venture capital market which is EUR3bn. Some estimates put 2013 growth at 81% which would push it over $1bn.

It also has some major advantages over regular debt funding or bank lending – it can fund small businesses and organisations that don’t have access to the regular financing channels and it can be much faster and more nimble than traditional funding sources.

In Europe crowd funding has mainly been a tool for energy cooperatives. Europe has a strong tradition of cooperatives (apparently more Europeans are invested in cooperatives than in the stock market). The speed with which crowd funding and the energy cooperative sector are expanding (European energy cooperatives grew from 1,200 in 2012 to 2,000 this year) demonstrates that there is potential for community-financed initiatives to shake up the energy market.

A number of crowd funding platforms have sprung up to focus on renewable energy projects including Solar Schools, Abundance Generation, SunFunder and Solar Mosaic. Solar Mosaic in the US has so far invested $3.8 million in different projects ranging from 1.5kW – 500kW. Abundance Generation in the UK is smaller but using a similar model has just raised £400,000 for SunShare Community Nottingham Project. SunFunder is focussed on emerging markets and connects investors to vetted solar businesses working on the ground in Africa, Latin America, Asia and the Caribbean.

Yes, it’s still small but it’s growing.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

November 07, 2013

Wall Street Banks Promote New Green Bonds Framework

by Sean Kidney
 

Earlier this month CitiBank (NYSE:C) and Bank of America Merrill Lynch (BoAML; NYSE:BAC) launched, via a special EuroWeek report on ‘sustainable’ capital markets, a “Framework for Green Bonds“. This is potentially a big development.

In the paper the two banks laid out a ‘vision’ for the green bonds market and called for a Green Bonds Working Group of issuers, dealers and investors to be formed to drive the evolution of the nascent market. The paper calls for debate about the green bond market, especially about how to guarantee that green bonds are more than just a coat of greenwash. Hear hear!

Citi and BoAML included an open invitation for banks, investors and fund managers to join a Steering Committee for a Green Bonds Working Group. JP Morgan (NYSE:JPM) and Morgan Stanley (NYSE:MS) are the first banks to join. Also invited are ratings agencies, NGOs, regulators and the like.

The paper proposes a voluntary “framework” for the issuing of green bonds (a.k.a. climate bonds), where issuers and banks commit two key things:

1. Creating transparency on the actual use of funds, and reporting on that use.

2. That issuers should use and refer to an authoritative, third party list of criteria for assets that can be included in a green bond.

The main point the framework asserts is that green bonds are about the “green” qualities of the underlying asset, not whether a company is relatively green or not. Bonds have to be linked to actual wind farms or green buildings, or projects to build them. This means that a company does not have to score well in ESG or green rating systems to be able to issue green bonds – they just have be building green kit. That – which is also the Climate Bonds Standard approach – allows a much wider universe of companies that can issue green bonds.

(Note that some of the EuroWeek journalists writing elsewhere in the report haven’t quite got this yet; they’re still thinking the idea is for “complicated” company ratings. But in fact a physical asset approach should end up being very simple for issuers. The complexity is in developing the simple criteria.)

That, of course, does raise the question of what is meant by green kit.

The paper then references five possible taxonomies for issuers to use: OECD, World Bank (BRD), IFC, EIB and the Climate Bonds Taxonomy (yes, we were involved in some of the discussions around the Framework). It allows that further credible taxonomies may arise.

There’s not a lot of difference between these taxonomies; they are all coming from the same position and are all about climate investments. But there are differences in the level of practical detail provided and underlying regimes, such as reporting requirements.

At Climate Bonds we’ve focused on developing a Climate Bonds Taxonomy to both explain what we mean by “investments important to a rapid transition to a low-carbon and climate resilient world”, and to signal where we’ll be rolling out detailed eligibility criteria under the Climate Bonds Standard. You’ll find more explanation of how it all works on the Taxonomy page.

What the Green Bonds paper doesn’t do is call for certification or verification, although it allows that this may be a further market development.

Our view is that in the corporate market, specifically for “asset-linked” bonds modelled on the World Bank’s Green Bonds, third party verification will be important to trust. The Climate Bonds Standard is pitched as a gold-level but straightforward certification scheme, designed specifically to add credibility to corporate green bonds.

Here is the full text of the Green Bonds paper: if you have thoughts or comments please let me know, or use the comments function at the bottom of the web site page for the blog. The more discussion at this stage, the better.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

November 05, 2013

Four Green Dividend Stocks That IPO'd In 2013

Tom Konrad CFA

Disclosure: Long BEP, HASI.

Canada’s stock exchanges have long had the lead as the place for energy infrastructure companies to list.  This includes green energy, as well as the fossil fueled sort.   Because Canada’s reporting rules are somewhat less stringent, and its markets less liquid than those in the US, the large number of offerings trade at lower valuations and higher yields than do their (few) US-listed equivalents.

In fact, it was the promise of a higher valuation which led Brookfield Renewable Energy Partners (NYSE:BEP, TSX:BEP-UN) to obtain its US listing on June 11th.  Brookfield had planned a secondary stock offering, which it delayed on June  20th because of “current capital market conditions.”  Although the stock has risen as high as $31 in anticipation of the US listing, rising interest rates had lowered its stock price to the $26 range shortly after the stock began trading in New York.

Even with the decline, however, Brookfield still offers at a dividend yield lower than its Canadian-listed peers.

US Stocks

Despite the higher yields on offer in Canada, many US investors prefer investing at home.  Part of that is undoubtedly because they find recovering Canada’s foreign tax withholding on dividends through the US Federal tax credit onerous (or impossible, if they are investing through a retirement account.)  Note that BEP’s distributions are still subject to this withholding, despite its US listing.

The reluctance to buy Canadian stocks also stems in part from concerns over the lighter disclosure rules on Canadian exchanges, the lack of liquidity, or simple unfamiliarity with trading foreign stocks.  Whatever the reasons, three recent IPOs and Brookfield’s listing have created a new, if short list of US listed green income options.  These are:

Brookfield Renewable Energy Partners, L.P.

Exchange/Ticker: NYSE:BEP

Portfolio: 3705 MW Hydropower, 777 MW Wind, 45 MW Hydro under construction.

Recent Stock Price & Declared Quarterly Dividend (Yield): $26.76, $0.3625 (5.4%)

Expected 2014 Dividend (Yield): $1.45 (5.4%) or more

Comments: Dividends are subject to Canadian tax withholding.

Hannon Armstrong Sustainable Infrastructure

Exchange/Ticker: NYSE:HASI

Portfolio: Bond-like investment mostly in Energy Efficient performance contracts, plus other sustainable infrastructure including solar and geothermal.

Recent Stock Price & Declared Quarterly Dividend (Yield): $12.34, $0.06 (1.9%)

Expected 2014 Dividend (Yield): $0.93 (7.5%) – my estimate based on statements from management.

Comments: HASI is a REIT, and so does not pay corporate tax.  Distributions are taxed to investors as ordinary income.

Pattern Energy Group Inc.

Exchange/Ticker: NASD:PEGI

Portfolio: 1041 MW wind in the US, Canada, and Chile.  270 MW Wind under construction in Ontario, CA.

Recent Stock Price & Declared Quarterly Dividend (Yield): $22.71, $0.3125 (5.5%)

Expected 2014 Dividend (Yield): $1.25 (5.5%).

Comments: I recently looked at PEGI in depth here.

NRG Yield

Exchange/Ticker: NASD:NYLD

Portfolio: 101 MW Wind, 253 MW solar (60 MW more under construction), 910 MW natural gas, 1098 MW (thermal) of heating or cooling projects supplying thermal energy (and a little electricity) directly to businesses.

Recent Stock Price & Declared Quarterly Dividend (Yield): $34.99, $0.23 (2.6%)

Expected Future Dividend (Yield): $1.44 (4.1%) – this is Goldman Sachs analysts’ estimate, and I’m not certain of their expected time frame.

Comments: I recently looked at NYLD in depth here.

Portfolios for US green div stocks.png
Conclusion

For a US investor looking for income in green energy, Hannon Armstrong seems a compelling addition to the portfolio.  Brookfield and Pattern also seem worth including for added diversification and income.  NRG Yield, is not nearly as green as the others, despite its the recent headlines about its solar investments.  Its expected dividends also seem low to justify its current price, at least compared to the other three options listed here.

This article was first published on the author's Forbes.com blog, Green Stocks on October 25th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

November 02, 2013

Solar Income, Really?

Tom Konrad CFA

NRG Yield logo.png

Disclosure: Long BEP, HASI.

NRG Yield (NYSE:NYLD) was spun out of its parent, NRG Energy, Inc. (NYSE:NRG) in July, and has since been greeted with enthusiasm by investors.  The stock priced at $22, 10% over the mid-point of its expected range, and the underwriters exercised their full over-allotment option.

NRG Yield presents itself as an owner and operator of contracted renewable and conventional electricity generation, as well as thermal infrastructure assets.  (Thermal infrastructure provides heat or cooling to businesses for use in their operations.)  The company has a green tinge because of its wind and solar generation, and seems to be designed to appeal to green investors who also like the green of a substantial dividend yield.

How Green Is It?

NYLD segments.png
Data: NYLD SEC Filings

Although I manage green portfolios professionally, I was not particularly interested, mainly because the company does not seem all that green.  Renewable energy only accounts for 30% of revenues, or 43% of assets and income (see chart.)  This is greener than most independent power producers, but there are many income stocks with greener portfolios available.

Show Me the Green

That said, most income investors care more about the green an investment pays out in dividends than the greenery of how it makes that money.  NRG Yield has yet to pay a dividend, but the most recent quarterly report states: “NRG Yield, Inc. expects to declare and pay a dividend of $0.23 per Class A common share during the fourth quarter of 2013.”

At the IPO price of $22, this would have amounted to a less than stunning 4.2%annual yield, but since then, investors have bid the stock up to $34.60, reducing the yield to 2.7%.  However, analysts at Goldman Sachs expect NRG Yield to raise its dividend further.  They recently issued a new price target of $41 based on a 3.5% dividend yield (corresponding to a $0.36 quarterly dividend.)

Comparables

Even the 4.2% yield offered by Goldman’s future dividend estimate at the current price of $34.60 seems low to me.

Completely green income alternatives such as Pattern Energy Group (NASD:PEGI), Brookfield Renewable Energy Partners (NYSE:BEP), and  Hannon Armstrong Sustainable Infrastructure (NYSE:HASI) all compare favorably on yield.  Pattern Energy owns a portfolio of wind farms, and expects to start paying a $0.3125 quarterly dividend (5.4% annual yield) in the fourth quarter, when NRG Yield will only be paying 2.7%.

Brookfield Renewable is already paying a $0.362 quarterly dividend (5.3%) and owns a portfolio of hydropower, wind, and solar generation.

Hannon Armstong’s business is less comparable, since it invests in energy efficiency projects and other sustainable infrastructure.  As a REIT, dividends may be subject to higher tax rates than the other three, but its CEO has said that it will declare a dividend in excess of $0.219 for the fourth quarter (7.4%), and will eventually ramp up to $0.234, or 8% based on the current $11.76 share price.  Even if we adjust Hannon Armstrong’s expected dividend down by 15% to reflect a 35% income tax rate rather than the 20% rate on qualified dividends, it’s expected yield is 6.8%, 2.6% higher than the yield Goldman is predicting for NYLD.  Such an adjustment would not be necessary for an investor in a lower tax bracket or one investing through a retirement account.

Conclusion

Given the other green income options available on US exchanges (not to mention more attractive yields available in Canada,) I fail to see the attraction of NRG Yield.

Looking at recent news articles, I can only guess that investors are giving the company a “green” premium based on frequent mentions in articles about solar.  That would be ironic, given that NRG Yield’s greenery is even less compelling than its yield.

This article was first published on the author's Forbes.com blog, Green Stocks on October 23rd.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

November 01, 2013

Investors Expect Rapid Growth At Pattern Energy Group

Tom Konrad CFA

gulf_035[1].jpg
Pattern Energy's Gulf Wind Farm in Armstrong, Texas

Disclosure: Long BEP.

Pattern Energy Group (NASD:PEGI, TSX:PEG) completed a very successful Initial Public Offering (IPO) on the Nasdaq and Toronto stock exchanges on September 27th.  Not only did the shares price at $22, near the top of the expected range, but the underwriters exercised their full over allotment option to purchase 2.4 million shares in addition to the initial 16 million offered.  Total proceeds from the offering were $404.8 million.  Most of the proceeds went to Pattern Energy Group, LP (PEGLP) in consideration for a number of contributions and class A shares sold in the offering, but $56 million will be used to pay down debt and $60.2 million will be retained for general corporate purposes.

Investors greeted the offering enthusiastically, and the stock is trading comfortably above the offering price at around $23 per share since the IPO.

The Company

Pattern owns six wind power projects in the US and Canada with total capacity of 1040 MW and two development projects in Ontario (270 MW) and Chile (115 MW) which are expected to enter production in 2014.  Post-IPO, public shareholders will control only a minority of the company’s common stock.  Control of the company is held by PEGLP, which, along with its partners, will control 63.1% of voting rights through as combination 47.4% of Class A shares and 99% of Class B shares.  Management owns the remaining 1% of Class B shares.  Class B shares do not currently pay a dividend, but will convert into Class A shares at the end of 2014, or upon commercial operation of the Ontario Wind farm, if that has not yet occurred.

Distributable cash flow for 2014 is expected to be approximately $55 million,80% of which the company plans to pay to shareholders as a quarterly dividend of $0.3125 per share.  Achieving this cash flow will depend on the on-time completion of the Ontario and Chilean wind projects.  At $23 a share, $0.3125 quarterly amounts to a 5.4% annual dividend.

While completion of the Ontario and Chilean wind projects in 2014 can be expected to increase distributable income, conversion of Class B into Class A shares will offset this in 2015 by increasing dividend-paying shares by 29%.  As a back-of-the-envelope estimate, if the income from the new wind farms is comparable to the existing wind farms on a per MW basis, we can expect distributable income to be increased by 37%.  Given the wide range in profitability of wind farms, however, I feel it is safer to assume that the increased income from the Ontario and Chilean wind farms will only serve to offset the share dilution.

After the transaction, Pattern’s capitalization will be approximately 67% debt, and 33% equity, which is stronger than its closest comparable, Brookfield Energy Partners (NYSE:BEP, TSX:BEP-UN), which has about 20% equity and preferred equity.  Brookfield’s longer track record and larger and more diversified portfolio of hydropower, wind, and solar assets should allow it to offer a lower yield than Pattern, but at $27.43, Brookfield’s yield of 5.3% is almost identical to Pattern’s.

Conclusion

Pattern’s shareholders seem to be betting on Pattern achieving rapid growth, or at least faster growth than comparable companies such as Brookfield.  However, most of its growth in distributable income over the next two years is likely to be offset by the increased number of shares paying dividends, when class B shares convert to class A shares.

At the current price, Pattern Energy Group seems fully valued relative to its US-listed peers, and expensive relative to clean energy power producers with only Canadian listings.  As such, the stock may be useful to increase the diversification and income in a clean energy stock portfolio, but it will probably not produce much share price growth in the near future.

This article was first published on the author's Forbes.com blog, Green Stocks on October 22nd.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

October 28, 2013

Sunny Climate For Solar Income Up North

Tom Konrad CFA

Solar investment ratios with incentives

Disclosure: I am long PW and HASI.

In a rational world, the sunniest places would have the warmest reception for solar technology and investment.  While solar is having its day in the sun in Hawaii, state incentives make the economics of photovolatics equally attractive in Vermont, a state not known for its sunny skies.  And while California is famous for its rapid deployment of solar, the economics are at least as good in Washington state, New York, New Hampshire, and chilly Maine.

It’s not only the economics of solar which can counter-intuitively get better to the North.  There are also some unique opportunities for small investors to finance of solar projects.  Last year, I wrote about attempts to allow US retail investors to invest in solar projects through Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs).  Solar REITs would require a ruling from the IRS, which now looks unlikely, while Solar MLPs would require an act of Congress… a Congress that can’t even keep the government open for business, let alone enact useful legislation.

Innovations in Solar Infrastructure Investment

While Congress fails to act, financial innovators are moving forward.  I’ve previously written about Solar Mosaic, Power REIT (NYSE:PW), and Hannon Armstrong Sustainable Infrastructure (NYSE:HASI).

Solar Mosaic offers small investors the opportunity to participate in loans directly, but the number of opportunities has so far been limited.  The interest on offer (4.5%) is attractive compared to many fixed income investments.  Unfortunately, Mosaic investments don’t allow the freedom to sell which investors can get with ordinary bonds or CDs, and are not available in tax-advantaged retirement accounts.

Power REIT is investing in the land under solar projects, but is in the middle of a civil case with Norfolk Southern (NYSE:NSC) and Wheeling & Lake Erie.  Resolution of this civil action has the potential to easily more than double the value of PW stock with (in my opinion) very little downside risk, but the associated expenses have forced Power REIT to temporarily suspend its dividend.  When the case is resolved and the dividend resumed, I expect Power REIT to become an attractive solar income investment.  Until then, I still consider it an attractive investment on the basis of the huge potential upside from the civil case, but it is not an income investment.

In contrast, I am very enthusiastic about Hannon Armstrong as a green income investment.  I’m confident that the company will be able to increase its dividend to $0.93 or more per year over the next two to three quarters, which will translate into an 8.2% yield at the current price of $11.32.  But HASI is an investment in sustainable infrastructure (mostly energy efficiency), as opposed to solar.

Two other clean energy income investments have gone public in the US are Pattern Energy Group (NASD:PEGI) and NRG Yield (NYSE:NYLD).  Both invest in clean energy infrastructure but only have minor investments in solar.  Pattern Energy plans to pay an initial $1.25 annual dividend, or 5.5% at the current price of $22.63 per share.  NRG Yield is expected to pay an annual dividend of $1.20 per share  initially and hopes to ramp that up to $1.44 per share by the end of 2014, corresponding to dividend yields of 3.9% and 4.7% at the current price of $30.58.  I have not evaluated either of these companies in depth, but plan to do so soon.

CleanREIT

In many ways, our Canadian friends to the North are as far ahead of us in creating a sunny climate for solar income investment as Vermont is ahead of Florida in creating a sunny climate for solar installations.  CleanREIT Partners, LLC is a specialty finance/management company investing in solar installations and based in California, but planning an initial public offering on a Canadian exchange to allow investors to take advantage of a structure called a foreign asset income trust.  I recently spoke to Bill Hillard, co-founder of CleanREIT, and asked him what made him consider Canada.

I expected him to cite the tax advantages of Canadian foreign asset income trusts.  Like US REITs, such trusts are not subject to income tax at the corporate level, but instead Hillard cited the large number of comparable renewable energy income investments already trading in Canada.  (I wrote about six of these, and selected the one I consider most attractive here.  Not only are there more than on US exchanges, but the yields on offer are typically higher.)  According to Hillard, solar’s existing tax advantages should be sufficient to shelter the income from solar investments to the extent that legislation such as the MLP Parity Act would not be necessary to create a US-listed solar investment vehicle which would not be subject to tax at the corporate level.

For investment bankers who would be underwriting the offering, having comparable companies already trading on the same exchange makes it much easier to price the offering.  In the end, if a company can’t find an investment banker willing to take it public, there will be no IPO.

Canadian Foreign Asset Income Trusts

In addition to the advantage of having numerous comparable stocks in Canada, the Canadian foreign asset income trust seems likely to prove a compelling structure for companies investing in US-based energy assets.  Several companies investing in conventional energy have already gone public using this structure, including The Eagle Energy Trust (TSX:EGL.UN), The Parallel Energy Trust (TSX:PLT.UN), and the Argent Energy Trust (TSX:AET.UN), which have investments in oil and gas wells mostly in Texas to avoid state level taxes.

The foreign asset income trust arose out of an exception in Canada’s 2007 “SIFT” rules which required Canadian income trusts to begin paying corporate tax on Canadian assets.  The purpose of these rules was to reverse the hollowing out of Canada’s tax base.  This hollowing out was the result of Canadian corporations converting to trust structures, which had only been subject to tax at the investor level, and not the corporate level at the time.  Because the SIFT rules were narrowly designed to prevent the loss of tax on Canadian corporate assets, they left in place the ability of a trust to avoid Canadian corporate income tax on foreign corporate assets.  This income would only be taxable to investors, not the corporation.

According to Hillard, income distributed to US investors in a carefully managed Canadian solar foreign asset income trust should also be tax-free because of the income tax shelter afforded by accelerated depreciation.  To his (and my) surprise, many large investors he has been speaking with seem more interested in this ability to avoid tax at all levels than the actual income on offer.

That said, the yield should also be attractive.  The distributed-scale, operating  solar projects the CleanREIT team has identified produce a 9% to 10% unlevered cash yield, according to company documents Hillard shared with me.  They expect to be able to grow income over time as rising interest rates and higher electricity prices increase the income on solar projects.  They also expect that solar technology efficiency gains will create investment opportunities to generate more revenue per square foot by upgrading existing solar plants as they age.  At the retail investor level, they expect this strategy to result in a 7% dividend yield plus growth in equity over time.

CleanREIT could IPO as soon as 2014 given sufficient capital from outside investors to consummate pre-IPO solar purchases and continued attractive conditions in public markets.

Bottom Line

Although a handful of clean energy income investments are  now available in the US, American investors would do well by considering Canadian stocks.  The existence of numerous comparable companies, favorable tax structures, and higher yields look likely to keep the Toronto Stock Exchange an attractive venue for both clean energy investors and financiers for years to come.  If CleanREIT successfully executes on its plan to IPO as a high-yield, tax-free, distributed solar investment, Canada will be virtually irresistible to American sun-seeking investors.

This article was first published on the author's Forbes.com blog, Green Stocks on October 18th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

September 22, 2013

Capstone Infrastructure: Green Income At A Cardinal Discount

Tom Konrad CFA


Cardinal.png

Capstone Infrastructure Corp.'s Gas Cogeneration facility in Cardinal, Ontario.

Capstone Infrastructure Corporation (TSX:CSE, OTC:MCQPF. Disclosure: I own this stock) is an international operator and developer of green infrastructure assets and utilities which is currently selling at a significant discount to most comparable firms.  I recently ran a comparison of six similar Canada-listed firms, and Capstone seemed much cheaper on several measures.

The Discount

The following chart compares five renewable energy and green infrastructure firms with most of their operations in Canada: Capstone, Algonquin Power and Utilities (TSX:AQN, OTC:AQUNF), Brookfield Renewable Energy Partners (NYSE:BEP), Northland Power (TSX:NPI, OTC:NPIFF), and Innergex Renewable Energy (TSX:INE, OTC:INGXF).  (I own all these stocks.)

CA income.png

As you can see from the chart, Capstone has not only the highest dividend yield, but also scores better on factors which reflect on its ability to maintain that dividend.  In particular, Capstone has much higher revenue and income relative to its market capitalization than the other companies.

That said, neither revenue nor income is a very good measure of a company’s ability to maintain its dividend for this sort of infrastructure company.  Revenue is not a good indicator of the ability to maintain a dividend when a company has too much  debt or preferred equity, or the business is not profitable.  As you can see from the chart to the right, Capstone’s common equity is in line with or stronger than the other firms in the comparison.

For capital-heavy infrastructure firms, income may understate the ability of a firm to pay dividends because of large non-cash depreciation and amortization charges.  Two of the firms compared (Algonquin Power and Infrastructure  and Brookfield Renewable Energy Partners) actually had negative income over the previous twelve months.  Most such firms publish a measure of Adjusted Funds From Operations (AFFO) to give investors insight into their ability to pay dividends.  Unfortunately, these measures are not defined by standard accounting rules, and so they can be problematic to compare across firms.

Rather than use published AFFO numbers, I chose instead to adjust for amortization and depreciation directly to get EBDA (Earnings Before Depreciation and Amortization), by adding them back in to income.  This has some of its own problems, in that it involves double counting the tax deductions on depreciation and amortization and it leaves out some other potentially relevant adjustments, but at least it is comparable between firms.  The yellow bars in the first chart (titled “Green Canadian Infrastructure Firms”) confirm that Capstone’s EBDA is also in-line with the other firms in the comparison.

Given Capstone’s high dividend and apparent ability to continue paying that dividend based on these accounting measures, I have to conclude the firm is trading at a discount.

Cardinal

Since Capstone seems to be trading at a discount to similar firms, it’s quite reasonable to ask why.  A quick review of management’s most recent discussion and analysis in its quarterly and annual filings makes the answer clear: Capstone’s largest asset, the 156 MW Cardinal gas cogeneration plant in Ontario (pictured in the lead photo) has an expiring Power Purchase Agreement.  This agreement covers the sale of the generated electricity to the Ontario Electricity Financial Corporation, and it expires in 2014.  The steam and compressed air generated by Cardinal is sold at contracted rates to an Ingredion (NYSE:INGR) Canada Inc. (formerly Casco Inc.) facility, one of the largest corn refining facilities in Canada, located adjacent to the Cardinal plant.  The agreements with Ingredion expire in 2016.

Capstone has been in discussions with the Ontario Power Authority over a new contract, but have not yet reached an agreement “that recognizes Cardinal’s value and its industrial, economic, social and community importance.”

Shareholder concern over the lack of a new contract has clearly been hurting the stock price.  Management is clearly aware of this, and says “Securing a new contract for Cardinal [is] our top priority for 2013.”

In 2012, electricity sales from Cardinal amounted to approximately 31% of revenue.  However, Capstone is in the process of buying Renewable Energy Developers (TSX:RDZ, OTC:STWPF).  After the merger, Cardinal’s share of revenue should drop below 29% for the combined entity, and will be even lower going forward, because RDZ brings with it a development pipeline which should increase Capstones future growth.

Is it really that bad?

With the market for 29% of Capstone’s revenue up in the air, it makes sense for Capstone to be trading at a discount relative to its peers.  But how much of a discount?

  • Based on its dividend yield of 7.8%, Capstone is trading at a 21% discount compared to similar firms, which pay on average 6.2%.  So investors are pricing in a 21% decrease in Capstone’s ability to pay dividends, which equates a 72% reduction in Cardinal’s profitability.
  • Based on Revenue, Capstone could lose all sales from Cardinal and still be trading at a lower multiple of sales than the comparable firms.
  • Based on a price to book ratio (P/B) of 0.7, it should be able to write off the entire value of Cardinal and still have Capstone trade in the P/B range of its peers (1.3 to 2.1, with an average of 1.6,) even if it accounts for up to two-thirds of Capstone’s equity.
  • Based on reported AFFO, Capstone’s dividend payout ratio was only 50% of AFFO in the first six months of 2013, while the company targets a long term payout ratio of 70% to 80% of AFFO.  Hence, AFFO could fall by one third and Capstone would be able to maintain its dividend while meeting its target payout ratio.

While the market of electricity in Ontario is not growing rapidly, economic factors make me believe that Cardinal should be able to operate at a profit even without a PPA.  In particular, growing demand in connecting regions (Manitoba, Quebec, New York, Michigan, and Minnesota) should provide a floor for electricity prices.  As long as  natural gas prices remain low, Cardinal should be able to sell its power at attractive prices, especially since some of its costs will be covered by sales of heat and compressed air to Ingredion.  Finally, with most of Ontario’s power coming from inflexible baseload nuclear and coal plants, the increasing penetration of renewables under Ontario’s Feed in Tariff makes Cardinal’s flexible gas cogeneration an increasingly valuable part of Ontario’s generation mix.

In any case, Capstone’s discussions with the Ontario Power Authority are more about “plans to reconfigure and expand the facility, rather than on extending the existing power purchase agreement (PPA)” according to the most recent quarterly report.  The negotiations in Ontario seem as likely to provide an upside opportunity as to reduce the firm’s future prospects.

Conclusion

With the uncertainty around the renewal of the Cardinal PPA, Capstone is trading at a substantial discount to its peers.  But that uncertainty has both upside and downside, while the market seems to be pricing in only a catastrophic downside.  With a 7.8% yield based on a C$0.30 dividend which was already reduced (in June 2012) to reflect the uncertainty around the PPA negotiations, Capstone should be very attractive to income investors.

If the results of the negotiations are unfavorable, Capstone should be able to maintain its current dividend.  If they can continue business as usual or achieve a framework which allows them to invest in and expand Cardinal, there is substantial scope for dividend increases going forward.

In either scenario, the increased certainty and constant or increasing dividend should lead to stock price appreciation on top of an attractive dividend over the next couple of years.  If the PPA is renewed on terms which allow the dividend to be maintained at C$0.30, and the yield falls to the 6.15% average of Capstone’s peers, then Capstones stock price would have to rise to C$4.88, 30% higher than the current C$3.76.

This article was first published on the author's Forbes.com blog, Green Stocks on Sepetmber 11th.

Disclosue: Long CSE, AQN,NPI,BEP,INE,RDZ

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

September 16, 2013

Five Pioneers Mining the Sun for Income

by Jared Wiedmeyer

For the past few years, solar industry stakeholders have imagined a future where the general public has the ability to invest in pure-play renewable energy real estate investment trusts (REITs) that finance and construct both utility-scale and distributed photovoltaic (PV) projects in the United States. While these stakeholders wait for this reality to come to fruition, existing REITs already have several options to own or develop solar projects that still allow them to comply with the IRS's asset and income tests.  This past May, Chadbourne & Park's Kelly Kogan and Scott Bank moderated a roundtable with representatives from several REITs who discussed the options available to REITs to invest in PV systems [1]. I've summarized these options here and provided some additional background information on how these strategies comply with existing IRS regulations.

Option 1 — Utilize a taxable REIT subsidiary (TRS) to own PV projects

A TRS is a subsidiary of an existing REIT that provides services (anything in addition to customary real estate services) to the REIT's tenants without jeopardizing its status as a REIT [2]. Unlike its parent REIT, a TRS pays corporate income tax because the income derived from these services is not considered "good" income by the IRS. Generally speaking, good income is income derived in some way from real property [3]. According to Will Teichman from Kimco Realty, a REIT can utilize its TRS to develop, secure financing for, and own rooftop PV systems [1]. The TRS can pass the benefits from the ITC or 1603 cash grant to the project's investors. The TRS can also sell the power generated to the building's tenants, and it can manage all aspects of the project, including systems operations, customer billing, and securing contracts for the sale of solar renewable energy certificates. The TRS must pay taxes on this income, but it can potentially distribute some of its after-tax income to the REIT in the form of a dividend.

  • Example: Kimco Realty (KIM) owns and operates 874 neighborhood and community shopping centers in 44 states with 128 million ft2 of rooftop space [4].
  • Results: Kimco's TRS has developed and assumed ownership of 3 MW of PV projects, mostly located in New Jersey.

Option 2 — Utilize a TRS to develop and construct PV projects

A REIT can utilize a TRS to develop and construct PV projects, but instead of owning the project after construction, the TRS can sell its ownership interest to an investor or utility. Electricity generated by the project is retained by the utility or is sold to an offtaker under the conditions of a long-term power purchase agreement (PPA). In this case, the TRS only acts as a construction contractor, and the parent REIT collects rent for leasing the rooftop space to the project owner, which is considered good income by the IRS [1].

  • Example: Prologis (PLD) — One of the largest industrial REITs in the world, Prologis owns and operates industrial warehouses and distribution centers around the world with 550 million square feet of rooftop space [5].
  • Results: Prologis hosts about 100 MW of solar that its TRS developed and sold. These systems are mostly located in southern California, but it has also developed systems in Europe and Japan [1].

Option 3 — Lease space to solar developers and project owners

In this case, a REIT owns rooftop space or land but does not form a TRS to construct or develop the PV project. Instead, the REIT will lease the rooftop or land to a PV project developer, which will pay the REIT monthly rent. This rental income is considered good income by the IRS [1].

  • Example: Power REIT (PW) is an infrastructure REIT whose primary asset is its ownership of the land under the Pittsburgh and West Virginia Railroad.
  • Results: PW has recently expanded its scope to owning and renting land under PV projects and has purchased the land under a 5.7-MW PV facility in Massachusetts and rented it to the project owner. The company has also entered into a term sheet to acquire 100 acres of land in California that will host 20 MW of PV projects currently in development [6].

Option 4 — Implement a diversified approach to sustainability/energy efficiency/renewable energy financing

In this case, a mortgage REIT utilizes a diversified approach to "green" investing but focuses most of its efforts on lending for energy efficiency (EE) investments and other building structural improvements, such as efficient HVAC systems. These improvements are permanently affixed to buildings and integrated into its systems so they are classified as good assets, and any interest income on loans secured by these systems is considered good income by the IRS [7]. When such a REIT builds up a large enough portfolio of these EE assets, it can choose to diversify its lending practices into other sectors that may not qualify as good assets or good income—such as utility-scale renewable energy projects—as long as the characteristics of these loans do not exceed the IRS's asset and income tests, which are discussed on REIT.com [8].

  • Example: Hannon Armstrong Infrastructure Capital (HASI) is a project finance firm with more than 30 years of experience in EE and renewable energy finance with $1.6 billion of assets under management.
  • Results: HASI raised over $150 million in an April initial public offering and plans to invest in additional EE and renewable energy projects. The company holds many EE-related assets on its balance sheet, allowing it to make a significant amount of loans to renewable energy projects and still meet the asset and income test thresholds [9].

Option 5 (potential) — Form a Canadian income trust

Instead of pursuing a private-letter ruling to classify renewable energy as "real property," or conforming to existing U.S. limitations, a company could choose to form a Canadian income trust. This entity is a pass-through entity, similar to a REIT, and it trades on the Canadian stock exchange. Unlike IRS regulations, Canadian tax laws do not prohibit the types of assets this company can own, but the trust's property cannot be used to conduct business in Canada [1]. This stipulation makes such a trust a potential option for owning PV projects in the United States. At the time of this writing, this option was actively being pursued, but to my knowledge there is not yet a Canadian income trust specializing in renewable energy projects on the Canadian stock exchange.

  • Example: CleanREIT is an early-stage REIT engaged with investment bankers whose goal is to issue an initial public offering on the Canadian stock exchange.
  • Results: To be determined, but it should be noted that non-Canadian investors face an additional 15% tax to repatriate any dividend income they receive [10].

Table 1 below presents some selected market characteristics of the companies discussed earlier. As you can see, the types of REITs actively investing in PV projects vary widely, suggesting that investing in PV is more dependent on a REIT's corporate mission rather than its organizational structure. For example, Prologis is a large-cap REIT with $45 billion of assets under management, while PW is a small-cap REIT with only $10 million of assets under management, yet both have made significant investments in PV projects.

Table 1 — REITs Investing in Solar: Facts & Figures
Name Share Price 9/16/13 52-week range Market Cap Total AUM Gross Leasable Area Location MW of PV Developed
Sector Focus Renewable Energy Investment Vehicle
Kimco (KIM) 20.65 18.11-25.09 $9.13 billion $8.46billion 131.3 million ft2 North and South America 3 MW
Retail and shopping centers TRS develops, owns, and operates PV system
Prologis (PLD)
37.59 32.31 - 45.52 $18.74 billion $45 billion 554 million ft2 Global 100 MW
Industrial warehouses and distribution centers TRS develops and constructs project, but sells project to third party once operational and collects rooftop rent payments from new owner
Power REIT (PW)
8.36 6.98-11.41 $14.01 million $12.3 million 2.35 million ft2 (4.36 million ft2 pending) United States 25.7 MW
Railroads, renewable energy projects Owns land under PV project
Hannon Armstrong Infrastructure Capital (HASI) 11.85 9.15 – 12.51 $187.11 million $1.6 billion N/A (mortgage REIT) United States N/A
EE, renewable energy, sustainable infrastructure Provides loan syndication services for renewable energy projects, lends to building owners that construct renewable energy systems that are integrated into the buildings they own
  • CleanREIT's IPO is currently in the planning stages, and no market data is available for the company.
  • All stock price information gathered from Yahoo! Finance on September 16, 2013.

Despite the many obstacles standing in the way of pure-play solar REITs, the REIT pioneers discussed here have found ways to work within the existing IRS rules to develop a significant amount of PV projects. Each company offers a unique way to mine good income from the sun, and the efforts of each REIT have worked to bring more clarification as to what the future of solar REITs could look like.

Jared Wiedmeyer is a Research Program Participant with the National Renewable Energy Lab’s Project Finance Team. His work at NREL includes studies in geothermal permitting and its effects on levelized cost of energy, community solar finance, and capital markets-based risk management strategies for renewable energy projects. Jared holds a B.S. in Cartography and Geographic Information Systems from the University of Wisconsin, and an MBA in Finance from the Leeds School of Business at the University of Colorado at Boulder.

This article wasfirst published on NREL's Renewable Energy Project Finance blog, and is reprinted with permission.

References:

[1] Bank, S.; Kogan, K. (June 2013). "How REITs Are Already Investing in Renewables." Project Finance NewsWire. New York, NY: Chadbourne & Parke LLP. Accessed August 12, 2013: http://www.chadbourne.com/files/Publication/6f0ba428-858a-471b-83af-ab16441780ba/Presentation/PublicationAttachment/99648285-ef43-4ec7-8593-b64ab8e9d8a6/pfn_june13.pdf.

[2] Matheson, T. (2001). "Taxable REIT Subsidiaries: Analysis of the First Year's Returns, Tax Year 2001."Internal Revenue Service. Accessed August 12, 2013: http://www.irs.gov/pub/irs-soi/01reit.pdf.

[3] REIT.com. (2013). "The Basics of REITs."Accessed June 19,2013: http://www.reit.com/REIT101/REITFAQs/BasicsOfREITs.aspx.

[4] Kimco Realty. (August 2013). "Current Investor Presentation." Accessed August 12, 2013:
http://investors.kimcorealty.com/CorporateProfile.aspx?iid=102965.

[5] Prologis. (2012). 2012 Annual Report. Accessed August 12, 2013: http://ar2012.prologisweb.com/prologis_2012_annualreport.pdf.

[6] Power REIT. (2013). "Power REIT Securities and Exchange Commission Form 10-Q." Accessed August 12, 2013: http://filings.irdirect.net/data/1532619/000153261913000029/firstquarter201310-qfinal.pdf.

[7] Kogan, K. (2013). "Is the IRS Considering Solar REITs?" Renewable Energy World.  Accessed June 18, 2013: http://www.renewableenergyworld.com/rea/news/article/2013/06/is-the-irs-considering-solar-reits.

[8] REIT.com. (2013). "Forming a Real Estate Investment Trust." Accessed June 19, 2013: http://www.reit.com/REIT101/FormingaREIT.aspx.

[9] Hannon Armstrong. (2013). "Investor Relations Presentation: June 2013." Accessed August 12, 2013: http://investors.hannonarmstrong.com/presentations.aspx?iid=4376922.

[10] Investopedia. (2009). "An Introduction to Canadian Income Trusts." Accessed June 18, 2013: http://www.investopedia.com/articles/stocks/08/canadian-income-trust-royalty-trust-canroys.asp.

July 27, 2013

The Making of a Solar REIT: By the Numbers

Tom Konrad, CFA

Fort Hunter Liggett CA solar project
A solar project at Fort Hunter Liggett in California. Photo: US Army Corps of Engineers
Power REIT (NYSE:PW) announced yesterday that it had closed on a deal to buy approximately 100 acres of land leased to the owners of over 20 MW of solar projects near Fresno, CA.  This will be the company’s second solar transaction and increases the share of its revenue from solar to 21%.  These two solar transactions put PW well on its way to becoming the nation’s first REIT to get most of its revenue from renewable energy.  The balance of its revenue comes from leasing its railroad property.  Whiile not renewable energy, rail is also a green asset in that transport by rail is much more fuel efficient than the alternative: trucking.

Salisbury, MA Transaction

Just last week, PW completed financing for its previous solar transaction, by closing on a $750,000 bank loan.  I thought it would be helpful to dig into the newly released numbers to understand the economics of the transactions.

Below are the details of the completed transaction for land under the True North Solar farm in Salisbury, MA. These, and the details about the Fresno transaction discussed below come from the press releases, interviews with the Chairman and CEO of Power REIT, David Lesser, and my own searches of news stories and public records.

  • Land: 54 Acres. Zoned commercial, near I-95. Potential for commercial development after lease term.
  • Solar Farm: 5.7 MW fixed tilt PV.
  • Purchase Price: $1,037,000
  • Lease: 21 years, at $80,800 with a 1% annual escalator.
  • Financing:
    • $122,000 municipal debt, amortizing over 19 years at 5%.
    • $750,000, 10 year bank loan, amortizing at 5% on a 20 year amortization schedule.
    • $165,000 equity from cash on hand plus new issuance between $10 and $11.
  • Real Estate Taxes: Approximately $9,000 in 2013.

This is nearly enough information to build a full financial model of the investment.   The remaining unknowns are:

  1. How and at what rate will the remaining $508K principal of the $750K loan be refinanced in 2023?
  2. How will property taxes change over the term of the lease?
  3. What will be the land’s value after the end of the lease?

I ran two scenarios, one which I consider conservative (refinancing at 7%, 5% annual increase in taxes, flat land value) and one which I consider optimistic, but not wildly so (refinancing at 4%, 2% annual tax increases, 50% increase in the value of the land over 21 years.)  The first scenario is very conservative in that it’s very unlikely that real estate taxes would almost triple  (a 5% annual increase becomes a 2.8x increase in taxes over 22 years) without some increase in property value.)  Mr. Lesser considers even my “optimistic” scenario to be conservative, since he believes that he acquired the land at half its true, unencumbered value because of the owner’s need to sell quickly.  Corroborating this, a Salisbury reporter I spoke to confirmed that the previous owner needed to sell quickly to pay debt secured by the land.

In both scenarios, net income from PW’s investment starts at over $28,000 per year, or a 17% annual return on invested equity ($165,000 – ROE will be higher on a GAAP basis), and increases from there because the increase in rent increases revenue much more quickly than property taxes rise.   In cash flow terms, both scenarios produce mildly positive cash flow until the loan is refinanced.  The conservative scenario then shifts to mildly negative cash flow, while the optimistic scenario achieves slightly greater cash flows than before.   The cash flow internal rate of return exceeds 10%  for the conservative scenario, and exceeds 13% for the optimistic scenario.  If the residual value of the land is higher, as Lesser expects, an extra $1,000,000 in terminal land value increases the IRR about 2.5%.

Given the small positive effect on cash flow in its early years, the investment has a slight stabilizing effect on Power REIT’s finances, while increasing earnings by approximately 1.6 cents a share, and revenue by 4.8 cents/share.

Fresno, CA Transaction

The Fresno area is currently a hotbed of PV development activity, with 17 utility scale projects having been approved by Fresno County since 2011.  The number of projects under construction makes it impossible for me to determine with certainty which ones occupy the land Power REIT just purchased.  However, we do have significant information about the projects.

  1. They have Power Purchase Agreements (PPAs) with Southern California Edison (NYSE:SCE) and Pacific Gas and Electric (PCG).
  2. They were originally supposed to be in service by October 2013, but it now appears that construction will not be complete until early 2014.  Note that PW is financially protected from such delays by supplemental payments from the developer which will begin in October and continue until the in-service date.
  3. The developer is a major international player, and has completed over 100 MW of other projects.  It has a pipeline of other projects which may lead to future transactions for Power REIT.

While many commercial solar farms have been approved in the Fresno area, the most active international developer is multinational European renewable energy developer Gestamp Solar.  Gestamp has an office in Fresno, and is developing seven solar projects nearby, with sizes between 1.5 MW and 14MW.   I did not find any other developer with projects of the right number and size in the Fresno area.

The financial details of the deal are:

  • Land: Approximately 100 Acres, most likely previously agricultural.
  • Solar Farms: Over 20 MW PV.
  • Purchase Price: Approximately $1,600,000
  • Lease: 25 years, at $157,500 fixed, with two options to renew at “market rate” through 2048.
  • Financing: Acquisition financing has been provided by Hudson Bay Partners, an investment vehicle owned by PW’s CEO, David Lesser.  The financing consists of two tranches:
    1.  Tranche A (Senior): $1,115,000.  Interest only at a 5% interest rate for the first 6 months, with a step up to 8.5% thereafter.  Planned to be replaced by bank financing ASAP.
    2. Tranche B (Mezzanine): $445,000.  Interest only at 9.5% for 6 months, with a step up to 13.5% thereafter.  May be refinanced by issuing new equity, depending on PW’s stock price.
  • No equity on closing, but see tranche B above.
  • Taxes: $27,000 annually.  If taxes rise, lease payment will increase to compensate.

I ran two financial models, both assuming that the first tranche could be refinanced at 5% in the next six months amortizing over the 25 year term of the lease.  In the first scenario, I assumed that Power REIT chooses not to issue equity to refinance tranche B, but instead refinances it with debt in 2020 (at 11%) and 2024 (at 7%) when the increasing equity in Tranche A allows.  In this scenario, increases earnings by $7,338 thousand in 2014 (about 0.4 cents a share), and by increasing amounts in future years.  Cash flow is again marginally negative until the second refinancing of Trance B after 10 years, when it turns slightly positive.  Assuming the terminal value of the land is equal to the purchase price, this scenario yields an internal rate of return on the cash flows of 7.6%.

In my second financial model, I assumed that Tranche B was refinanced at a rate of $100,000 a year by issuing new equity.  This scenario produces an IRR on the cash flows of 9.3%, and returns on equity which start around 40% in the early years, but falling as more equity is invested.  Once the full $445,000 in Trance B has been repaid by issuing equity, the cash flow from the project is $51,300 a year, and the income is $80,600.  This repayment would require the issuance of 54,000 shares at the current price of $8.25, or 42,380 shares at $10.50 , where the stock was trading when the deal was first announced.  At $8.25, each new share would be producing $0.95 of cash flow and $1.49 of income.  At $10.50, each new share would be producing $1.20 of cash flow and $1.90 of income.  This opportunity to invest funds from newly issued shares at an effective P/E of 5.5 is part of the reason I consider PW to be massively undervalued at the current price.

Even at the current price of $8.25, this deal would be significantly accretive to both cash flow and income if tranche B were to be repaid by issuing new equity.  If management refrains from issuing new equity because of the current low share price, the deal will still be accretive to income while putting a burden of approximately $9,000 a year on cash flow.

Although the step-up interest rate on Tranche B is high at 13.5%, this tranche effectively takes the place of new equity which would have to be issued by Power REIT.  At the current share price, I think even paying 13.5% per annum for the flexibility to wait for a more attractive share price is worth while.  I would prefer if the funding had come from a source other than Power REIT’s CEO, but so far, discussions with outside investors have not led to a reliable source of short term funding other than Hudson Bay Partners, even at the rates Power REIT is willing to offer.

Conclusion

Power REIT has now completed two solar real estate acquisitions  which are both accretive to income and at worst put only a tiny burden on cash flow.  Given the current low share price, issuing equity to refinance the Fresno deal does not currently look attractive to me, since it would spread any gains from the resolution of Power REIT’s attempt to foreclose on its rail property over a larger number of shares.

In my opinion, both of these deals seem good for Power REIT, and I’m happy to see the significant progress the company has made over the last two weeks towards its goal of becoming the nations’ first Renewable Energy REIT.

Disclosure: Long PW

This article was first published on the author's Forbes.com blog, Green Stocks on July 17th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

July 08, 2013

The Sustainable Infrastructure Income Trust

Tom Konrad CFA

eckel-jeff.jpg
Jeffrey Eckel

Jeffrey Eckel has an investor relations problem.

No, there has not been any scandal involving fudging the books or sweatshop labor.  Rather, most investors simply don’t seem to “get” his company.

His company recently went public as a REIT, or Real Estate Investment Trust, and the traditional REIT investor likes the familiar.  They invest for income, and for many, a track record of past income and dividends is a must.  While Eckel’s company manages $1.8 billion of securitized energy efficient and sustainable infrastructure assets, it has not been able to invest in such assets itself until the funds from its IPO made that possible.

Dividend Policy
  • Commence dividend in Q2
  • Grow dividend as capital deployed
  • Distribute substantially all net income
  • Ramped yield of 7%
  • Yield targeted to exceed MLPs and infrastructure funds

Eckel’s firm is now in the process of investing those IPO proceeds, and he expects the average investment will yield near 5.5%.  Using a 2 to 1 leverage ratio, he plans to ramp that up to 7% of the IPO price ($12.50.)  This is well above the yields of most other REITs, but given that there are no other REITs which invest in the same asset class, traditionally conservative REIT investors don’t seem to know what to make of it.  Eckel’s predicted yield translates to annual earnings (almost all of which will be distributed to shareholders) of around 88 cents a share.  The two analysts who have initiated coverage so far are predicting 2014 earnings of $0.84 and $1.08, which makes sense given that Eckel is probably being a bit conservative about his earnings projections in order not to disappoint Wall Street.

One other, somewhat less serious, problem Eckel has is the name of his firm.

If you have never heard of “The Sustainable Infrastructure Income Trust” in this article’s headline, that’s because the company does not (yet) exist.  I recently sat down with Mr. Eckel at the Renewable Energy Finance Forum (REFF) Wall Street, and suggested the name to him.  His company is called Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI).  I think the re-branding might make it easier to convey exactly what his firm does.

Many successful public companies have names that don’t describe their businesses.  Proctor and Gamble (NYSE:PG) doesn’t monitor exams at casinos, and Honeywell (NYSE:HON) doesn’t raise bees.  But for every Honeywell or P&G,  there’s a General Electric (NYSE:GE) and a Waste Management (NYSE:WM).

I think small, environmentally oriented, investors might pay a little more for HASI than professional income investors.  The professionals care a lot about the financial sustainability of the dividend, but could not care less about the environmental aspects of the business of funding energy efficiency and other sustainable investments.  Retail investors are more likely to care about both.  It might be easier to attract their attention if  Hannon Armstrong’s name were more descriptive of what it does.  Hannon Armstrong produces sustainable income from sustainable infrastructure investments; the name should reflect that.  Hence, “The Sustainable Infrastructure Income Trust.”

Eckel seemed to take my idea seriously, so there may be some re-branding in HASI’s future.  He got an extra nudge  less than an hour later: The moderator of a panel he was speaking on at REFF Wall Street choked while trying to say “Hannon Armstrong” in Eckel’s introduction.   No doubt it was a coincidence, but it spurred me to write this article.

Pounds of CO2 Equivalent saved per dollar invested. Cogeneration includes fuel cost.
Source: Hannon Armstrong with data from EIA, CME Group, Company filings, HannieMae.

Conclusion

Rebranding or no, real dividends will get the attention of traditional REIT investors even if HASI’s environmental credentials do not.  HASI will announce second quarter results and its first dividend on August 8th.  That will give investors a taste, and I expect the stock price to “ramp up” from there as successive dividends are announced.  My guess is that we’ll see the full dividend by Q1 2014.

I like investing in companies that are having difficulty communicating their stories to Wall Street.  Eventually, the hard earnings numbers will reflect the company’s reality.  Whenever I have a chance to buy a stock before I have to pay full price, I’m as happy as a fashionista who finds a pair of Manolo Blahniks in the clearance bin at Bergdorf.

I don’t know when the sale on Hannon Armstrong Sustainable Infrastructure Capital will end, but it could be as soon as the first dividend announcement on August 8th.

Disclosure: Long HASI, WM.

This article was first published on the author's Forbes blog on June 28th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 23, 2013

Three Clean Energy Stocks That Won't Keep You Up At Night

Tom Konrad CFA

If you want to green your portfolio, but the wild swings of First Solar (NASD:FSLR), Tesla (NASD:TSLA), SolarCity (NASD:SCTY), and even clean energy ETFs like Powershares Wilderhill Clean Energy (NYSE:PBW) are a bit too much to let you sleep at night, you’re not alone.

PBW FSLR TSLA SCTY weekly chart

A reader recently suggested I write about more green stocks like Waste Management (NYSE:WM), which readers can own and not worry about too much.  I thought it was an excellent suggestion; I’ve recently been writing much more about much more exciting or terrifying stocks, because there is simply a lot more to say about them.  But such stocks should not be anyone’s whole portfolio, not even most of it.

Unfortunately, articles about stocks that will let investors sleep at night run the risk of putting readers to sleep.

On the flip side, none of us want to spend much time worrying about the safety of our portfolios, and I think it’s a good policy to build a green stock portfolio around large positions in boring, dividend paying stocks that may not ever produce spectacular returns, but which also are unlikely to go bankrupt or plummet if they miss a quarterly earnings estimate.

Below are three such stocks which I have not been writing about much, but they are still good dividend payers, and all are significant holdings in my green stock portfolios.

Brookfield Renewable Energy Partners

Ticker(s): NYSE:BEP, TSX:BEP.UN

Recent Price: $27.42

Quarterly Dividend (Annual Yield): $0.3625 (5.3%)

Business: Brookfield Renewable is one of the largest listed pure-play renewable power platforms globally, and is Brookfield Asset Management’s (NYSE:BAM) primary vehicle through which acquires renewable power assets on a global basis.  Formerly listed only on the Toronto Stock Exchange as TSX:BEP.UN, BEP began trading on the New York Stock exchange on June 11th.  The partnership’s portfolio consists of hydroelectric and wind power assets with more than 5,800 MW of installed capacity.

Why you can sleep at night: As long as people need electricity, the rain falls, and the wind blows, BEP’s geographically diversified portfolio will generate electricity and income for the fund’s limited partners.

Algonquin Power and Utilities

Ticker(s): TSX:AQN, OTC:AQUNF

Recent Price: C$7.20

Quarterly Dividend (Annual Yield): C$0.085 (4.7%)

Business: Algonquin Power & Utilities Corp. owns and operates a diversified portfolio of $3 billion of regulated water, electricity, and natural gas utilities and  and non-regulated renewable energy, natural gas, and waste to energy generation and co-generation in the US and Canada.  Algonquin also develops renewable power and clean energy projects.

Why you can sleep at night: Utilities in developed markets are a traditional haven for conservative investors, and add diversification to the only-slightly-less stable income from its sales of electricity under long term power purchase agreements.  Algonquin has the financial strength to fund its renewable energy project developments, which provide earnings and dividend growth for shareholders.

Hannon Armstrong Sustainable Infrastructure

Ticker(s): NYSE:HASI

Recent Price: $11.76

Quarterly Dividend (Annual Yield): Current $0; 2014 expected $0.21 to $0.27 (7.1% to 9.2%)

Business: Hannon Armstrong Sustainable Infrastructure Capital, Inc. provides debt and equity financing focusing on energy efficiency, clean energy, and infrastructure projects. The company provides financing services for solar, wind, geothermal, biomass, natural gas, water, communications infrastructure, and energy efficiency projects. It also  offers mergers and acquisitions, tax equity advisory, corporate finance, and merchant banking services.  The company recently went public as a REIT, raising funds which will be invested in the same sustainable infrastructure projects which it has historically provided financing for via securitization.

Why you can sleep at night: Although HASI’s track record does not include the investments it is currently making with the funds from its IPO, it does have a long track record of managing such investments for institutional investors like pension funds.  The simplicity of these investments allows me and other analysts to gain a fairly reliable estimate of the income such investments will produce.  Since HASI is a REIT, managment intends to return all of this income to investors in the form of dividends.   The $0.21 to $0.27 quarterly dividend estimate I used above is the current range of analysts’ estimates.

Even if the dividend comes in well below the expected range at $0.18 a share, we will still have a REIT with a 6.1% yield at the current price, making HASI a very safe investment despite the uncertainty.  If earnings are in-line with analyst expectations, I would expect the stock to appreciate 20% to 50% to bring the yield in line with similar REITs.  The combination of expected safe income and a high chance of significant price appreciation convinced me to make HASI the largest holding in my managed portfolios.

Since company insiders have been buying the stock (which is very unusual following an IPO,) I’m fairly confident that they are also betting on significant price appreciation.  Most recently, Hannon’s CEO Jeffrey Eckel bought 18,090 shares at $11.48 and $11.  I have an interview with him this Wednesday (6/26) at REFF Wall Street.  I invite you to use the comments here to suggest questions.

Conclusion

It may not be easy being green if the only stocks you look at are hot solar and electric vehicle plays.  But if you are interested in investing in renewable energy and energy efficiency infrastructure, it’s easy to combine significant income and relative safety with greenery. 

PBW HASI BEP AQN Chart

DICLOSURE: Long WM, BEP, AQN, HASI

An earlier version of this article appeared on the author's Forbes blog on June 13th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 17, 2013

Income From Hydroelectric Power

by Debra Fiakas CFA

niagara1[1].jpg Are you an investor hungry for current income?  Is there a green line of global warming fear running through your investment selections?  I have stock that fulfills both requirements.  Brookfield Renewable Energy Partners (BEP:  NYSE) is a renewable power producer with assets in Canada, the U.S. and Brazil.  Brookfield generates over 5,900 megawatts of power each year from plants running on river water, wind or natural gas.  Another 2,000 megawatts is apparently under development in Canada and Brazil.

What Brookfield does best is hydroelectric production.  The company claims over 170 hydropower stations across the U.S., Canada and Brazil, diverting river water through turbines to generate very clean energy.  Hydroelectric power generates less than 5% of the greenhouse gas emissions from coal-fired power plants, which can spew out as many as 900 tons to 1,000 tons of carbon dioxide per gigawatt hours of electricity produced.  More details can be found from the Global Reporting Initiative provides information on the greenhouse gas emissions from various power sources.

If Brookfield’s hydroelectric power is green enough for you, then let’s move on the company’s generation of income for its shareholders.  Since Brookfield shares began trading in October 2001, the stock price has climbed steadily to a level 230% higher than its debut price.

Brookfield started paying a quarterly dividend in December 2011.  Management has pledged to distribute between 60% and 70% of funds from operations as well as to grow distributions by 3% to 5% each year.  The current quarter dividend is $0.3625 per share.  At the current price that represents a very attractive forward dividend yield of 5.1%.  Does Brookfield have the cash to fulfill its dividend pledge?

Brookfield has reported net losses in two of the last three years.  Yet, investors looking only at net income will not get the full answer to the dividend policy question.  Indeed, the company consistently generates significant positive cash flows.  In the last twelve months Brookfield converted $1.33 billion in revenue to $395.0 million in cash from operations.  Brookfield’s sales-to-cash conversion ratio of 29.7% stands out among power producers.  What is more Brookfield has $227 million in cash on its balance sheet.  That is a good nest egg, but we do note the company has $7.2 billion in debt on the balance sheet as well.

Despite the debt, Brookfield is an attractive holding for income-seeking investors.  The icing on the cake is a beta measure of risk at a tepid 0.40. If the stock as it trades on the Toronto (BEP.UN:  TSX) or New York exchanges (BEP:  NYSE) appears a overpriced, there is several series of preferred stock that also trade on the Toronto exchange.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

June 07, 2013

Massachusetts: Green Bond Auction Hot, Other Bonds Tepid

by Sean Kidney

The Massachusetts AA+ green bond I mentioned last week got a lot of coverage on release this week – even the WSJ ran the story. But there was a twist: it seems the State had to scale back the total $1.1bn GO [general obligation] offering to $670m on tepid demand, but the green bond bit was 30% oversubscribed.

For all you prospective issuers out there: the green bonds also lured as many as 9 new institutional investors for Massachusetts bonds. One buyer went so far as to say “We think more municipalities should do the same." So perhaps this is Massachusetts starting a trend yet again?

Mind you, for those of us concerned about climate, Massachusetts is applying a broad interpretation of “green”, as Assistant Treasurer Steve Grossman said to BloombergTV. The bond has more of a Parks & Recreation focus than the IFC / World Bank flavors that inspired them, with only a subset of allocations looking like they would qualify under the Climate Bond Standard.

Cut to Climate Bond Standard board member, California State Treasurer Bill Lockyer:

Climate Bond Standards offer a valuable tool to help investor to assess the integrity of environmental claims for green bonds.”

One important point: Massachusetts say they will be putting effort into transparency for investors via website reporting – good on them.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

May 22, 2013

Tesla Issues First EV-Related Climate Bond

by Sean Kidney

Tesla issues $600m, 5yr EV convertible bond

Tesla Motors’ [NASD:TSLA] inaugural bond issue has been, as you’d expect, electrifying (just had to say that). The US electric sports car manufacturer has just issued a 5 year, $600m convertible bond in a fundraising program which has seen it raise approximately $1bn through shares and convertible bonds. Coupon is 1.5-2%; conversion premium is 35%; bookrunners were JPMorgan, Goldman Sachs, Morgan Stanley.

Tesla had planned to raise $450m through convertible bonds, but this was raised to $600m after strong demand from investors. That demand allowed Tesla to drop what was going to be a 2-2.5% coupon down to 1.5%-2%. Investors were certainly bullish on the notes.

Over 200 investors participated in a group investor call and Tesla management also held a number of one-to-one investor meetings. We’re not sure yet who the main investors were (although we do know that one of them was the company’s co-founder and CEO Elon Musk) but unlike many convertible bond deals, buyers were primarily long-only funds (few hedge funds).

Approximately $450mn of the money raised will go towards repay a $452mn loan from the Federal government through the  DOE’s Advanced Technology Vehicles Manufacturing loan guarantee scheme.

Would the Tesla bonds qualify for Climate Bonds certification? Well, electric vehicle (EV) technology will be eligible, although we are still working on details of inclusion definitions. At this stage, we don’t see any problem with convertible bonds for pureplay companies like Tesla; but if it wasn’t pureplay then we’d have to take a deeper look. In our 2012 Bonds and Climate Change report, we didn’t find any bonds solely linked to EVs, so (as far as we can tell) this is a first!

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

May 02, 2013

A Clean Energy REIT: Hannon Armstrong Sustainable Infrastructure

Tom Konrad CFA

hannon armstrong logo On April 18th, Hannon Armstrong Sustainable Infrastructure Capital (NYSE:HASI) IPOed on the New York Stock Exchange.  HASI is one of only two publicly traded Real Estate Investment Trusts (REITs) dedicated to sustainable infrastructure.   The other such sustainable REIT is Power REIT (NYSE:PW), which I have written about extensively.  PW is both illiquid and involved in significant litigation, two factors which may put off the conservative investors who gravitate towards REITs. 
Salisbury Solar Farm
In December, Power REIT purchased the land under the 5.7MW True North Solar Farm in Salisbury, MA. Photo Source: Power REIT

HASI, on the other hand, has market capitalization approximately ten times larger than PW, and traded over five million shares on its first day. That is about as many shares as PW trades in nine months.  HASI’s liquidity will fall as its shares enter the hands of long term investors, but the company will remain far more liquid than PW.

About Hannon Armstrong

Hannon Armstong has long been a leader in financing sustainable energy projects.  The company is a fixture at clean energy financing events, and its partners have impressed me with their level of knowledge in our conversations at such events.

By going public and converting to a REIT structure, HASI is tapping a pool of relatively low-cost capital from small investors.  Many small US investors have previously had few opportunities to invest in sustainable infrastructure.  The most comparable investments I know are solar-backed loans from Solar Mosaic, and PW.  Those few of Mosaic’s  loans available to small investors sell out quickly, and are currently limited to investors in California and New York State.  Further, these loans cannot be purchased within a retirement plan such as a self-directed IRA.  HASI will have none of these problems; I have purchased small amounts of HASI in IRAs and a brokerage Health Savings Account which I manage.  REITs are particularly suited as investments in such tax-sheltered accounts because their distributions are not “qualified dividends” and are taxed as income.  The interest on Mosaic loans (4.5% on recent offerings) is also taxed as income, but cannot be purchased in a tax-sheltered account.

Hannon Armstrong’s business is arranging finance for sustainable energy projects.  Jeffrey Eckel, the company’s  President and  CEO defines these as projects of sufficient quality which reduce carbon emissions.  Such projects include the installation of sustainable HVAC equipment as well as (potentially) clean energy generation such as solar and wind farms.  Such projects are not the typical investment which you would normally expect to find in a REIT, but there has been some ambiguity regarding how photovoltaic solar and similar infrastructure should be treated.

Private Letter Ruling

In an interview, Eckel told me that the IRS issued a private letter ruling detailing exactly what types of such infrastructure HASI will be able to invest in and maintain REIT status in July 2012.   The issue of what sorts of renewable energy projects are suitable for inclusion in a REIT is of great interest among developers and financiers over the last few months.   Joshua Sturtevant, an Associate with solar aggregator, financier, and developer Distributed Sun of Washington, DC, tells me that “based on its historic approach to issuing private letter rulings, I am skeptical that the IRS will go far enough in any of the new rulings to enable broad-based direct investment in development-stage solar projects. Some of the existing rulings could conceivably benefit certain individuals who are making requests to address specific boutique structures, but it is not likely that anything that has been issued will lead to the sea change that many in the industry are hoping for. ”

In the event, Sturtevant may have been too pessimistic.  Not only did HASI request and receive their ruling before many industry observers were even talking about the possibility, but it seems to be quite comprehensive.  Eckel has not been forthcoming about its contents: He told me, “
We’re keeping the ‘private’ in ‘private letter ruling.’” However, he did say that, while the ruling is very specific to what Hannon Armstrong does, it allows the company to continue its existing business investing in solar, wind, geothermal, and energy efficiency infrastructure as a REIT.

All that means that solar, wind, and geothermal can be suitable REIT assets.  Since Hannon Armstrong does not have to significantly change the way it structures deals and manages its portfolio, other REITs may also be able to make similar investments without a prohibitive number of convolutions.  More details of the exact requirements will emerge as more PLRs are issued, and when HASI’s ruling is published by the IRS.

HASI as an Investment

Now that the IPO is complete, HASI intends to invest the funds in eight sustainable energy projects which they have lined up and ready to go.  Eckel told me that they expect their investment mix will not change significantly now that they are a public REIT, so we can expect these new projects will roughly mirror their current portfolio of managed assets.

Roughly a third of the projects will be invested in renewable energy such as solar, wind, biogas, and geothermal, with the balance in energy efficiency projects and other sustainable infrastructure.  Because Eckel specifically mentioned “baseload renewables such as geothermal” as a sector he is particularly excited about, I would not be surprised if at least one of the eight initial projects is geothermal.

If HASI funds multiple geothermal projects over the next few years, this could be excellent news for geothermal developers with projects in the United States, such as Ormat (NYSE:ORA), Ram Power (TSX:RPG, OTC:RAMPF), and US Geothermal (NYSE:HTM).

Likely Dividend

Hannon Armstrong is still in a quiet period because of their recent IPO, so Eckel was unable to tell me anything about their likely earnings prospects or planned dividends.  We do know that the company earned $0.60 a share in 2012, and that they intend to distribute 100% of their REIT earnings as dividends to shareholders.  REIT earnings are defined by the IRS, and will differ in some respects from the GAAP earnings.  In addition, the IPO has increased HASI’s share base six-fold, meaning that the profitability of the new investments will dominate earnings going forward.

That said, the mix of HASI’s projects will not change going forward. The main difference will be that the improved ability to raise equity means that the REIT will retain a larger stake in projects it finances.  This could increase earnings per share if it allows more profitable deals which might not have gone through without HASI having skin in the game, but it could also dilute earnings if the income HASI earns by managing projects is diluted over a larger equity base invested in the projects themselves.  That said, HASI’s partners would not have taken the firm public if they thought it meant they would earn significantly less than they would have had the firm remained private.

One other factor to consider is the pricing of the IPO.  HASI priced at the low end of the $12.50 to $17.50 range in the prospectus.  Because of that, they will be able to invest less new money per share than they could have if it had priced higher, which will lead to lower earnings per share than we could have expected at a higher IPO price.  On the other hand, new investors are paying less for the earnings from HASI’s existing business.  After dilution from new equity, 2012 earnings would amount to approximately ten cents a share.  According to the April 19th prospectus update, HASI netted $9.70 per share from the IPO, after dilution of the new money and estimated expenses.   Assuming they can invest this at a yield between 5% and 8%, we can expect total earnings per share to be between $0.58 and $0.87 per share, all of which we can expect to be distributed as dividends.

At the current price of $11.25, HASI will have a dividend yield of between 5.1% and 7.7% if my assumptions are correct.  A quick survey of the top 10 holdings of the SPDR Dow Jones REIT ETF (NYSE:RWR), shows that these REITs yield between 2.6% and 4.2%, so I expect HASI will appear attractively priced in comparison to other REITs when it starts paying dividends, assuming it does not appreciate before then.  It should also be attractively priced in comparison to the green infrastructure investments I mentioned earlier: Loans from Solar Mosaic yielding 4.5% and Power REIT, which yields 3.9% at $10.20.

Conclusion

I can’t help but be enthusiastic about Hannon Armstrong Sustainable Infrastructure Capital.  The REIT presses all my buttons:

  • It invests in sustainable infrastructure.  
  • It has an emphasis on energy efficiency.  
  • It’s likely to pay an attractive dividend yield from long-term stable income.  

What’s not to like?

Disclosure: Long PW, HASI, HTM, RAMPF.

This article was first published on the author's Forbes.com blog, Green Stocks on April 22nd.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

April 21, 2013

Three New Green Bonds

by Sean Kidney
  • The International Finance Corporation (IFC) is planning to issue $1bn Green Bonds per annum.
  • Hawaii is setting up a bond-funded green bank
  • Germany’s PNE Wind is planning a €100m corporate bond
IFC Logo Trade Finance magazine reports that the IFC is planning to issue $1bn a year of Green Bonds. After talking with IFC folk in Washington DC last week I think I can say that the resounding success of last month’s first $1bn IFC Green Bond is making them think much more ambitiously than before.

We think they should also be looking at stretching their balance sheet by securitizing some of their existing climate change related loans, with a small dollop of credit enhancement to get them an A rating. Result: blue chip (I mean green-chip) bonds with at last a bit of yield for suffering insurance and pension funds, and the IFC gets to more quickly recycle capital in climate investments. Watch this space.

Bloomberg’s Sally Bakewell (one of our favourite clean energy journos) reports that Germany’s PNE Wind AG (PNE3.AG) is planning to issue a €100m ($131m) corporate bond. (Given the pure-play windpower nature of PNG’s activities, that’s a Climate Bond for our purposes.)

Hawaii is pushing through legislation to set up a new “green infrastructure authority” that would make loans to consumers wanting to install solar panels on their roofs. Hawaiian consumers, who pay among the highest prices for electricity in the US, would repay the loans from the energy savings on their electrical bills. Hawaii has a goal of getting 70% of its energy needs from renewable and conservation by 2030.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

March 26, 2013

Is Suzlon's $650m Wind Bond the First of Many?

India had been trying to get a corporate bond market going for 15 years – search “growing India corporate bonds” and you’ll find papers on the subject from the Reserve Bank of India, Bank of International Settlement and others scattered over past years.

The latest Indian 5 year plan has this as a priority – and has green finance as a priority in a separate section.

India has a particular need: a miniscule local corporate bond market means restricted financing options for business, including for renewable and energy efficient building developers – diversity with financing options helps drive down costs of finance.

India also needs suitable instruments – e.g. corporate bonds – to attract some of the vast amount of capital currently going into buying gold and inflating the property market – a misallocation of domestic savings if ever there was one.

Corporate bond markets need help from governments to get started. Among other things, they usually need a stimulatory dose of government guarantees and credit enhancements to kickstart the market. (We think there’s room to grow an equivalent asset-backed securities market as well, but more on that another time).

That’s why this bond issued by Suzlon Energy Limited (Bombay: SUZLON) is so exciting! The US dollar denominated. 5 year bond carries a 4.97% coupon, and was provisionally rated, Baa2 by Moody's.

One swallow does not a summer make, but it’s a great precedent. India’s 5 year plan should support much more of this, by simply bringing together the corporate bonds and green finance strands.

The Suzlon bond is backed by a Stand-By Letter of Credit (SBLC) from the State Bank of India. The bonds will be listed on the Singapore stock exchange (SGX). Suzlon says it’s the first ever USD credit enhanced bond from India.

Suzlon is a “pure-play” wind energy company; we see their corporate bonds as fully-blown climate bonds.

BTW, where companies only have part of their business in qualifying sectors, we encourage them to issue corporate “asset-linked” bonds, similar to the European Investment Bank’s Climate Awareness Bond, or last year’s Air Liquide Health Bond. If the relevant assets were verified as qualifying (like wind farms) and there was accountability around use of proceeds, credit enhancements should be available. Oh, and the Climate Bonds Standard provides a means to verify with confidence.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

February 05, 2013

Roundtable Greenlights Effort on Renewable Energy Covered Bonds

by Sean Kidney
“There is more liquidity than ever being put into the system, but funds are still not being allocated to renewable energy projects”
“The bottleneck for renewable energy is not in construction financing but a year or two after construction [re-financing].”

“[Renewable Energy] is not an asset class where risk changes over time – it changes [only] between pre-completion to post-completion stages… it is incorrect to think that offloading an asset post-completion dumps risk onto others because the riskier part of the project is past.”

“Alignment of interest with investors is strong as the issuing bank retains the credit risk in Covered Bonds.”
On 14 December some 40 people attended a Renewable Energy Covered Bonds Roundtable London, either in person of via teleconference facilities. It was a very interesting discussion; highlights are noted below.

Click here for the original paper proposing Renewable Energy Covered Bonds.
Members of the Roundtable Discussion Panel were:
  • Frank Damerow: LBBW bank, Climate Bonds Advisory Panel
  • Sean Kidney: CEO Climate Bonds Initiative
  • Stuart Clenaghan: Climate Bonds Advisory Panel
  • Christoph Anham: Royal Bank of Scotland, Head of Covered Bond Origination
  • Angela Clist: Allen & Overy, Partner. Experience: Worked on first covered bond in UK and on committee setting up law, involved in setting up other laws in Canada, NZ, Belgium, Greece and Cyprus. Currently working with World Bank on covered bond regimes in Latin America.
  • Julia Hoggett: Bank of America Merrill Lynch, Managing Director, Head of Short Term Fixed Income Origination, EMEA, Head of Covered Bonds and FIG Flow Financing, EMEA
  • Alexandre Chavarot: Clinton Climate Initiative, Climate Bonds Advisory Panel
  • Fabrizio Baicchi: CitiBank, infrastructure energy finance
  • Sarah Eastabrook: Alstom, Head of Strategy Development. Perspective is on the project end and how and financial products might help with scale up.
  • Karlo Fuchs: Standard and Poor’s, Structured Finance
  • John Hale: Association of British Insurers, fixed income committee
  • Georg Grodski: Legal & General, Head of Credit Research: The preferred way of investing is to do it themselves even if it’s more resource intense as they know what they are getting into.
  • Paul Guire: ICAP CEO. ICAP is involved primarily in the secondary markets and is very involved in the Pfandbriefe market

Introduction

The financial requirements for a transition to a low carbon economy are huge ($1trn p.a. above business as usual, according to the International Energy Agency), and policy makers are looking for ways to encourage such investment.  However there is a massive shortfall between targeted and current levels of investment.

Given recapitalisation pressures of the banking sector, this gap will not currently be able to be bridged by bank lending. Pressure on bank balance sheets means that they are not willing to hold long-term assets such as renewables on their balance sheets so lending will remain constrained unless banks have an exit strategy (as they have for mortgages). There is, therefore, currently credit capacity to finance a sizeable amount of short term construction risk, but limited capacity to fund the term take-out.

On 14 December 2012, a group of 30 finance experts and investors was convened in London by the Climate Bonds Initiative in a Roundtable to discuss the possibility of bridging part of this finance gap through the development of a Renewable Energy (RE) Covered Bonds market.
Covered Bonds are an on-balance sheet financing mechanism, where the holder has recourse to a pool of assets (cover pool) in the event of a default by the issuer.

Covered bonds have been used for decades to pursue policy imperatives such as homeownership (where mortgage loans are used as the cover pool). Given their dual recourse nature, Covered Bonds could help to address the finance gap by allowing pools of RE loans to support highly rated Covered Bonds.

The participants see covered bonds as one of a myriad of potential financing options available for RE all of which will need to be utilised to bridge the finance gap. Therefore while Covered Bonds may not be the lowest hanging fruit, they are an important tool which may be suitable to certain assets and investors.

Discussion points at the roundtable

The idea to build a renewable energy Covered Bond market is still in a concept stage and therefore the roundtable was held to discuss issues, practicalities and process to define whether or not the idea should be pursued further. The following topics were covered at the meeting:

Changes to legislation

Substantial changes are required in most jurisdictions to allow renewable energy assets to act as collateral and form a cover pool. Changing legislation can take time, suggesting RE Covered Bonds might be a long rather than short term option — for example in Germany it took 5-6 years for aviation covered bonds to be approved. The development of a fully-fledged covered bonds market was therefore seen by the group as a 5-7 year project, assuming the process starts now.

However, a shorter term option might to allow existing mortgages that have a qualifying green aspect – solar cells on the roof, or a high level of energy efficiency – to be used as a separate cover pool. Ideally governments would then attach a differentiated risk weighting for these, further educing the costs of finance for banks and for green end-homeowners. For governments, agreeing on definitions may be an issue; however definitional work is part of the remit of the Climate Bond Standards and should be able to be used.

Quality, diversity and track record of assets

Typically, Covered Bonds are backed by a portfolio of liquid, transparent and stable assets. While pools of mortgage loans are relatively homogenous and therefore meet these criteria, each renewable asset is “different to the next”. They vary significantly in size, type and quality and may be difficult to put into a single cover pool.

In addition to this, RE assets do not presently have a long enough track record in the debt market for an accurate credit rating process to be conducted; however, such adequate track records are likely to exist by the time new legislation can be brought into being, and it may be possible to accelerate the process by conducting performance reviews of existing wind bonds.

In the short term there is still scope for RE Covered Bond issuance where cash flow characteristics  are strong (i.e. Feed-in Tariffs – FiTs) and where overcollateralization is part of the structure to compensate investors for this additional risk. Initially, the haircut required for RE assets to serve as collateral and for a bond to get a good credit rating would need to be significant but, as the track record increases, the required haircut should also decrease.

Cost of issuing a covered bond

The up-front cost of structuring, issuing and running a Covered Bonds programme is high, but in case of repeat issuance can be more favourable when compared to securitisation. For RE, as for all other covered bond assets, a bond would only be issued in cases where it is deemed to be worth these costs. Such cases could include:
  1. where the capital raised is sufficient to offset these costs; covered bonds can prove more cost effective than other forms of funding due to their wide recognition
  2. when a broader range of investors can be attracted who wouldn’t otherwise be interested;
  3. if other methods of financing have been exhausted.

Metrics for financing

Financing for covered bonds is usually done on a loan to value basis; this may not be possible for renewable energy where cash flow predictability is the important metric. Feed-in Tariffs can play a pivotal role here. Solving these technical issues is pivotal for the long-term development of fully-fledged covered bond market.
However short term proposals (see below) do not require for this to be solved. In the long-term and as the assets gain a longer track record, adequate metrics and appropriate regulation will be discussed and proposed.

Ability to re-sell assets in the event of default

In the event of default, assets will need to be liquidated in order to compensate bond holders. However, selling renewable assets may prove challenging particularly if there is a time limit on the sale. Wind farms, for example, cannot easily be dismantled and there is a cost involved in doing this. However, they can continue to be operated by a new owner post-bankruptcy..

While this was seen as a concern if a utility or developer issued a Covered Bond, there was general consensus that the bottleneck in RE financing exists for term re-financing rather than for construction financing. As such, it is anticipated that issuances will be backed by cover pools of RE loans rather than the assets themselves. Liquidation potential is therefore less of a concern if a default occurs.

The way forward

There was widespread acknowledgement by the group that renewable assets are not like mortgage assets (generic, good track record, granular asset pool, high quality and liquid) and are unlikely to become so in the short term. However, the value of using covered bonds as one of the tools to bridge the finance gap for low carbon infrastructure was also clear. Therefore, in order for this idea to move forward, both short term and long-term proposals are necessary.

Short term

It is possible that legislative change could be accomplished quickly (1-2 years) by a determined government; but the most likely time-frame is around 5 years.

However, there are also some short and medium term options not requiring legislation that could be considered:

a)     Demonstration issuance with development support

In the short-term, demonstration RE Covered Bonds could be issued under existing regulatory environments, assuming an adequate cover can be assembled.

There are precedents for issuing covered bonds that are not governed by legislation.  In particular, ”structured” covered bonds are issued in a number of markets that don’t have special covered bond laws; the terms and conditions are simply defined in the issue-specific legal documentation rather than legislation.[1]

There are a few investors interested in this asset class & structure, particularly when getting them involved at an early stage of the structuring process. The search for assets, the hunger yield and the need of 10yr+ plus tenors are strong driving factors.

We believe there is potential to develop a Structured Covered Bond in Germany, Austria, Switzerland, the United Kingdom and the Netherlands.
It may be that without the benefits of eligibility under regulated schemes, the success of a Structured Covered Bond will depend on a modest level of credit support from government or development banks, for example providing an insurance wrapper. Our aim will be to see if it can be done without such support.

b)     Green mortgages

In the European Union an option for the medium-term would enable mortgages for buildings that meet certain green criteria (e.g. solar panel or energy efficiency technology installed) to have a different risk-weighting attached to them compared to standard mortgages. As a result homeowners would be able to get a discount on the running costs of their mortgage from mortgage provider.

That differential could be achieved with either a change to the eligibility criteria governed by either national regulation (or, in the EU, by the Capital Requirements Directive) or possibly because energy efficient housing assets and green mortgage bonds are seen to have better credit characteristics than old stock

Because this would involve a only a modest variation of rules for existing eligible loan pools, this may be politically achievable at national levels. These mortgages would go into a dedicated covered bonds pool – thus allowing a green mortgage cover pool without requiring significant changes to legislation.

Long term

In the long term, it should be possible to create a fully-fledged covered bonds market. This will require proposals to change the legislative and regulatory framework as well as the building up of a track record for renewable assets.

This process of achieving regulatory change, primarily by expanding the list of eligible assets for cover pools to include RE, will take some years and requires clarity on FiTs over many years in grid-based energy supply policy. Initial feasibility studies can be conducted to ascertain which jurisdictions have the highest potential for developing a market. The group thought that potential candidates would be the UK, Austria and the US.

Conclusion

  • Despite some hurdles, initial discussions have indicated that the concept is worth pursuing but that different products are applicable and/or viable in the short term and the long term.
  • A fully regulated Renewable Energy Covered Bond market will take legislative and regulatory change; that process of change will invariably take some years.
  • While we see that as an important longer-term objective, in the short-term we will focus on options that do not require legislative support, such as separating and differentially risk-weighting green mortgages, demonstration Structured Covered Bonds, potentially supported by public sector banks, and other models that would work within existing legislative arrangements.
  • The Steering Group, formed of industry experts Christoph Anhamm, Stuart Clenaghan, Angela Clist, Frank Damerow, Sean Flannery, Julia Hoggett and Sean Kidney, will take these discussions forward.

[1] As cited in Global Financial Stability Report: Navigating the Financial Challenges Ahead.  IMF 2009. http://www.imf.org/external/pubs/ft/gfsr/2009/02/pdf/text.pdf


Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

January 17, 2013

Power REIT's First Solar Deal

Tom Konrad


Salisbury Solar Farm
The 5.7 MW Solar Farm in Salisbury, MA is the largest solar farm in New England. The land under if was purchased by Power REIT (NYSE:PW) in December. Photo source: Power REIT

I first wrote about Power REIT’s (NYSE:PW) plans to invest in renewable energy real estate in May 2012.  The intent was to buy the real estate underlying a solar, wind, or other renewable energy project, charging the project owners rent.  This can be done profitably because REITs often have a lower cost of capital than other businesses, such as renewable energy power producers.

At the time, I (and Power REIT’s CEO, David Lesser) thought such a deal was immanent.

Then life got in the way.

A Potentially Lucrative Distraction

Life, in this case, was a civil action between Power REIT and the lessees (Norfolk Southern Corp. (NYSE:NSC) and sub-lessee (Wheeling and Lake Erie Railroad, aka WLE)) of its only asset at the time, 112 miles of railroad track.  Although still making lease payments, WLE and NSC had failed to comply with the terms of the lease, at least in Power REIT’s interpretation.  Power REIT attempted to foreclose on the lease, and WLE and NSC filed a civil action to prevent the foreclosure.

Power REIT initiated the foreclosure attempt because WLE had failed to pay some of its legal fees, as the lease requires the lessee do for all such fees reasonably incurred in order to maintain Power REIT’s interest in the leased track.  Since the lease requires the lessee  to pay all its legal fees, Power REIT has little incentive to drop its attempt at foreclosure, as might be expected when a tiny company has to take on a much better-funded opponent in court.  In addition, the lessees could be forced to pay as much as $84 million dollars (PW’s market capitalization is currently only $16.2 million) in debt and back interest incurred since the inception of the lease in 1967.  Even if, in the worst possible case,  Power REIT loses in all counts and is unable to foreclose, the $15.9 million principal portion of this indebtedness could be written off on Power REIT’s taxes.  That write-off would allow 25 years’ worth of its current dividend to be characterized as a return of capital, and hence be tax-free to PW’s shareholders.

Investment Delays

Despite the heads-I-win-big-tails-I-still-win situation for Power REIT in court, the litigation has been a massive drain on the firm’s resources and management’s time over the last year.  While Power REIT’s legal costs are likely to be recovered through the court, WLE is not currently reimbursing them.  Meanwhile, the legal tussle with much larger companies has been making some lenders and investors wary, leading to a low stock price and making it more difficult to finance renewable energy real estate transactions.

A few months ago, I noticed that Power REIT had removed the investor presentation from its investor relations page.  This presentation had detailed its  investment plans for renewable real estate.  When I asked Lesser about this, he told me it was because so much of the firm’s focus had been on the litigation.

Proof of Concept

Salisbury Solar.png
Location of True North solar farm from Salisbury Assessor map.

As it turns out, Power REIT’s renewable plans had not been completely to the back burner.  On January 4th, the company filed an 8-K with the SEC detailing an investment in 54 acres of land under a 5.7 MW solar farm in Salisbury, MA. Given its size, location, and 54 acre site with 43 buildable acres, I identified the farm as the solar farm recently completed by Power Partners MasTec (NYSE:MTZ), and owned by True North, LLC.   The total cost to Power REIT was $1.037 million, including the assumption of a $122,000 municipal sewer financing carrying a 5% interest over 19 years.  Lesser’s investment company provided an $800,000 bridge loan at 5% for six months, to allow the transaction to close quickly.  According to Lesser, the seller wanted a quick sale.  Lesser’s statement is corroborated by this article, which states the land was listed for sale in October with a “minimum bid” of $1.75 million.  It seems unlikely that True North would have come down 42% from its asking price in just two months if there had not been some urgency to sell.  [Update: Since this was written I spoke to a Salisbury reporter who has been covering the True North solar farm since before its inception.  She confirmed that the developer of True North was under considerable financial pressure.]

The bridge loan can be extended for another six months at 8.5% interest.  In an interview, Lesser told me he believes Power REIT will be able to obtain bank financing for the property at an interest rate in the high 5% range.

True North has a 21 year lease on the property paying $80,800 annual rent, with a 1% annual escalation.  Power REIT will be responsible for paying real estate taxes on the property (but not taxes on the solar farm.)  According to the Salisbury Assessor’s website, the Fiscal 2013 Tax Rate is $11.51 per thousand dollars (1.151%) of assessed value.  The property is currently assessed at $715,100, for an annual tax bill of $8,231.  If the property is assessed at the sale price of $1 million and tax rates are unchanged, annual tax will be $11,510 in 2014.  Annual interest on the sewer financing is $6,100.

Power REIT’s revenue from the lease will be $80,800 in 2013 and $81,608 in 2014.  Between 2000 and 2010, Salisbury property taxes have increased at a 4.6% compound annual rate.  If we assume the higher property assessment and a 5% annual increase in property taxes, Power REIT will have $63,422 in annual income to cover the financing costs on the $915,000 closing price.  That means that the transaction should increase earnings per  share if Power REIT is able to obtain financing at an interest rate below 6.9%, or if they receive more than $7.25 for any shares issued to finance the deal.

Since PW stock is currently trading around $10 a share, and Lesser thinks banks will be willing to lend against the property at interest rates below 6%, the deal will likely increase PW’s earnings per share.  However, given the small size of the deal, the annual earnings increase will be less than a penny a share.  I estimate the earnings increase will be approximately 0.5 cent a share.

After the Lease

After the current lease is up, it seems likely that Power REIT will be able to extend the lease on terms at lease as favorable as the current lease.  After all, solar farms typically last longer than twenty-two years, and they are difficult to move.  Furthermore, according to Lesser, the property was assessed at twice the purchase price in 2010.  Given that assessment, Power REIT will likely  have several financially viable options for the land  when the solar farm is at the end of its useful life, or if it is not possible to extend the lease on favorable terms.

Delayed Dividend

In the same SEC filing, Power REIT declared its regular $0.10 quarterly dividend for the fourth quarter of 2012, to shareholders of record on January 14th, 2013.  The dividend was delayed because Power REIT’s low income in 2012 (caused by legal expenses) and the possibility of a tax write-off in 2013 make it more advantageous to pay the dividend in the 2013 tax year.  Power REIT still intends to pay usual $0.10 first quarter dividend as well.

Conclusion

The Salisbury solar transaction is likely to increase Power REIT’s earnings per share, if only in a small way.  The more important aspect of this transaction is as a proof of concept for Power REIT’s business plan.  It shows the company can increase earnings per share by investing in real estate underlying renewable energy production.   Power REIT’s strong balance sheet should make more and larger deals possible in the future, especially once the litigation with WLE and NSC is resolved.

Disclosure: Long PW

This article was first published on the author's Forbes.com blog, Green Stocks on January 7th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

December 24, 2012

Renewable Energy REITs or MLPs Would Unlock Billions

Jennifer Runyon

According to Richard Kauffman, Senior Advisor to the Secretary, DOE, making REITs or MLPs available for renewable energy project financing is the key to advancing the industry.
 
Top engineering, procurement and construction firms gathered to network, learn and do business with corporate-level project developers at the PGI Financial Forum, one of four co-located events that took place in Orlando, Fla. earlier this month. Richard Kauffman, Senior Advisor to the Secretary of the U.S. Department of Energy, gave the keynote address during a luncheon that took place during the conference.
Jennifer Runyon is managing editor of RenewableEnergyWorld.com and Renewable Energy World North America magazine. She also serves as conference chair of Solar Power-Gen Conference and Exhibition and Renewable Energy World North America Conference and Expo.

This article was originally published on RenewableEnergyWorld.com, and is republished with permission. 

October 20, 2012

Solar REITs: A Better Way to Invest in Solar

Tom Konrad CFA

KD501The last day for a solar developer to submit an application for the Treasury’s 1603 grant program was September 30th, and only for grandfathered solar projects which broke ground before the end of 2011.

Solar panel prices have continued to drop this year, but solar project development remains a capital-intensive business.  The 1603 program allowed solar developers to monetize the solar investment tax credit (ITC) much more quickly than they could otherwise, and this essentially reduced their cost of capital.  As the rush of projects begun before the end of 2011 are completed, developers are looking for new ways to finance their next projects, especially since traditional forms of financing have been harder to come by since the financial crisis.

Jan Schalkwijk, CFA, a portfolio manager with a focus on sustainable investments at JPS Global Investments based in San Diego, CA  says, “Any solution that further improves financing of solar projects should be of interest to investors; especially if returns come in the form of dividends, from financial structures that are collateralized.”

The Solar REIT

Currently, the only way a small investor can invest in solar is by buying stock in solar manufacturers.  I have long argued that solar manufacturers are unattractive as an asset class because of the fiercely competitive nature of the solar industry.  The massive decline of solar stocks over the last several years has convinced most investors of the danger of investing in solar manufacturers, even when solar installations are skyrocketing.  Since inception in April of 2008, the Guggenheim Solar ETF (NYSE:TAN) has fallen 93%, while solar installations have risen six-fold with rapidly falling costs.

While those rapidly falling costs destroy solar manufacturer margins, they improve the opportunities for profitable solar farms.  Yet stock market investors find themselves shut out of this opportunity.  The two layers of taxation for public companies make common stocks a less than ideal investment medium for solar farms, unlike the private equity investments and LLCs used by large investors.

What sort of structures might be attractive?  Master Limited Partnerships, or MLPs come immediately to mind, since they combine the tax structure of a limited partnership with the liquidity of public exchanges.  MLPs allow the investor to avoid the two layers of taxation by passing their tax liabilities (and benefits) through to their limited partners (shareholders), which leads to a level of tax complexity most small investors are unaccustomed to.

In addition, MLPs are limited by law to specific businesses, mostly fossil energy extraction and transport.  While extending MLPs to solar and other renewable energy has a certain appeal on the basis of fairness, such an extension would require an act of Congress.

WILMINGTON, DE - SEPTEMBER 16: Democratic U....

Sen. Chris Coons introduced the Master Limited Partnership Parity Act on June 7th

Senator Chris Coons (D) of Delaware introduced The Master Limited Partnership Parity Act to allow MLPs to invest in renewable energy on June 7th, and Representative Ted Poe (R) of Texas introduced identical legislation in the House September 19th.  Unfortunately, the chances of these bills becoming law seems low.  Govtrak.us puts their chances at only 4%.

A second appealing structure is the Real Estate Investment Trust (REIT).  Like MLPs, REITs avoid the double taxation of traditional corporate structures, and are limited to investing in certain asset classes, which in the case of REITs means real property.  REITs pass through their income, rather than their tax liability to investors: REIT dividends are treated as ordinary income to the investor.

As Jim Hansen, a financial consultant at Ravenna Capital Management in Lake Forest Park, Washington and publisher of the Master Resource Report notes, “for retail investors the REIT would be the simplest and could be used in IRA’s which MLP in many cases cannot”  because a certain portion of MLP income may be taxable, even if the MLP is held in an IRA.  Indeed, Congress first enacted the REIT model in the 1960s to enable small investors to “secure advantages normally available only to those with large resources.

Garvin Jabusch, Cofounder and CIO of Green Alpha Advisors in Boulder, CO and manager of the Sierra Club Green Alpha Portfolio also thinks REITs would be a good structure for solar investments.

“Making PV [photovoltaic solar] a REIT eligible asset class will give investors access to what is currently the best value in solar, the annuity of electric power sales agreements.  Currently investors can mainly invest in panel manufacturers (and to some degree BOS [balance of system] providers such as converter manufacturers), which is not these days the most profitable way to play solar. Buying a piece or pieces of solar PV projects on the other hand is profitable right now but is currently the province of private equity investors. Utility scale solar on a project basis is very attractive because, unlike a coal or other fossil-fuels based plants, once the solar plant is running it produces electricity which can then be sold essentially indefinitely without risk of the price of its fuel increasing (or indeed ever costing anything at all), with very low risk of plant failure (and if it does fail, it’s likely only offline for a short time, no risk of explosion), and relatively low overhead in terms of maintenance.

 Legal Considerations

“The IRS could declare that solar assets were REIT-safe with a stroke of the pen.”

Joshua Sturtevant has done extensive research on the legal requirements to allow REITs to focus on solar investments.

The other potential advantage of REITs as an solar investment structure is that it would not require an act of Congress for PV to become a REIT-qualified investment class.  Joshua L. Sturtevant, an Associate with solar aggregator, financier, and developer Distributed Sun of Washington, DC, has done extensive research on the changes which would allow REITs which would generate all or most of their income from solar generation.

He found that “the IRS could declare that solar assets were REIT-safe with a stroke of the pen.  Because of the broad authority it has been granted to regulate REITs, it could bring solar assets into the fold simply by issuing a ruling to that effect. … [I]t wouldn’t require legislation or huge changes to the tax code.”  Getting a favorable IRS ruling might not be easy, but it would almost certainly be easier than getting legislation through Congress.

Sturtevant says that an IRS ruling might take the form of a “private letter ruling”  or through a “revenue ruling.”  The IRS grants a private letter ruling in response to a taxpayer asking for clarification on an aspect of the tax code applies to them.   A private letter ruling does not have broad applicability, in that it is only binding on the requesting taxpayer and the IRS.  However, private letter rulings “often end up having some trickle-down influence on business decisions as they are generally accessible to tax lawyers and accountants.”

A revenue ruling is  ”often issued at the prompting of a government official. To the extent that an issue might be a close call, it is better for the request for clarification to come from within the government as there is a better chance of obtaining a favorable (from the perspective of the requestor) outcome.”

The Wheels of Government Turn Behind the Scenes

No one was able to tell me anything definite, but there are rumors that a request for an IRS revenue ruling is imminent.  In June, the National Renewable Energy Laboratory (NREL) issued a report, ”The Technical Qualifications for Treating Photovoltaic Assets as Real Property by Real Estate Investment Trusts (REITs).”  The report concluded that PV meets many of the important criteria to be considered “real property” and hence a proper asset class for investment by REITs.

The fact that NREL issued this report suggests that someone in the government is working to prepare the way for a favorable revenue ruling.  David Feldman, an NREL analyst and co-author of the report, said ”We’re not trying to make the decision — the Internal Revenue Service will do that.  We’re giving them the technical information they need to make the decisions.”  But somebody asked them to write the report.

Sturtevant says, “My pulse of the situation suggests that there are parties who are moving to place a request to the IRS by election time. If such a request were successful, it could be less than two quarters before a company claiming REIT status is developing solar.”

Jabusch has also heard rumors predicting everything “from year end this year to Q2 2013.”

UPDATE: The Renewable Energy Trust Capital, Inc., a San Francisco, CA based mission-driven company founded in 2011 to “facilitate the transition to a clean and sustainable economy” apparently already has ruling request “on file with the IRS.”  I’m seeking an interview with RET to determine if this is a request for a private-letter ruling (most likely since this is not a government entity) and when the request was filed.  10/12: I’ve published an article about Renewable Energy Trust’s request based on my interview here.

Will the IRS Rule in Favor of Solar REITs?

If there has already been a request to the IRS for a revenue ruling on PV as real property, the the odds are good that the ruling will be favorable for those of us who would like to see Solar REITs.  According to Sturtevant, enough political will would be sufficient to guarantee a favorable ruling.  The political will is likely to depend on the outcome of the election on November 6th.

Giving solar a similarly advantageous  investment structure to the MLPs enjoyed by investors in fossil fuels should be a “politically neutral concept,” as Sturtevant puts it.  Obama has long been in favor of leveling the playing field between alternative energy and fossil fuels, while allowing Solar REITs is seemingly in line with Romney’s expressed belief that alternative energy should sink or swim on its own merits: Investors would evaluate each deal on its investment merits, as both Hansen and Schalkwijk implied above.  On the other hand, Romney has repeatedly called green jobs “fake” or “illusory” while championing the fossil industries, and has plans to sharply cut funding for clean energy: He may have already concluded that PV has no “merits,” and hence might see little point in giving it similar privileges to the extractive industries he promises to promote in the name of energy independence.

The First Solar REITs

Even if there is a favorable ruling, it may take a while for the first REITs dedicated to solar to emerge.  The first movers are most likely to be traditional REITs that are already thinking about renewable energy investments.

A few REITs have dabbled with solar already as a revenue enhancement.  IRS rules allow them to generate up to 25% of their income from sources other than real property, and this allows some scope for solar on REIT-owned buildings, for instance.  Some solar developers are even specifically targeting the traditional REIT market.  However, few REITs are likely to use this option to obtain more than a few percent of their income from solar because “ the IRS tends to be very wary of anything that doesn’t smell right in the context of REITs” and “ leads to wariness and conservatism by many REIT managers,” according to Sturtevant.  REIT managers generally feel that a little extra revenue is not worth risking greater IRS scrutiny.

ProLogis Global Headquarters, Denver, Colorado

ProLogis Global Headquarters, Denver, Colorado (Photo credit: Wikipedia)

The conservatism of REIT managers has most likely already proven a barrier to some potential solar installations on REIT property, and a positive revenue ruling would have the added advantage of giving a green light for existing REITs to install solar on their property.

ProLogis, Inc. (NYSE:PLD) is one of the few REITs not waiting for a ruling.  ProLogis had installed 75 MW of solar on its buildings by the end of 2011, and claims to be “just getting started.”  According to  my calculations (using aggressive assumptions of a 20% capacity factor and $0.10 per kWh electricity price), even 75 MW of PV would generate only $13 million in annual revenue, or 0.85% of ProLogis’s 2011 total revenue.

pwlogo5[1].jpgAnother REIT which might be expected to take advantage of a positive revenue ruling in a big way is Power REIT (NYSE:PW).  Power REIT invests in the embedded real estate of transportation infrastructure and renewable energy installations.  PW currently owns only railroad real estate, but its CEO, David Lesser plans to acquire real estate underlying renewable energy generation (most likely a wind or solar farm) in the near future.

Talking ‘Bout a Revolution

ProLogis and Power REIT will undoubtedly continue investing in renewable energy in any case.  Lesser says, “We believe that that there is an attractive investment role for Power REIT to play in the renewable energy space with or without a clarification of PV being included as a real estate asset for REIT purposes.”

But for both investors and solar developers, the IRS could completely revolutionize the solar investment landscape by classifying PV as real property.  That revolution could be upon us before year-end.

Disclosure: Long PW

This article was first published on the author's Forbes.com blog, Green Stocks on October 9th.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 19, 2012

Five Green Dividend Stocks to Watch

Tom Konrad CFA

The Perfect Stock

My ideal stock is:

  1. Green (in that the company is helping to make the economy more sustainable)
  2. Pays a good dividend (in the current low-interest rate environment, I consider 4% to be “good”)
  3. Has earnings and free cash flow large enough to easily sustain the dividend, and
  4. Has low debt, leading to low earnings and cash flow volatility.

I like such stocks because I can buy them, and pretty much ignore them.  This leaves me time to research more speculative green stocks, while still knowing that much of my portfolio is producing reliable income.  Until recently, however, my ideal stock did not exist.

The recent decline of many green stocks has changed that, and I’m finally building a core of my portfolio around such reliable income producers.  For a list of the dividend stocks I am buying, see the end of the article here.

Dividend Stocks to Watch

bigstock-Money-Vision-4708416.jpg
Money Vision photo via Bigstock

Still, many green companies I like don’t meet all my criteria.   Here are five I’m watching, and why.

 #1 General Electric (NYSE:GE)

Why it’s Green: GE is involved in almost every green sector.  It’s a leading wind turbine manufacturer, produces all sorts of efficient vehicles, machinery, and appliances, and has a strong smart grid division.  The company’s Ecomagination initiative has long been core to its growth strategy.

Why I’m Watching, Not Buying: At $18.24, the dividend yield is a little lower than I’d like, at 3.7%.  Earnings and free cash flow are easily enough to support a higher dividend, but GE’s debt to equity ratio (3.65) is uncomfortably high.

What I’m Waiting for: GE’s high debt will probably be a barrier to me adding it to what I consider the “safe” part of my portfolio, but  if the dividend were to rise to 5% or more, and income still looked stable, I would probably buy, but to continue to watch the stock for signs of weakness.

 #2 Siemens (NYSE:SI)

Why it’s Green: Siemens is also a leading wind turbine manufacturer, as well as a leader in electric transmission and distribution technology.  Siemens’ automation technology helps innumerable industries use energy more efficiently.

Why I’m Watching, Not Buying:
 At $80.22, Siemens’ dividend is 3.5%.  Earnings could easily support a higher dividend, but free cash flow is weak.  Debt is at a comfortable 60% of equity.

What I’m Waiting for: I’d like to see free cash flow improve, and maybe a modest price decline to make this stock a better value.

#3 Honeywell (NYSE:HON)

Why it’s Green: Honeywell is a leader in efficient buildings, a key area society needs to address to become more sustainable.

Why I’m Watching, Not Buying: At $53.58, Honeywell’s dividend yield is 2.8% well below my threshold.  Income and cash flow are easily strong enough to support the dividend, and debt is also reasonable at 2/3 of equity.

What I’m Waiting for:  A fall in the stock price.  All Honeywell needs is the right price, and I’ll be a buyer.  If it fell below $40 today, I’d be buying.

 #4 Johnson Controls (NYSE:JCI)

Why it’s Green: Johnson Controls is a leader in efficient buildings, and a leading battery manufacturer.

Why I’m Watching, Not Buying: At $29.17, JCI’s dividend yield is 2.5% well below my threshold.  Earnings are easily enough to support a higher dividend, and debt is low, but free cash flow is negative.

What I’m Waiting for:  Like GE, Johnsons Controls is not likely to make it into the “safe” part of my portfolio any time soon, but a fall in the stock price might see me pick it up for the more speculative part of my portfolio.

#5 Veolia (NYSE:VE)

Why it’s Green: Veolia is a leading water and waste management company.  It also has a mass transit division, although it is looking to sell that.

Why I’m Watching, Not Buying: I own Veolia, but consider it speculative, not safe.  The company has a cash flow problem, but is currently working to restructure its operations.  Earnings are volatile, and, while the dividend is attractive at 6.8%, the company follows the European practice of setting a new dividend every year.  I’m far from sure the 6.8% level will be maintained.  Debt is high at over 2x equity. 

What I’m Waiting for:  The results of restructuring.  The company has the revenues and businesses to be a reliable cash producer.  If Veolia is able to sell some divisions and pay down its debt, the current low price ($12.18) would allow it to transform itself into my ideal stock.

UPDATE: I sold my position in VE when the stock rallied to $12.40.  I may repurchase if it falls below $11
This article first appeared on the author's Green Stocks blog at Forbes.com.

Disclosure: None.

May 15, 2012

Green Bond Update: Wind Company Bonds

by Corporate Bonder

Market Overview

Data compiled by the Bank for International Settlements indicate that the total size of the global debt securities market (domestic and international) was $98.7 trillion as at September 2011, of which $89.9 trillion were notes and bonds. Governments accounted for $44.6 trillion of outstanding debt securities, financial organizations $41.9 trillion, corporations $11.2 trillion and international organizations $1.0 trillion.

The focus of this report is on corporate borrowers. US corporations are the largest debt issuers, accounting for 46% of corporate debt globally, followed by the Eurozone with 20%, Japan 9%, China 6%, and the UK and Canada with 3% each.  The Merrill Lynch Global Broad Market Corporate Index (MLGBMCI), excluding financials, can be used as a proxy for the global corporate bond market in order to estimate splits by credit ratings, currency and sectors.

bonds by currencybonds by rating

Two thirds of the MLGBMC Index (ex-financials) has been issued in USD and 77% has an investment grade credit rating. Capital intensive industries account the majority of issuance with Utility, Energy, Telecommunications, and Basic Industry sectors accounting for 14%, 15%, 11% and 10% respectively.

Factors affecting issuance during the March 2012 quarter

There were 849 new developed market corporate bonds issued during the quarter, raising over $414 billion. BBB rated corporations were the largest issuer group by credit rating accounting for  29%. Sub-investment grade and European issuers increased their proportion of issuance versus Q4 2011 as market sentiment improved.

The following two charts illustrate how issuance was split by credit rating and currency during the three months to 31 March 2012.

issues by ratingissues by currency

Factors affecting investor demand during the quarter

credit spreadsU.S. long-term mutual funds experienced $105.8 billion net inflows over the quarter. Despite appetite for risk has made a come back, investors in aggregate continued to move out of equities and into bond funds, with $10.0 billion coming out of equity funds and $93.7 billion of net inflows to bond funds over the period.

The ECB’s introduction of the Long Term Refinancing Operation and improving US economic data led to an increase in risk appetite from investors. Credit spreads tightened, particularly for bonds issued by financials and corporations based in so-called periphery nations. Some of the spread tightening has unwound at the end of the quarter and into the start of the second quarter as familiar themes of Spanish sovereign risk and bank balance sheet uncertainty re-emerged.

YTMDevelopments in the low-carbon corporate bond market

The misfortunes of equity investors in publicly listed wind turbine manufacturers are well documented.  The following brief analysis is a glance at the bond market for wind turbine manufacturers and explores how bond investors have fared and how they perceive the risks surrounding the companies.

The author could only find two bonds from dedicated wind turbine manufacturer companies, listed in the table below.  (In addition, Suzlon (SUZLON.BO) has convertible bonds on issue, but has not issued conventional bullet bonds)

Table 1. – Wind turbine manufacturer public bonds – What currency?
Issuer Coupon Maturity Price* Yield (YTM) Credit Spread (OAS)
Nordex (NRDXF.PK)
6.375% 2016 95 7.9% 680
Vestas (VWDRY.PK)
4.625% 2015 88 9.5% 864

* At 12/4/12

nordexEach company had one senior unsecured bond, with the rest of their debt financed through banks in the form of term loans and revolving credit facilities.

vestas chartIn the author’s opinion the bond documentation carries weak covenants, more in line with investment grade bonds, rather than the high yield bonds. Further, the companies do not provide information regarding financial covenants provided to the bank lenders (and not the bond investors), which cedes control to the banks and creates uncertainty for bond investors (and even more so for equity investors).

As demonstrated in table 1, the bonds of Nordex and Vestas have lost capital value since they were issued, however Charts 1 & 2 illustrate that bond investors who bought the bonds at the issue date have broken even (so far) with coupons received making up for the capital loss. The charts also illustrate the size of the capital loss that equity investors have incurred over the same period.

chart 3While wind turbine manufacturer bonds have outperformed their equity counterparts, they have underperformed the broader bond markets. Charts 3 & 4 illustrate how the Nordex and Vestas bonds have risen in yield and credit spread versus the Merrill Lynch Eur High Yield B-BB Bond Index (an index of higher risk European corporate bonds) and the Merrill Lynch EMU Non-Financial BBB Bond Index (an index of lower risk European corporate bonds).

wind bond
spreadsNeither bond has an official public credit rating. However,  4 gives us an indication of how the market perceives the credit worthiness of the bonds. The higher the credit spread, the higher the credit risk is perceived.

When the Vestas bond was originally issued, it was priced with a credit spread close to a low BBB bond, while the Nordex bond was closer to a BB rated bond. The market’s opinion of their credit worthiness has clearly deteriorated since then, with Vestas trading more in line with low single B bonds and Nordex with high single B issuers. The Vestas bond has underperformed Nordex since the latter originally issued its bond in April 2011.

Corporate Bonder is a corporate bond fund manager in the London. This article first appeared on the Climate Bonds Initiative blog.

March 12, 2012

Buffet Bet Comes Out for Solar

by Sean Kidney

Warren Buffet is a famous proponent of value investing and he surely received a sign of the value in solar investments over fossil fuels last week. The MidAmerican Energy $850m Topaz solar project bond we mentioned a couple of weeks ago was so successful that a second tranche is expected to cover the remaining debt of the project. The offer was oversubscribed by $400m which would have mopped up the total $1.2bn of debt in the project; Buffet's Berkshire Hathaway (BRK-A) controls MidAmerican.

In contrast, Buffet’s investment in $2bn of bonds from gas company Energy Future Holdings is taking a hit due to low gas prices in US. The market value of the investment is already at $878m with further write downs expected.

It’s interesting to note that the expansion of drilling in the US rewrites the script on the increased policy risk of renewable investments over fossil fuels. It seems investors are beginning to recognise the steady fixed returns on renewables over the volatility of fossil fuel prices. Topaz is the latest in several large solar bonds offered including Desert Sunlight ($595m) and NextEra Genesis ($562m) both at AAA tranches due to loan guarantees. Topaz and the secondary tranches of the other two projects were both rated at BBB-/A-.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

February 11, 2012

Developments in the Solar Corporate Bond Market

by Corporate Bonder

The global bond market is huge. Data from the Bank for International Settlements shows that the total size of the global debt securities market (domestic and international securities) was $99.5 trillion as at June 2011, of which $89.9 trillion were notes and bonds. Governments accounted for $43.7 trillion of outstanding debt securities, financial organizations $43.8 trillion, corporations $11.0 trillion and international organizations $1.0 trillion.

Against that, Bloomberg has estimated that there are $230bn outstanding of fixed-interest securities that meet their “green bonds” definition. And of course the IEA talks of $1 trillion of investment a year needed for the global shift to a low-carbon economy.

The Solar Corporate Bond Market

There’s been a lot commentary on the collapse in the solar market and the accompanying share prices of solar companies. In this first of what we plan will be a quarterly market update we’ll have a look at the bond market for the solar industry and how it has been affected by market developments.

To illustrate the state of the market we found three solar companies that have issued corporate bonds and another five with convertible bonds outstanding. The bonds are listed below; they show that the market is clearly distressed, with yields on a number of bonds greater than 20%, despite a significant rally in solar convertible bonds during January. Credit spreads of greater than 1000 are typically thought of as being at distressed levels. The pricing data is as at February 7th 2012 (Bloomberg).

Table: List of bonds (convertible and conventional) issued by solar companies. Market prices trading at distressed levels.
Bond Price Yield Credit Spread
WFR (MEMC) 7.75 19 USD 84.3 11.0 950
SOLARW 6.375 16 EUR 61.5 22.4 1884
SOLARW 6.125 17 EUR 58.5 20.6 1855
REC 11% 14 NOK 97.9 12.9 912
REC 0% 16 (FRN) NOK 77 14.3 1162
REC 9.75% 18 NOK 71.8 18.2 1428
REC 6.5% 14 EUR CONVERT 60.9 38.2 2949
SPWR 4.75 14 USD CONVERT 91.8 9.0 842
SPWR 4.5 15 USD CONVERT 87 9.4 876
TSL 4 13 USD CONVERT 87.7 13.7 1289
STP 3 13 USD CONVERT 73 34.6 3356
JASO 4.5 13 USD CONVERT 84.8 18.6 1761
SOL 4.125 18 USD CONVERT 67.8 12.0 1405

REC Case Study

REC (RNWEF.PK) is a useful case study as it has publicly listed senior debt, subordinated convertible debt and listed equity which we can use to compare the performance of different parts of the capital structure. The chart illustrates the total return (rebased to 100 at 15 April 2011 when the longer bonds were issued) for all listed instruments in the capital structure.

The senior bonds have exhibited less volatility and a smaller fall in market price due to their lower risk profile than the convertible bond and the equity. Nevertheless, having lost less will be of little comfort to investors that bought the longer dated senior bonds at or around the issue price of 100, as they are now priced in the 70s. The fall in the price of the bonds reflects a substantial increase in the market’s perception of the risk in the sector and uncertainty regarding the value of solar assets. This does not bode well for solar companies looking to raise finance in the debt markets at present as the required yields are simply too high to make the businesses viable. The lowest risk solar companies in the market may be able to access markets but most companies will have to wait until yields come down and investor appetite improves before they can issue bonds.

Implications for Other Renewable Energy Companies

Corporations with solar activities amongst a much larger set of businesses (eg. integrated utilities or industrial conglomerates) are better placed to raise corporate finance for solar activities as the interest rates the market requires on these more diversified businesses are currently significantly lower.

While the solar market’s woes are unhelpful to the broader renewable energy market, many of the issues are specific to the industry and therefore should not inhibit the borrowing ability of corporations operating in other renewable energy activities. The current sovereign and financial sector malaise is a much more serious issue for broader renewable energy financing at the present time.

REC bond spreads
REC bond spreads

Bryn Jones, manager of the Rathbone Ethical Bond Fund commented: “the solar market continues to suffer from a number of headwinds, however senior bonds with higher coupons or structured debt can outperform equity in more stressed conditions. As a result this could support the view for more Structured Bonds issuance within the renewable energy space.”

Corporate Bonder is a corporate bond fund manager in the London. This article first appeared on the Climate Bonds Initiative blog.

January 13, 2012

The True Story of Clean Renewable Energy Bonds

Sean Kidney

Where did all the CREBs and QCEBs go? Mystery solved.

The US has for a long time used tax credits to promote the development of oil and gas and other industries. With tax credits the bond issuer still pays a coupon, but their payment is subsidized, effectively lowering the rate of interest paid.

The Obama administration brought in a big program of credits for renewable energy bonds. The plan was that States, large local governments, tribal governments and public power bodies would issue bonds to finance energy efficiency or renewable energy. The US Treasury states that some $5.6bn of allocations to over 1800 applicants have been made for these tax credits. This would seem to suggest that there were $5.6bn of bonds out there, but when we went looking we found we could only find out information about a few of them.

A report late last year by the US National Association of State Energy Officials has helped explain what’s happening. It seems that only a small part of the approved tax credits have actually led to a bond being issued.

The Government allocated $2.4bn for Clean Renewable Energy Bonds (CREBs) and $3.2bn for qualified energy conservation bonds (QECBs). After some investigation, Bloomberg New Energy Finance calculates public issuance at $646m, although they believe there is also a private placement market of up to $400m. That would bring total issuance up to around $1bn. I.e. bonds have been issued for less than 20% of allocated tax credits – that’s a severely under-utilized public finance mechanism!

Renewable energy financing consultant and former Ernst & Young senior partner, Jonathan Johns, has previously written for Climate Bonds Initiative on the benefits of tax-exempt bonds. I asked him what was going on.

First, he said that he’s “not that disappointed”. He says that “these are nudge rather than demand pull measures and require participants to pull schemes together and go through various procedural hurdles involved.  In a way they illustrate the future challenges of the industry as it seeks new sources of capital from the bond markets.”

Jonathan says that nudge mechanisms are often undersubscribed. “It’s interesting to note that those states with a strong record in renewables, e.g. California have used very high percentages of their allocations (which are based on population) whereas some more equivocal states have not. For other states there will be a natural cap on appetite if there are state or local borrowing limits.”

“There are lessons to be learned for the US and other jurisdictions – future schemes need to be more streamlined and remove some of the barriers – and also be accompanied by focus on demand stimulation and distribution channels for the bonds themselves.”

“Tax exempt bonds are a cost effective form of support, as relief is limited to the interest on the capital and not based on the capital itself. There’s also a relatively high payback per job created, with that payback localised when there’s a strong energy efficiency component – that’s been the case in over 50% of QECBs issued.”

A relatively large number of bonds issued are for small schemes in the $1m to $5m range. In other jurisdictions this has been difficult to achieve, with bond issues confined to recycling of large scale project finance portfolios.

Johns thinks it’s important to build on the CREB/QECB story and take the bond market to its next stage of development through the Climate Bonds Initiative and other mechanisms. Positive thinking.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

August 28, 2011

Has the Sell-off Created Value Stocks Among Clean Energy Conglomerates?

Tom Konrad CFA

The silver lining of all market declines is the chance to buy stock in quality companies at attractive prices.  That opportunity has been notably absent over the last two years, which is why my focus has shifted to smaller and smaller companies in search of reasonable valuations over that time.  Although I still don't believe the market is cheap by any measure other than comparing it to a couple months ago, the volatility is starting to bring some individual bargains, especially on heavy selling days. 

For instance, I've started to acquire some of the waste management stocks that I looked at last week, although I'm still waiting on another round of selling to purchase others.  In particular, I am looking for companies with high dividend yields that are well covered by free cash flow and earnings.  I also want companies with low levels of debt to ensure that income would be relatively stable, even when revenues drop.

Clean Conglomerates

I like the waste sector because I think it will benefit as higher commodity and energy prices lead to more profitable recycling and waste to energy operations. 

In contrast, the companies I'll look at today are not in any one sector, but rather they are broader industrial companies with a range of businesses in the clean energy arena that have drawn my attention over the years. 

Because these companies are large and well covered by mainstream analysts, I don't feel that I have the resources to gain an informational advantage over other market participants.  Instead, my strategy with companies like these is to wait until a general market downturn produces good valuations, and buy those companies which have decent dividends supported by healthy capital structures, earnings, and cash flow, with the intent on holding them for the long term.

In particular, I'm looking for a dividend yield around 3% or more, with earnings and Free Cash Flow (FCF) yields considerably higher than the dividend, so that there is room for earnings and cash flow to fall without imperiling the dividend.  I'm also looking for moderate levels of debt, preferring companies that are mostly equity rather than debt financed. 

I looked at the following seven companies:

  1. ABB Ltd. (ABB), which attracts me because of their expertise in electricity transmission and distribution, especially high voltage DC transmission.  They've recently been expanding their cleantech offerings with acquisitions in smart grid, electric vehicle, and efficient motors sectors.
  2. AECOM Technology (ACM) provides planning and technical support services in the sectors as diverse as transportation, facilities, environmental, and energy markets.  Since efficient infrastructure requires careful planning, a shift towards greater efficiency should mean more business for AECOM. Many renewable energy projects (such as hydropower) also require a level of planning expertise not necessary in traditional fossil fuel projects.
  3. Roper Industries (ROP) makes medical and scientific imaging equipment, energy systems and controls, and radio frequency products and services.  Many of their activities are focused on saving money for utilities, such as better ways to deliver water, better logistics, and leak detection systems.  Such efforts do a lot to improve energy and resource efficiency as they help their customers' bottom lines.
  4. John Deere (DE) provides services and products to the agriculture and forestry industries, so I see it as a potential beneficiary of increased demand for biomass for biofuels and electricity generation.  
  5. Siemens (SI) is an electronics and electrical engineering company with significant wind turbine, electric transmission, and building efficiency offerings.
  6. General Electric (GE) has been pushing their commitment to energy efficiency and renewable energy for most of the last decade, with green technologies accounting for a growing share of revenues.
  7. Johnson Controls (JCI) is both a leading battery manufacturer, and is a leader in building automation, a key technology in increasing building efficiency. 
I compare the companies' dividend, earnings, and cash flow yields, and Debt/Equity ratios in the chart below.

conglomerates.png

Conclusion

Of the companies listed, only ABB, Deere, Siemens, GE, and Johnson Controls have even moderately attractive dividends.  Of these, only ABB and Siemens have a level of debt I consider low enough to give it flexibility to cope with a sluggish world economy.  Yet both these companies have uncomfortably low FCF to support their dividends.  Free cash flow can be quite volatile, so I would want to take a closer look to decide on the cause of the current low cash flows at the companies before making an investment.  Furthermore, neither stock is particularly attractive on the basis of earnings, since analyst's predicted growth may not materialize, and both trade near 17 times 2010 earnings.

Of all the companies I consider here, Roper Industries looks the healthiest, with strong alignment between earnings and cash flow and low debt, but as with ABB and Siemens, the current valuation is unattractive. 

Especially when you consider that company analysts tend to be overly optimistic as a whole, we should probably discount the 2011 and especially 2012 earnings estimates.  None of these stocks looks like a great value at current prices, despite having fallen between 12% (ABB) and 35% (AECOM) year to date.

I take the lack of great values as a sign that this market decline likely has farther to go.

DISCLOSURE: None.
DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

August 23, 2011

Trash Stocks Trashed: An Income Opportunity?

Tom Konrad CFA

Dumpster diving for high yielding gems.

An earlier version of this article was written at the end of July and published on my Forbes blog, before the August market implosion. I've updated it here to reflect the new stock prices and some recent company news.

Renewable energy has many advantages over fossil energy.  One of the most important is that it's renewable.  As supplies of Oil and other fossil fuels are used up, they become harder and more expensive to extract, while renewable energy is generally getting cheaper over time, due to improving technology.

Unfortunately, while there is no real limit to how expensive fossil fuels might become, as we start using more and more renewable energy, we will start running into resource constraints which will eventually end the decline in renewable energy prices.  Where fossil energy uses a small capital investment up front, followed by a long tail of fuel cost, renewable energy requires a large capital investment up front, followed by little or no fuel cost.  Unfortunately, that up-front capital investment is not just money: it's an investment in capital equipment such as solar panels or wind turbines using much more raw material than an equivalent fossil fuel plant.

Commodity prices are already high and rising higher because of buoyant demand in developing countries.  The transition to clean energy will only accelerate this trend, as old fossil fuel based generation is replaced with new renewable energy that require a far larger investment of industrial metals.  This is what Jeff Vail calls the Renewables Gap, and John Petersen calls the Alternative Energy Fallacy.  We cannot transition to clean energy without making other significant changes to our economic system: the resources in energy and raw materials are not there.  In reality, we must make those changes, because we simply do not have the resources to transition to clean energy while continuing business as usual.

Commodities and Trash

Rising commodity prices have recently been hurting waste haulers even as volumes fall during the recession.  On July 28, Waste Management (WM) missed Q2 Earnings expectations by $0.12, earning $0.50 per diluted share.  Waste Management's CEO, David Steiner, attributed a $0.04 earnings shortfall to increased operations and maintenance due to rising commodity prices in the earnings call, yet "[h]igher commodity prices, improved recycling volumes, acquisitions and year-over-year yield increases contributed to the [year over year] revenue growth."  Overall volumes dropped due to a slower economy, and management attributed a decline in revenues to this, in addition to increased competition. 

The other side of rising commodity prices is not a cost, but a revenue source.  This comes in two forms: Recycling and Waste-to-Energy.  Waste Management is expanding in both these areas, with significant waste to energy operations, which benefit from rising energy prices, and recycling operations, which benefit with rising prices for recycled paper, plastics, and metals. 

Stocks Trashed

While Waste Management has fallen from around $36 to below $30 (17%) because of the earnings miss and market decline, another waste and water purification stock I follow, Veolia Environnement SA (VE) has been much worse hit, falling from $26 to $15 (42%) because of lower guidance related to restructuring because of declining volumes, plans to downsize, and an accounting fraud in its US division.  Veolia has been hit by declining volumes and increased competition in the US, as well as European economic woes. 

Yet both Waste Management and Veolia are high yielding companies, and are beginning to look tempting to income investors as dividend yields are pushed up by declining stock prices. Unfortunately, Veolia's restructuring could easily lead to a dividend cut since the company already distributes most of its earnings to shareholders in the form of dividends, and this could lead to a further fall in the stock price, if it is not already priced in. 

Progressive Waste Solutions (BIN) also missed second quarter earnings, a shortfall the company blamed on bad weather.  The stock fell further than many others in the recent sell-off because much of it's revenue comes from Western Canada, where the economy is heavily dependent on the oil fields.  But I seriously doubt that oil price declines will come anywhere near the levels needed to seriously dent the oil sands boom, so investors' fears over oil seem to be providing a buying opportunity in this stock, as outlined in a recent Barron's article.

The downtrend in waste stocks has been industry-wide, with the Global X Waste Management ETF (WSTE) having declined 18% over the last three months, while the S&P 500 index has declined less than 15%.  This under-performance is surprising in an industry which is often considered a defensive play.

WSTEvSPY.png

Safe Income From Trash?

While I'm tempted by the high current yields, I want to be sure that the companies can easily cover their rather high dividends with earnings going forward.  I'd like a stock with a high dividend yield, but with that dividend well covered by earnings and Free Cash Flow (FCF).  I'm also looking for a low leverage ratio (debt to equity,) so that the effects of any future decline in revenues will have only a moderate effect on earnings.  Below, I show dividend yield compared to three years of earnings yeilds and estimates as well as trailing FCF yield and debt to equity ratios for several waste management stocks.

As long as earnings and FCF yields are comfortably higher than the dividend yield, the company in question should be able to continue to pay (or even increase) the dividend.
Waste Co Stats.png

Per Share
Stock Price Dividend 2010 EPS 2011 Est 2012 Est FCF Debt/Equity
Waste Management (WM) $29.40 $1.36 $2.10 $2.14 $2.44 $2.04 1.38
Veolia (VE) $15.18 $1.47 $1.60 $1.85 $1.95 $0.85 1.94
Casella Waste (CWST) $4.81 $0.00 $0.24 -$0.50 $0.09 -$0.13 4.95
Republic Services (RSG) $27.50 $0.80 $1.71 $1.88 $2.13 $2.25 0.87
Progressive Waste (BIN) $20.91 $0.51 $0.94 $1.12 $1.30 $1.54 0.79
Waste Connections (WCN) $30.99 $0.30 $1.24 $1.48 $1.71 $1.74 0.83
Data Source: Yahoo! Finance

As I noted earlier, while Veolia has an attractive yield of almost 10%, but with earnings and Free Cash Flow yields only slightly higher, and FCF far below, Veolia will probably have trouble maintaining its dividend if the fierce competitive environment and low waste volumes persist or worsen, with 84 cents of every dollar earned being paid out as dividends.  With a Debt to Equity ratio of almost 200%, the company is quite vulnerable to further drops in revenue, although they may be able to pay off some of this debt by selling divisions as part of the downsizing. 

Waste Management's dividend payout is also higher than I would like at 64% of earnings and 67% of free cash flow, but the lower debt to equity ratio makes this more manageable, so I expect they will be able to maintain the current dividend.

Of the other companies listed, both Republic Services and Progressive Waste are beginning to look attractive because their lower dividends (at 3% and 2.5%) are very well covered by earnings and cash flow, and their low debt means that earnings will be more resilient in the face of a potential continued revenue decline.  On the other hand, if earnings continue to grow as projected, these two companies have plenty of room to increase dividends further.

Conclusion

The falling volumes and increased competition in the waste management industry, along with the last few week's market decline have made these stocks into attractive income investments.  Since the sector has a reputation for earnings stability, the recent earnings misses and revisions have hit investors particularly hard, leading to potential buying opportunities.  Nevertheless I feel there is still room on the downside, so it's probably better to dip a toe into the trash bin rather than engaging in full scale dumpster diving. 

The most attractive names right now are Waste Management and Republic Services, while Veolia's gigantic dividend will tempt braver investors, and Progressive Waste is probably worth including in a portfolio for additional diversification.  I have a bias toward Waste Management and Veolia because they have stronger focuses on recycling and waste-to-energy, which I believe will serve them well if commodity and energy prices continue to rise due to growth in emerging economies. 

DISCLOSURE: Long WM,BIN.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

August 03, 2011

Climate Bond Standard to be Released This Week

Tom Konrad CFA

Conserving the planet for conservative investors.

Investing in clean energy stocks has an (often well-deserved) reputation for risk.  Although energy efficiency and more inclusive progressive energy indexes have held up fairly well over the last few years, the performance of narrower clean energy sectors has been dismal, and some industry observers feel that the declines in wind and solar are structural (and hence permanent) as opposed to cyclical (and therefor temporary.)

This presents a conundrum for investors with long time horizons who not only need their investments to earn a steady return and meet long term financial obligations, but also care about the long term health of the planet.  Individuals saving for retirement, as well as many pension funds and insurers match this profile. 

Why should such long term investors care about the environment?  Because runaway climate change has the potential to undermine the goals which they are saving to achieve.  If a property insurer doubles its money by investing in businesses that increase the frequency of floods, droughts, and hurricanes, the financial gains will be undermined by an increase in claims.  A retired couple will be happier and healthier on any given amount of money if the Florida condo where they planned to retire is not inundated by sea level rise, ocean acidification has not destroyed the coral reefs where they want to take their grand kids snorkeling, and they can feel optimistic about those same grand kids' future health and economic well-being not being undermined by environmental toxins and energy insecurity.

Funding Clean Energy

There is a temptation to compare investing in clean energy to investing in information technology (IT), since both are rapidly advancing technologies that are disrupting old, inefficient ways of doing things.  But clean energy is fundamentally different from IT in that it is very capital intensive.  Lists of the most successful college drop-outs in history are dominated by IT moguls who started companies in their garages or with minimal capital: Bill Gates, Larry Ellison, Larry Page, Micheal Dell, Paul Allen, and Steve Jobs, are six of the top ten on one list I found.

It's unlikely that the same list will be filled with clean energy entrepreneurs thirty years from now, because clean energy start-ups are capital-hungry, and college drop-outs have a harder time convincing investors to part with a few million dollars than businessmen with degrees and successful careers behind them.  Clean energy projects are typically even more capital-intensive than traditional energy projects (with the exception of nuclear,) because the low fuel and operating expenses come at the cost of higher up-front costs. 

According to an IEA 2010 report, between $600 billion and $1 trillion will be required every year until 2030 above existing infrastructure requirements in order to transition to a clean energy economy.  The Stern report places the economic costs of avoiding dangerous climate change at approximately 2% of global GDP.  Only the global bond market has the necessary amount of capital to deploy, but nearly all fixed income investments in low carbon technologies have very short maturities, and do not match the investment needs of the conservative institutions that would prefer green investments over brown ones, if they only had the option.

Climate Bond Initiative

The Climate Bond Initiative was founded in late 2009 to bridge the gap between the needs of fixed income investors and the needs of clean energy developers.  The initiative's goal is to catalyze the issuance of Climate Bonds to finance the global transition at speed and scale.  To do this, the Initiative is developing the financial infrastructure necessary for the new class of Climate Bonds to emerge with the speed and scale necessary for the task at hand.  Large pension funds such as the California State Teachers’ Retirement System, investor groups such as the Ceres Investor Network on Climate Risk,  governments like the California State Treasurers’ Office, and nonprofits such as the Natural Resources Defense Council worked together to create a Climate Bond Standard which will be suitable for the broadest possible range of investors and projects, while still giving investors an assurance that the underlying projects are indeed helping to mitigate climate change.

The Climate Bond Standard was initially scheduled to be released at the end of July, but it was expanded to include a broader range of bond types, and so the release is now scheduled for this week.

For the Small Investor

The limited number of Climate Bonds issued to date have mostly been sold in the commercial market, but we can hope that the new Standard will catalyze the issuance of Climate bonds available to the retail investor as well.  While retail investors are unlikely to provide a large fraction of the funding needed for the clean energy transition, retail investors can play important roles in helping to engage the public in the effort to tackle global warming, and help draw attention to the efforts of participating institutions. 

In my opinion, retail Climate Bond offerings cannot come soon enough.  When small investors see that green energy investing can not only be the right thing to do for the planet and our grandchildren, they are more likely to give political support to government initiatives that remove the barriers and confront the vested interests that are holding back the transition to a clean energy future.

Not to mention I'd like to buy a few Climate Bonds for my own IRA.

DISCLOSURE: None.




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