Brookfield Renewable Power Partners (BEP, BREP)

Brookfield Renewable Power Partners (BREP) has the world’s largest publicly traded hydroelectric power generation portfolio with significant and durable competitive advantages. These advantages form a wide protective moat of natural barriers to entry including limitations on river availability, suitable locations with substantial water supplies and competing uses for those rivers. The moat supports the economic advantage of an inexhaustible and free fuel supply in an energy intensive industry producing the lowest cost electric energy available.

BREP Featured Image

BREP is the second major entity spun off as part of Brookfield Asset Management’s (BAM’s) transformation to a global asset manager. BREP was launched [Source] in November of 2011 combining Brookfield Asset Management’s portfolio of renewable operations in the U.S. and Brazil with the Brookfield Renewable Power Fund’s portfolio of renewable assets in Canada and North Eastern U.S. This strategic combination created the world’s largest publicly traded hydropower generation company focused on low cost and environmentally preferred hydroelectric power with a market capitalization of about $8 billion and $17 billion of assets under management (AUM).

Brookfield Renewable Power Partners parent company BAM has a long history in renewable hydroelectricity. Originally founded (1899)[Source] to provide electricity and transportation in Brazil from which the company’s original name was derived “Brascan” (“Brazil” + “Canada”). In 1912 they incorporated a company in Toronto to develop hydroelectric power operations in Brazil. The Great Lakes Power Company (1916) a provider of hydroelectric power was acquired years later. The 100+ years of Brookfield history in renewable power has positioned the company well for the increasing recognition of renewable power in the world today.

Over the past 10 years BREP has built or acquired hydroelectric power assets in North and South America to create an irreplaceable portfolio of these unique assets.  Good growth prospects continue to exist in both hydroelectric and wind generation. In hydroelectric grass roots development opportunities at suitable locations with substantial water supplies exist primarily in Brazil and favorable economic conditions prevail for hydroelectric acquisitions in North America due to temporarily low electric market prices. BREP appears positioned to generate stable, long term cash flows under long term contracts supporting regular and growing cash distributions to unit holders.

Brookfield Renewable Power Valuation Summary:

Brookfield Renewable Power provided a 13.5% total return for unit holders in 2012 during cyclical low power prices and drier than normal water conditions. The company appears well positioned for the future and will likely be an outstanding income and growth investment.

Please be advised this valuation has been updated; click here for the update.

Map of Operations:

BREP Map of Operations

[Source]: Brookfield Renewable Energy Partners

Operating Profile:

The portfolio of assets is 85% hydroelectric with a growing wind generation and other renewable component of about 15%. Brookfield Renewable Power has 5,800 megawatts (MW) of installed capacity and is diversified across 70 river systems and 11 power markets in Canada, the United States and Brazil.

BREP Profile Graphic

[Source] Brookfield Renewable Energy Partners Company Profile

Markets by Capacity: In the following table the key markets and capacities of the electric generation portfolio owned and operated by BREP are outlined as of December 31, 2012 whereas the graphic above is updated as of April, 2013 so some differences in the values exist. Please note capacity is measured in megawatts (MW) and long term average (LTA) in gigawatt hours (GWh).

BREP Capacity Table

 

BREP Pie Chart of Markets

[Source] Brookfield Renewable Energy Partners 4Q12 Supplemental Information

Contract Profile: BREP’s portfolio of power generating assets produce stable cash flows from a fully contracted portfolio with long term power purchase agreements that have a weighted average remaining duration of 18 years.

BREP Contract Table

 Investment Attributes:

Brookfield’s Renewable Power portfolio of assets are characterized by barriers to entry and strong competitive positions, the investment attributes include:

  • Assets costly to construct with long lives, up to 100 years, providing electricity a vital service
  • Demand tends to be inelastic given the necessity of the electricity in modern society
  • Low cost electricity producers with margins protected by less efficient predominant technology
  • Lowest cost producer capacity use preserved by distinct price advantage over competitors
  • Hybrid investments showing both fixed income like cash flows with potential for capital gains
  • Significant growth opportunity in Brazil with world’s largest remaining hydroelectric potential
  • Investments from low risk regulated (Brazil) to moderate risk unregulated power markets
  • Fully contracted long term purchase agreements with average remaining duration of 18 years
  • North America water reservoirs and Brazil regulatory framework increase the scarcity value

Focus on attractive hydroelectric: BREP’s assets are 85% hydroelectric one of the longest life, lowest cost and most environmentally preferred forms of power generation. In North American reservoir waters can store up to 38% of BREP’s annual generation. In Brazil they benefit from a regulatory framework to level generation risk across producers assuring generation during unfavorable conditions. Both provide partial protection against short-term changes in water supply. As a result of scale and the quality of BREP is competitively positioned compared to other listed renewable power platforms and provides scarcity value to investors.

Lowest cost producer: Electricity is a commodity product in an industry that can only make a profit on products at prevailing market prices. If demand and prices decline the lowest cost producers can maintain earnings power while the higher cost producers (marginal producers) must incur losses or go out of business.  Hydropower competes with electric producers based on nuclear, fossil steam (coal, natural gas, oil) and gas turbine (natural gas) fuels. As the lowest cost producer it has a distinct cost advantage over these competitors. The tables below using U.S. based data as an example illustrate the large advantage of hydroelectric producers over others primarily due to zero fuel costs of hydroelectric producers in an otherwise energy intensive business.

BREP Graphs by Fuel Source[Source] Data from U.S. Federal Regulatory Energy Commission

Durable competitive advantage: In commodity businesses the lowest cost producers always wins so typically competitors, over time, adopt the lower cost technology or go out of business. In hydroelectric production this adaptation is limited due to limited suitable locations with substantial water supplies and competing river uses in North America. In Brazil with the world’s largest remaining hydroelectric potential, government regulatory regimes encourage hydropower development as electricity demand is increasing 5,000 MW per year and is expected to double by 2020. This increase in demand and BREP/BAM’s 100+ year local presence provides a significant local advantage.

BREP’s cash flows are stable with approximately 95% contracted in 2013 and power purchase agreements in place with an average duration of 18 years. The unique, irreplaceable portfolio is geographically diversified in the large industrialized nations of U.S. and Canada and the emerging economy of Brazil over 70 river systems providing a strong base for sustainable earnings and future growth. The large capital investments required for the growth is funded by equity issuance and long-term debt that is not guaranteed by Brookfield Asset Management.

BREP Diversification Pie Charts

[Source] Brookfield Renewable Energy Partners Company Profile

Strong financial profile: BREP has $17 billion of power generating assets and a consolidated debt-to-capitalization of about 38%. The liquidity position remains strong and approximately 80% the obligations are non-recourse. Debt has a weighted-average term of 10 years.

Future Growth:

Growth through Increased Demand:

Demand for electricity is increasing dramatically in Brazil due to rapid growth of the economy and the middle class. Brazil’s gross domestic product (GDP) growth is almost twice that of the U.S. & Canada. With 50% of the Brazilian population in the middle class, per capital electric consumption is equivalent to 1/3 of France and 1/6 of the U.S. and Canada. This provides considerable potential for demand growth as living standards continue to rise.

Brazil holds the world’s largest remaining hydroelectric potential in the world. The government’s regulatory regime encourages development through an assured generation program as it faces 5000 MW of increasing demand per year. This bodes well for BREP/BAM’s long history in Brazil and their strategic focus on hydroelectric power.

During 2012 BREP completed construction and commissioned a 19 MW hydroelectric facility in Brazil and construction on a 29 MW hydroelectric project is progressing for completion in early 2013. In Canada construction is started on a 45 MW hydroelectric project in British Columbia to be completed in 2014 with a 40 year power purchase agreement.

Growth through Acquisition:

Over the last 10 years BREP has acquired or developed over 20 hydroelectric assets totaling approximately 3,000 MW.

BREP Record of Growth

Their ability to invest with a contrarian view creates opportunities as the electrical industry faces challenges. Electric prices are low in North America due to the low price of natural gas fuel available to the marginal producers of electric, the natural gas generators. This results in a low price for all electric producers and those without contracted sales may be challenged with lower volume as well. BREP’s contracted power production and low cost producer status assures cash flow in an oversupplied market. Coupled with a value oriented investment philosophy this low price commodity market is turned into an opportunity to deploy capital at favorable economics.

During the Investor Day Presentation [Source], Sachin Shah, BREP’s CFO, explained (paraphrasing) that low gas around $3.30 today due to shale gas is not sustainable and a longer term price between $4.50 and $6.50 is reasonable. At that level and assuming a 10% return required for electric producers using gas as a fuel (the marginal producers) a $80 to $90 a megawatt hour electric price is required. Without a price level to cover cost to produce and provide a return electric capacity needed to meet demand growth will not be built. It’s unlikely the increase in demand will be met with lower cost nuclear plants or coal fired plants so gas generators will remain the marginal producers setting the price level at $80–90 a megawatt hour.

If the price setting marginal electricity producer is break even at $80-90 megawatt hour, the low cost hydroelectric producer is profitable at this price level. Hydroelectric operating costs including fuel averaged only 16% of the marginal (gas) electrical producer’s operating cost over the past decade (in the U.S.). BREP is a patient producer with long term contracts and has become active in the market buying assets under favorable terms from hydroelectric producers without long term contracts or in need of cash.

Sachin Shah summarizes the opportunity in the Investor Day Presentation: “On the hydro[electric] side, as I mentioned, today 85% of our business is hydroelectric. Clearly, this is going to be the majority of the content in our portfolio for the foreseeable future. We feel like it gives us a tremendous cash flow advantage in terms of its margins and we continue to acquire hydro[electric] in this market. And if we can acquire hydro[electric] that have price exposure longer term in a $3 gas market or in a $40 power market, we think that we’re deploying capital on a very low risk basis with significant downside protection, but tremendous upside optionality if gas even goes to $4 or $5 or $6 and power prices commensurately grow to $60, $70 or $80. Very rarely do you have opportunities to put capital to work where you can see a path of doubling your value over ten years. And this I’d say is one of those, without taking outsized risk and while having a strong downside protection.”

Historic Performance:

BREP’s goals are outlined [Source] as: “Our goal is to be one of the world’s largest renewable power businesses with the highest quality portfolio:

  • Invest and manage assets to achieve a 12% to 15% total return
  • Global growth mandate with a focus on core markets
  • Focus on highest value, longest life renewable technologies
  • Maintain capabilities to pursue full spectrum of opportunities but favor highest value for shareholders
  • Leverage Brookfield Asset Management platform and expertise”

As prospective investors we ask; have they delivered on these objectives historically? As a newly consolidated entity we have to rely on the past performance of the components now making up the renewable assets of BREP:

BREP Historical Performance[Source] BAM Investor Day Presentation page 110

To update this information through 2012’s performance, we find in the low electrical power pricing market and below average rainfalls a 13.5% total return was achieved among other accomplishments:

BREP 2012 Summary

[Source]: Brookfield Renewable Energy Partners Company Profile

Although past performance does not guaranty the future; the results at a minimum made and often exceeded the 12-15% total return targets.

Management:

As in Brookfield Asset Management’s (BAM’s) other spun off entities, the executive management team, successful at Brookfield Asset Management, is the team supporting Brookfield Renewable Power Partners going forward. At BAM they produced compounded annual returns of 19% over the past 20 years. BREP’s Chief Executive Officer, Richard Legault, for example was Brookfield Asset Management’s Chief Financial Officer from 2000 to 2001 and held several senior positions in operations, finance, and corporate development with the company’s forest products operations prior to that. And as we know it also takes a good business to produce impressive results over the long haul, here we have both.

Favorable Structure of Master Limited Partnerships (MLPs):

Investors in an MLP buy units of the partnership rather than shares of the stock thus the term “unit holders” and payments to the unit holders are referred to as “distributions” rather than dividends. There are two levels of MLP ownership, the general partners and the limited partners.

The general partner, in BREP’s case is Brookfield Asset Management. BAM as general partner manages the operations and all services including management are provided by the general partner. The publicly traded limited partner (BREP) pays the general partner (BAM) for the services provided through an agreed to fee structure and performance incentives. The limited partner units are publicly traded and the general partner units are not.

Stable cash flow and capital intensive businesses such as Brookfield Renewable Power Partners and the unit holders can benefit from the master limited partnership structure in a number of ways:

Alignment of Interests: The general partner BAM is paid an incentive to increase distributions to the limited partners. BAM collects a 15% distribution incentive then a 25% incentive after certain distribution levels are reached. This Incentive Distribution Right (IDR) gives the general partner an incentive to increase limited partner distributions.

The general partner can also own limited partner units as is the case with BAM owning 68% of BREP limited partner units aligning BAM’s interest with unit holders in BREP. It is also then in the general partner’s interest to increase distributions since they also receive the distributions through direct ownership as well.

BAM as a general partner is also paid 1.25% of market capitalization of the limited partner, above $8 billion in BREP’s case, as an incentive to work to increase the market value of the limited partner’s units.

Favorable Tax Treatment: Shareholders in a corporation pay double taxation, first at the corporate level then at the personal level when dividends are received. Partnership owners are taxed only once, when they receive distributions.

Reinvestment of Cash Flow: Since there is no partnership equivalent of corporate income tax funds from operations, not paid out as distributions, can be reinvested in the business on a pretax basis. This provides for tax free compounded returns (capital gains) where reinvestment opportunities exist with suitable returns.

Lower Cost of Capital: Without the equivalent of corporate income tax MLPs typically enjoy a lower cost of capital than a taxed corporation.

Valuation:

Benjamin Graham, considered the “Father of Value Investing” argued businesses should be purchased below their current intrinsic value to provide a “margin of safety” with little or no regard for future growth. This creates a dilemma however with companies, perhaps not selling at discounts to current intrinsic value, but with increasing intrinsic value as is occurring with BREP.

Warren Buffett explains how Berkshire Hathaway resolved the dilemma in their 1992 letter to shareholders [Source] “In our opinion, the two approaches [growth and value] are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.”

One solution is to consider future growth but not to pay for it by treating growth as (part of) the margin of safety. Brookfield Renewable Power Partners is clearly growing, so we’ll use the growth, built around management’s stated targets, as part of our margin of safety. This view is important with companies like BAM/BREP that operate with long term growth strategies or we may forever be locked out of great investments and income streams.

Management’s total return target of 12%–15% per share is the sum of yield (distributions) and capital appreciation. An underlying premise in our valuation is that these returns can only be achieved where there are comparable increases in cash flow through operations improvement, organic growth, acquisition growth, or improving business conditions. A second premise is the capital structure of the company remains relatively constant over time.

Management’s job is to decide how best to utilize the excess cash generated in the business. They can either reinvest it in the business, if opportunities exist to do so at sufficient returns, or return it to shareholders as distributions (or share repurchases). If investment opportunities exist to generate 12-15% returns in this low (near zero percent) rate environment, my vote will always be to maximize reinvestment.

Please be advised this valuation has been updated; click here for the update.

Risks:

As with any equity investment there are various risks to consider including the following with BREP:

Political Risk: About 20% of BREP’s investments are in Brazil, an emerging economy where socio-economic factors can result in politics that at times have adversely influenced the business environment.

There are several offsetting factors to consider as well. Brookfield and its predecessor companies have 100+ years of operations experience in Brazil. Management also seems to use their global presence defensively where and when political risks are uncertain. For example, renewable assets investments in U.S. (40%) and Canada (40%) enable BREP to reallocate capital there if periods of higher risk develop elsewhere.

Compared to many of its emerging market peers, Brazil is considered to have a relatively benign risk profile. Although the Democracy is relatively new it is very well established. As  Brazil’s economy and middle class continues to grow with foreign capital investment its status as a politically and economically stable world partner likely increases to sustain this growth.

The management team has an excellent track record over a long period of time demonstrated with prudent capital allocation, critical thinking and a refreshing ability to walk away where risk is unacceptably high.

Interest Rate Risk: MLP units are often viewed as income investments and can trade somewhat like bonds, rising when interest rates fall and vice versa. We are likely facing higher interest rates in the future. BREP also uses debt to finance its business so a rise in interest rates will, all else equal, decrease returns.

Offsetting the interest rate risk to some degree is BREP’s ongoing growth and financial strength enabling its current strategy of refinancing debt at record low interest rates present today and lengthening terms. Further, increasing interest rates tend to occur in improving economic environments where electric capacity utilization tends to increase and improve cash flows.

Commodity Price Risk: Electricity is a commodity product and electric prices are at cyclical lows in North America due to the low price of natural gas fuel available to the marginal producers of electric, the natural gas generators. This will result in a low price for all electric producers as long as shale gas prices continue to remain at current levels.

Offsetting the commodity price risk is BREP’s 85% hydroelectric and 15% wind generating status where fuel costs are zero and profit margins positive even at these cyclical lows. Brookfield’s contrarian investment approach, financial strength, and long term contracts allows Brookfield to acquire additional assets under favorable terms during this low price market.

Summary:

Contrary to what might be perceived throughout the power generation industry, Brookfield Renewable Power Partners has demonstrated outstanding performance at a cyclical low due to the durable competitive advantages of its portfolio in North and South America. It appears it is an ideal investment climate for BREP, and therefore prospective investors:

BREP Summary Table of Ideal Investments

Management summarizes the momentum in the 4Q12 Letter to Unitholders [Source] “Brookfield Renewable experienced a strong year in 2012. While our short-term financial results were impacted by unfavorable hydrology in some of our markets, we nonetheless made excellent progress in growing and strengthening our business, and solidifying our position as a global leader in the renewable power sector.”

“Together with our institutional partners, we announced the acquisition of nearly 1,000 MW of renewable power assets, including two large scale hydroelectric portfolios expected to add significant value in the coming years. The first of these is our 378 MW Smoky Mountain portfolio consisting of four generating stations in the U.S. southeast, which was originally announced in the second quarter of 2012. The transaction was completed on schedule in November and we have since integrated the assets into our U.S. operating platform.”

“Just prior to year-end we announced an agreement to acquire a 351 MW portfolio of 19 hydroelectric generating stations, including eight upstream storage reservoir dams on four rivers in Maine. This asset fleet is one of the region’s largest independently-owned hydro portfolios of scale and includes the two largest hydroelectric facilities in the state. This portfolio complements our existing 103 MW of operating capacity on the same river systems, and increases our footprint in the attractive New England market to nearly 1,000 MW of installed capacity. Importantly, it provides a unique opportunity to leverage our operating platform while positioning us to participate in rising electricity prices over time. The transaction is expected to close in the first quarter of 2013.”

BREP Financial Strength

[Source]: Brookfield Renewable Energy Partners Company Profile

BREP Summary

Brookfield Renewable’s first year was one of significant achievements and they appear to be starting 2013 with momentum. After a first year of excellent strategy execution unit holders realized a total return of 13.5% a two distribution increases in the past 12 months. The current $1.45/unit distribution provides a current yield of about 4.8%. These levels of returns will not continue forever, however it is hard not to be optimistic, based on their past performance, accomplishments with unfavorable power prices and low water conditions and the opportunities generated with their contrarian investment style.

The stable cash flows from a unique portfolio of low cost, irreplaceable and environmentally preferred assets should make cash distributions on the units predictable. BREP appears well positioned for the future and will likely be a significant growth platform for Brookfield Asset Management and an outstanding income and growth investment in itself.

Up in the next post, Brookfield Property Partners (BPY)

Disclosures: Long BAM, BIP, BREP, BEP

Note: Subsequent to original posting certain tables in this analysis were corrected.

References:

  • Brookfield Renewable Partners Website [Source]
  • BREP Investor Presentation, Corporate Profile [Source]
  • BREP 4Q12 Letter to Unitholders [Source]
  • BREP 4Q12 Earnings News Release [Source]
  • BREP 4Q12 Supplemental Information [Source]

 

 

Comments

  1. Is the last chart correct? Refers to BIP and not BREP…typo or wrong chart?

    • Gary, not sure how that happened but the BIP chart has been replaced with the BREP chart. Thank you for bringing it to my attention. It is appreciated.

      Regards,
      George

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