CA - $825 Billion Asset Manager Says Buy Renewables: Our Top Picks

2023-06-27 08:00:00 ET

Summary

• Renewable energy stocks have been beaten down severely over the past 10 months.
• Cost of capital concerns along with political uncertainty are weighing on the sector.
• That said, leading investors remain bullish on the sector and so do we.
• We share some of our top picks in the sector that we are buying hand-over-fist.

Renewable energy production stocks have taken a beating lately, with the likes of Brookfield Renewable ( BEP )( BEPC ), TransAlta Renewables ( TRSWF ), Clearway Energy ( CWEN )( CWEN.A ), Atlantica Sustainable Infrastructure ( AY ), and NextEra Energy Partners ( NEP ) down substantially over the past eight months:

Some of this pullback is likely warranted due to a combination of:

• Rising interest rates that appear increasingly likely to remain higher for longer, resulting in higher capital costs for a capital-intensive growth industry.
• Rising political uncertainty ahead of the 2024 U.S. presidential election.

However, we believe that this sell-off is largely overblown, especially in certain names, given the strong corporate fundamentals, attractive growth profiles, lucrative distribution yields, and bullish perspective of a leading alternative asset manager with nearly $100 billion in renewable power assets under management.

In this article, we will look at the reasons to be bullish on the sector and share our top picks of the moment.

The Bull Case For Renewable Energy Stocks

While it is true that a higher cost of capital is weighing on growth investments in the renewable power sector and there is uncertainty over what a Republican victory in 2024 would mean for the sector and the fate of the IRA, there are plenty of reasons to be bullish on the sector.

First and foremost, valuations are looking quite attractive due to the beatdown that the sector has suffered in recent months. In some cases, the yields are very high. For example, AY's distribution yield is well over 7.5% and likely to grow at a 3-6% CAGR moving forward and TRSWF's yield is nearly 8.5%. NEP's NTM yield of 6.1% is way above its five-year average NTM yield of 4.24% and management continues to guide for a double-digit distribution per unit CAGR for the foreseeable future.

Second, balance sheets are generally in good shape. BEP leads the sector with a BBB+ credit rating, plenty of liquidity, well-laddered debt maturities, and the backing of alternative asset management giant Brookfield ( BN )( BAM ). AY and TRSWF have strong corporate balance sheets as well with little near-term maturity risk and both also have the backing of major external investors with investment grade balance sheets (AY is ~40% owned by Algonquin Power & Utilities ( AQN ) and TRSWF's parent and significant shareholder is TransAlta Corporation ( TAC )). CWEN has the backing of Clearway Energy Group as well as a strategic partnership with TotalEnergies ( TTE ). NEP has the support of its A-rated parent NextEra Energy ( NEE ).

Growth, while slowing in most cases, remains robust. CWEN and BEP are on pace to generate high single digit annualized per share growth for the foreseeable future. NEP is facing some cost of capital constraints, but is getting IDR waivers from its parent and is also looking to sell its quality pipeline assets to generate lower cost equity capital to reinvest into its robust renewables growth pipeline. AY has a pipeline and balance sheet that can support a mid-single digit per share CAGR moving forward and is currently undergoing a strategic review that could unlock significant shareholder value and/or result in some sort of partnership or strategic transaction that could further catalyze the growth rate. TRSWF is the only one of these that is struggling to generate growth at the moment, but it is buying back its deeply discounted stock fairly aggressively by flexing its underleveraged balance sheet and we would not be surprised to see it get acquired by a bigger player in the not-too-distant future.

Last, but not least, BAM's CEO Bruce Flatt recently highlighted the strength in the sector, their belief that strong growth will continue in renewable power production for years to come, and that investors can still make a lot of money in the space, stating:

Renewables and infrastructure have been highly efficient...those businesses have been strong...we've earned in...renewables 14% or 15% [per year]...[our] most interesting [strategy] is our transition strategy.

When comparing BAM's different businesses across renewables, insurance, private equity, direct lending and private credit, real estate, and infrastructure that make up its near trillion dollar empire, Bruce Flatt singled out their renewable business as one of the very best places to allocate capital right now. These aren't just hollow words either, as he recently allocated well over $1 billion for Duke Energy's ( DUK ) renewable energy assets.

Our Top Renewable Energy Stock Picks

While the likes of Brookfield are seeing attractive opportunities to generate mid-teens annualized returns in private renewable energy assets, the public markets give investors the chance to buy high quality renewable assets at a steep discount to intrinsic value. Our top two renewable power picks of the moment are AY and NEP thanks to their high yields, growth potential, and discounted valuations.

AY trades at steep discounts to leading peers on an EV/EBITDA and P/DCF basis while still boasting a solid balance sheet, very stable and well-diversified cash flow profile, and solid long-term growth prospects. Moreover, it has one of the highest yields in the sector and has a potential near-term upside catalyst due to its ongoing strategic review.

NEP, meanwhile, trades at a clear discount to its own recent history while remaining committed to its double-digit distribution CAGR profile. It also benefits from the support of its well-financed parent and also can make use of creative forms of capital raising such as selling its pipeline assets and issuing convertible notes in order to achieve its growth objectives.

We expect both of these renewable energy businesses to generate very attractive total returns over the next 3-5 years while also paying out very generous and growing tax-advantaged distributions in the meantime.

Investor Takeaway

Renewable energy has taken a beating over the past 10 months or so and cost of capital headwinds remain at the forefront of the industry. However, there are numerous gems in the sector that offer well-covered and growing high yields. Moreover, the long-term growth outlook for the sector remains attractive and immense sums of institutional capital continue to pour into the sector via alternative asset managers like BAM.

As a result, we remain very bullish on the sector and are buying shares of deeply undervalued AY and NEP hand-over-fist along with several other deeply discounted high yield dividend growth stocks while they remain deeply discounted to lock in lucrative income streams and promising growth profiles for years to come.

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