Last Monday, President Obama unveiled his new plan to use the EPA to enforce a range of new restrictions on power plants and their methods for generating electricity. The regulations are geared towards addressing the serious issue of climate change by reducing carbon emissions to 32% below 2005 levels by 2030.
It’s an ambitious plan: their strategy of labeling carbon dioxide as a pollutant, and using the EPA to regulate it allows the Obama administration to sidestep congressional approval that would not be coming anyway and actually take action on a pressing issue. It’s also a move that will, if implemented over time, crush what’s left of the coal industry and force American utilities to look elsewhere.
On the whole, if Obama’s plan actually lasts beyond whoever the new president is in 2017, it should completely change the face of power generation in the United States.
Gonna Be a Bright, Bright, Bright Sunshiny Day…
The better question for investors, though, is how to play this change. Shorting coal companies, obviously, would have been a pretty sweet move a few years ago. That said, this would be the killing blow to an industry that’s already been laid low by crashing prices for natural gas. The value left in betting against coal looks to be negligible.
Playing renewable energy stocks is another option, but that can be a pretty dicey proposition. Trust me, I know. The companies that manufacture solar panels are carving out a new marketplace and currently aren’t showing a ton of profit. Long term, I love the prospects of these stocks, but there’s a lot of volatility.
That said, there is another option: yieldcos. Yieldcos are holding companies that acquire and own solar power plants. They’re usually spun off of major solar companies as a way to isolate the steady revenue streams of an operating utility from the big swings that come from manufacturing and selling solar panels.
As such, these are projects that are specifically exposed to the American market for generating electricity, usually with a specific focus on renewable energy that should benefit from this new set of regulations. They’re also built as income stocks, with strong dividends based on steady and reliable income streams.
Why Solar Investors Should Know about Yieldcos
Looking at a yieldco is somewhat similar to looking at an MLP or REIT. It’s an income stock, so a healthy dividend and revenue growth are traits you want to look for. Yieldcos, though, are unlike MLPs or REITs in that they’re a lot riskier, and typically a lot newer. Most of them are carrying a pretty serious debt load, and many aren’t showing a ton of profits in the short term.
Throw in the fact that the entire solar industry (and by extension, my portfolio) has been taking a serious beating this summer, and there’s certainly plenty of reasons to exercise a great deal of skepticism regarding yieldcos.
However, if they can make it through this relatively volatile period and come out the other side in a regulatory environment that dramatically boosts demand for their product, yieldcos could be a good way to play an evolving energy economy.
Pattern Energy Group (PEGI)
While most yieldcos tend to focus on solar energy, there are also a few that have a broader base of renewable energy projects in their portfolio. Pattern Energy Group is one such example, with 12 wind power projects in the United States, Canada, and Chile.
Pattern Energy is viewed favorably by analysts and features a dividend yield in excess of 6.5%. Like most of its yieldco brethren, it’s carrying a lot of debt, but growing revenue, projections for increased profits, and strong gross margins all point to this yieldco having a good chance to turn into a strong income stock in the future.
Abenoga Yield (ABY)
Abenoga Yield is a British company, but it is pursuing projects in North America as a part of its portfolio. The company owns and manages renewable energy sources in addition to conventional power generation and electric transmission lines. All told, the company has some 15 assets comprising 890 megawatts of generation capacity.
Abenoga can also boast exceptionally strong margins, a dividend yield over 6%, and strong revenue growth, albeit over a relatively short time frame. Like a lot of solar/renewable energy stocks, Abenoga has been in freefall this summer, shedding almost 40% of its value since the start of June. One could see that as a sign to stay away, but if you’re of the belief that this is just short-term volatility, then the present might offer a great opportunity to get in cheaply.
TerraForm Power (TERP)
TerraForm Power is the yieldco spun off of SunEdison (SUNE) , one of the biggest solar companies in the world and the originator of the power purchase agreement (PPE) that has help launch residential solar to new heights. However, in more recent news, it’s the company that took a nearly 35% tumble on Thursday and Friday of last week.
The sell-off was sparked by a Q2 earnings report that showed more wide losses and a lot of debt, which was nothing new but had apparently reached a level where even a significant portion of the sort of risk-on investors who were in the stock in the first place were ready to get out.
Whether that was the correct response or an overreaction that failed to appreciate the long-term strategy of the company, the fact remains that TerraForm Power is tied up in all this. SunEdison appears to be pushing projects and debt to TerraForm where they will then start generating cash, something to factor into any potential investment decision. Even for a yieldco, the debt levels for TerraForm Power are, in fact, very high.
On the whole, looking at TerraForm independently would seem to indicate that it’s as strong a yieldco as any. The company’s revenue spiked in 2014 and appears en route to another FY increase for 2015 as well as projections for major revenue and earnings growth in the future. It has a dividend yield over 5% and strong gross margins.
8point3 Energy Partners (CAFD)
Including 8point3 Energy Partners here is a little out of sync with the rest of the list in many ways. The company is a young one, having held its IPO in June. This yieldco was formed in a partnership between First Solar (FSLR) and SunPower (SPWR) , and it lacks the data on market performance thus far to come to any really solid conclusions.
However, it seemed relevant to mention here for a few reasons. The first being that First Solar is the largest solar company in the world. Focused primarily on utility-scale projects, First Solar seems tailor-made for a yieldco in many ways. Secondly, First Solar appeared to avoid the bug that bit SunEdison during this last earnings season, posing a huge beat that had the stock soaring and allowed it to avoid the broader solar sell-off that hit the market after SunEdison’s earnings miss. And thirdly, 8point3 owns projects entirely within the United States, making it a particularly well-suited way to play the new EPA regulations in the long run.
All told, 8point3 may need a little more time to prove itself one way or the other, but it is currently a little shy of a 6% dividend yield and projecting huge earnings increases in the next few years. That, plus its association with First Solar, would mean that anyone considering investing in a yieldco should at least consider 8Point3 Energy Partners.
Global X Yieldco Index (YLCO)
Of course, why pick one yieldco when you can just grab the whole sub-industry in one go? The Global X Yieldco ETF offers broad exposure to yieldcos that doesn’t put all your eggs in one basket. Sure, this is going to include both the strongest and the weakest yieldcos, but that also means that a lot of your risk is hedged to some degree.
If you’re confident in the long-term potential of yieldcos, this ETF could be one of the simplest ways to play the larger trend towards renewable energy.
Stocks that are far Less Reliable than the Setting Sun
For the most part, the solar industry and, by extension, yieldcos are in a similar state. There seems to be some consensus that the future of electrical generation is going to include a lot more renewable energy. There is, however, less consensus on how that will be monetized and just how much success the current crop of solar companies will have on the march there.
As of today, most of the industry has seen a pretty significant sell-off in its shares since the start of May, with the Guggenheim Solar Trust (TAN) losing more than a quarter of its value in that period.
So, if you’re an investor who thinks that’s just a sign of how weak these companies and the industry was to begin with, it probably makes sense to stay away. These stocks are anything but a guarantee. However, if you’re the sort of investor with a long-term outlook, an appetite for risk, and a belief that solar power really is the future, the current sell-off would have to look like a solid buying opportunity.
If the day comes when the solar industry really finds solid footing and starts to claim a large share of the utility industry, stocks like these yieldcos are likely to shed their volatility and become fairly solid income stocks. That’s a big if, but if you’re looking to roll the dice, this could make some real sense.
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