BAMKF - Best Renewable Energy Stocks To Watch: Our Top Pick Is Atlantica Sustainable Infrastructure

2023-04-24 09:30:00 ET

Summary

• Renewable energy stocks have taken a beating lately.
• That said, there are several exciting opportunities in the space with high yields that are compelling buys at the moment.
• We share our favorite pick: AY.

Renewable energy stocks have taken a beating lately. As you can see in the chart below, the Global X Renewable Energy Producers ETF ( RNRG ) along with several leading renewable energy stocks such as Brookfield Renewable ( BEP )( BEPC ), Atlantica Sustainable Infrastructure ( AY ), Clearway Energy ( CWEN )( CWEN.A ), and NextEra Energy Partners ( NEP )( NEE ) taking a beating over the past seven months, especially when compared with the relatively flat performance of the S&P 500 ( SPY ) over that period:

This is not surprising when you consider that renewable energy producers are generally capital-intensive industries and still rely to some extent on government subsidies, making them sensitive to:

• rising interest rates.
• growing geopolitical tensions that are competing for government resources amid already strained government budgets.
• turmoil in capital markets in the wake of the recent failure of Silicon Valley Bank ( SIVBQ ).

That said, there are several exciting opportunities in the space with high yields that are compelling buys at the moment, as we view the sell-off in some of these businesses as overblown. In this article, we share our favorite pick: AY.

Why We Like AY Stock

We are bullish on AY for the following reasons:

#1. AY Stock Is A Great Stagflation Pick

AY is well-positioned to weather macroeconomic challenges with little exposure to floating interest rates, significant indexing to CPI in its lengthy power purchase agreements, and a balance sheet that has been pretty aggressively deleveraged lately.

Overall net debt declined by nearly $500 million over the course of 2022. The net corporate debt to CAFD pre-corporate debt service ratio was a very reasonable 3.4x. Meanwhile, 92% of its debt is at either fixed or hedged interest rates, making it well-insulated against further increases in interest rates.

Moreover ~33% of its cash flow is indexed to inflation. Combined with its low percentage of unhedged floating rate debt, AY is well-positioned for the current high inflation - rising interest rate environment.

#2. AY Stock Has An Attractive Valuation & Dividend Yield

The stock trades at an attractive valuation, with a 6.8% dividend yield and mid-single digit per share CAGR expectations for the foreseeable future that are backed by contractual increases to its PPAs along with a robust growth investment pipeline. Between the yield, growth, and likely multiple expansion over time, the path to low to mid-teens annualized total returns is quite clear without much long-term downside risk in the business.

It currently has as much as $185 million already earmarked for growth investments this year. These include investments in batteries in the United States, solar farm projects across North and South America as well as Europe, expanding AY's existing electricity transmission lines, renewable energy storage, and its first hydrogen project.

AY is hardly blowing us away with its underlying performance, but it is also delivering quite stable performance and is in a strong position to weather whatever the economy throws its way in the coming months and years. We view this as a relatively low-risk high-yield stock with the strategic review serving as a potentially powerful upside catalyst. While we wait, we collect the dividend.

Risks & Catalysts For AY Stock

While the positives for AY are clear, there are also a few risks to keep in mind.

The biggest one is probably the simple fact that - while politicians and corporate heads are making big plans for converting to a net zero emissions future - the reality of getting there could prove to be much more difficult to bring to reality. The sheer number of resources - both financial and raw material - that will be needed to successfully execute this transition could prove to be too great of a hill to climb, especially if we face any prolonged and/or deep economic downturns on the road to get there.

With the massive sum of debt and unfunded liabilities in major economies increasingly weighing on sovereign budgets, if economic growth falters, these countries will increasingly be pressured to cut subsidies and special funding for green energy products and will also face pressure to raise taxes to meet budget obligations. This means that their economies will likely have to forsake expensive investments in energy transition projections in favor of more economically valuable investments.

Furthermore, China plays a vital role in making the green energy transition a reality as it has the greatest renewable power generation capacity in the world, it is a leading producer of some of the important ingredients involved in the green transition and - perhaps most importantly - if China fails to adopt some of the key emissions standards that the West wants, entire treaties could very well fall apart due to the fact that it would give China an unfair economic advantage.

On top of that, if conflict were to break out between China and the West, it could also lead to a rapid abandonment - or at the very least a de-prioritization - of these net zero goals and commitments across major economies across the globe in favor of more immediate and pressing demands for economic and political capital.

In summary, the main risk to the long-term bullish thesis for renewable energy businesses is that the envisioned energy transition timeline is extremely ambitious and could suffer major setbacks or even become completely unraveled if macro events do not align favorably.

Another risk is that capital markets could lock up due to an economic collapse. This would likely provide two major headwinds to growth:

1. Governments would likely lack the political and financial capital to continue subsidizing and prioritizing renewable energy production growth in such a climate.
2. AY would have a very difficult time raising the necessary capital to fund growth projects. Furthermore, paying down its existing debt would likely force it to cut or even eliminate its dividend in order to maximize cash flow towards debt reduction.

That said, if such a scenario were to play out, AY's dividend would likely be the least of our concerns. The biggest likely scenario is simply that interest rates remain higher for longer and AY's share price remains suppressed. This would prevent AY from effectively accelerating its growth rate and likely lead to very slow dividend growth for the foreseeable future.

In terms of catalysts, AY has been a pretty boring slow and steady dividend stock recently. However, it is currently undergoing a strategic review with the support of their largest shareholder - Algonquin Power & Utilities ( AQN ) - which we believe could unlock significant value for shareholders in the coming months. We expect that a partial or full sale of the company is a very possible outcome, especially to a larger player in the renewable power production space like Brookfield ( BN )( BAM ).

Investor Takeaway

Renewable energy production has been enjoying strong growth momentum in recent years and - with the passage of the IRA in the United States - the tailwinds could get even stronger in the near future. AY looks like an undervalued, high-yield way to take advantage of this trend with a further potential upside catalyst via its ongoing strategic review.

While it is not a risk-free investment, it is a great pick for the current stagflationary environment and could deliver substantial total returns to investors over time. For more information on AY, you can read our full investment thesis here and our recent exclusive interview with AY here .

Please let me know in the comments section below: what is your top renewable energy pick of the moment?

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