Slow and Steady Wins the Race — Brookfield Renewable Partners (BEP)

In the last post, I discussed Toronto based Brookfield Renewable Partner’s (BEP’s) strong growth in capacity since their launch in 2011. Two wide competitive moats protect this capacity in North America: low electrical production cost and limited locations for competitors.

BEP performed well over the past few years, with a strong growing annual distribution and an improving total return (as you can see in the graph below). Is BEP still a good investment in 2017? I believe it is, and suggest you consider it.

Growth is Accelerating

One of the things that makes BEP such an attractive opportunity is that, since launch, they’ve more than doubled the size of the asset base and expanded into new countries and a new continent while maintaining a predominantly hydroelectric portfolio.

In 2015, BEP made nearly 1,000 MW of acquisitions in hydroelectric, wind, and biomass assets. In 2016, BEP and institutional partners acquired Isagen S.A., Colombia’s third-largest power generation company, making up 20% of Columbia’s annual production. BEP shareholders are expected to own 25% of Isagen and the balance owned by institutional partners. In 2017, there is 300 megawatts of assets under construction or development, of which $240 million is BEP’s generating $45-50 million FFO on completion. These projects target high-teen returns on invested capital.

Brookfield Renewable also maintains a pipeline of hydroelectric and wind development projects and plans to build approximately 1,000 MW of projects over the next five years delivering target returns or better.

The strategy over the years is to attractively deploy capital when others retreated. BEP’s global footprint and strong balance sheet positions the company well to continuous this in the future.

Long Term Growth Looks Promising

Continuous long term growth is rooted in a focus on carbon free renewable electric power generation. It is replacing legacy thermal facilities, or adding power where supply has not kept up with demand growth.

In North America, governments are replacing coal and nuclear due to stringent renewable standards at the state and regional levels. So, BEP has been buying renewable hydroelectric assets at the bottom of the electric price cycle.

Although new capacity additions are limited in North America, there is surprisingly still a lot of hydroelectric capacity to buy. In the U.S., the private sector owns 70% of hydroelectric plants, representing an additional $35 billion investment opportunity. Nearly 75% of the private plant owners own just one facility, supporting BEP’s tuck-in acquisition strategy.

And in South America, there are markets with growing industries and middle class populations where electric power markets remain undersupplied due to a scarcity of capital. As both an owner and operator of its company, BEP can leverage operating and financial expertise to capitalize on these undersupplied markets.

Brookfield Renewable

Brookfield Renewable Power Operations Photo

BEP’s owner and operator expertise and geographic footprint in hydroelectric power gives them a competitive advantage in the global hydroelectric market.  Brookfield estimates there is about $340 billion in hydroelectric acquisition opportunity worldwide. Global investment in total renewable power is about $300 billion annually, so there’s still a huge opportunity for growth in this market.

Why Invest in Hydroelectric Capacity?

Hydroelectric technology is over 100 years old. Is it wise to invest in a company using century old technology in 2017? BEP outlines why in their investor day presentation. I think these reasons are compelling:

  1. BEP’s hydroelectric EBITDA margins are greater than 70% of which 90% of the cash flow is contracted with creditworthy counterparties and the cash flow often indexed to local inflation.
  2. Hydroelectric dams have perpetual lives and low sustaining maintenance capital requirements. They produce the highest quality cash flows in the electric generations business.
  3. These assets are irreplaceable and protected by two protective moats: limited locations, and the lowest electric generation costs.
  4. BEP is diversified in 7 countries and on 82 river systems reducing exposure to regulatory risk, currencies, and natural water fluctuations over time.
  5. The global footprint and years of owner and operating expertise provides excellent growth prospects.

These include:

  • 6,800 MW of internal development projects;
  • The ability to invest $500-600 million annually;
  • Producing 12-15% total returns for shareholders.

What does all this mean in terms of potential returns for BEP investors today?

BEP’s long-term target is 12% to 15% total annual return. They raised the annual distribution 5% in 2017 from $1.78 to $1.87 per share, within their long-term target increase range of 5% to 9% annually. At the current price of $30/share, the yield is 6.1%.

But Not all is Rosy

The payout ratio is elevated at 90%, above the target of 70% of funds from operations (FFO). Operations have been below the 30-year long term average generation level due primary to water levels running at 97%, 91% and 85% of capacity in 2104, 2015 and 2016 respectively. The 2016 decline was an outage at a large hydroelectric facility in Brazil covered by business interruption insurance expected to be recovered in 2017.

BEP maintains this payout level is temporary until new projects come online, electric power prices recover from today’s unsustainably low levels, and hydrology returns to the 30-year average across the 82 river systems. Unless we run out of rain, I agree with management’s essential logic of reversion to the long-term mean. Their confidence is reflected in the recent 5% distribution increase.

Brookfield Renewable is a total return investment, consisting of an attractive and growing income stream and potential for significant capital appreciation through organic growth and acquisitions. As most investors view BEP as an income investment, the dividend discount model is used to reflect the income investment point of view.

BEP is Undervalued

The dividend discount model is a more conservative valuation method which values the stock on the stream of dividends paid to the shareholder rather than the often-used higher cash flow stream. Let’s also conservatively assume a 10% discount rate in today’s lower return markets. Recall, dividends are unambiguous real payments made directly to shareholders not subject to accounting variations and interpretations.

The table below shows the estimated intrinsic value at various distribution growth rates.

Brookfield Renewable Intrinsic Value

Another way to determine value is to assume BEP will have similar yields in the future.  The table below shows the implied yield total return, an attractive total return of 140%, about 28% per year, over a five-year period. If you would like to see how I calculated these returns or get an explanation of how to calculate these returns on your own, let me know.

Brookfield Renewable Implied Yield Valuation

In the Brookfield’s Investor Day presentation, the company offered estimates of future valuations for investors to consider. The slide below from Brookfield Renewable’s presentation summarizes the potential returns for investors using a yield sensitivity analysis.

Brookfield Renewables Investor Day Yield Sensitivity

BEP’s projected price is based on higher yields (4.9% and 4.4%) than those used in my analysis (4.0% and 3.5%). I also used the estimated 2021 distribution of $2.45/share while BEP’s are applied to 2016 yield of $1.78/share.

Adjusting for the time differences my estimates are still more optimistic than BEP’s, which means that it is undervalued in the market and could be a good opportunity for you to consider. It seems a company with two wide competitive moats and the lowest operating costs in power generation deserves at least similar yields to its peer group. Time will determine if Mr. Market agrees.

Brookfield Renewable is a likely Winner for the Long Term Investor

Brookfield Renewable Partners is well positioned to produce outstanding returns for investors for years to come. Renewable assets are acquired at a deep discount to replacement cost and a robust pipeline of internal growth projects exists for years to come.

A growing demand for electric power; BEP’s low cost and environmental advantages; wide protective moats; and perpetual investment in hydroelectric will likely provide investors with strong downside protection and significant upside. My suggestion is to go long BEP.

Long BEP

Brookfield Renewable Partners Website

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