BBUC - Brookfield Renewable And NextEra Energy Partners: Only One Is A Strong Buy

2023-12-11 08:05:00 ET

Summary

• BEP and NEP are leading in high-yield renewable power yield cos.
• We compare them side by side.
• We share why we think only one of these is a Strong Buy at the moment.

Brookfield Renewable Partners (BEP)(BEPC) and NextEra Energy Partners (NEP) are two prominent players in the renewable energy sector that boast attractive current distribution yields and lengthy and impressive distribution growth track records. While both offer investors attractive platforms for gaining exposure to the expected long-term growth in demand for renewable energy production, only one of these is a Strong Buy at the moment in our view. In this article, we compare them side-by-side and offer our take on which offers the best overall risk-reward proposition to investors at the moment.

BEP Stock Vs. NEP Stock: Business Model

Both BEP and NEP benefit from the backing of A-rated sponsors. BEP (which issues a K-1 tax form and has an economic equivalent BEPC that issues a 1099 tax form) enjoys considerable support from its parent and largest individual equity investor Brookfield (BN)(BAM). Meanwhile, NEP primarily serves as a fundraising/financing vehicle for its parent and majority shareholder NextEra Energy (NEE).

Both of these relationships afford BEP and NEP access to scale, development, and operational expertise as well as deal flow that sets them apart from some of their peers. BEP makes regular use of its relationship with Brookfield by participating in its institutional fund investments, which enables it to invest in assets and deals that it otherwise would lack access to. NEP's symbiotic relationship with NEE was recently put on display when NEE suspended NEP's IDR obligations through 2026 at least to give NEP more financial flexibility to work through a period of significant CEPF and debt maturities that happened to coincide with elevated interest rates and an overall high cost of capital for NEP.

BEP's portfolio is significantly more diversified than NEP's by both asset type as well as geography. While NEP is mostly focused on wind power production (though it does have a growing solar farm portfolio along with one remaining natural gas pipeline along with some energy storage assets) and is entirely concentrated in the United States, BEP has a diversified portfolio across hydro, wind, solar, distributed generation, storage, and nuclear power, and also has assets located in a plethora of countries and continents. This diversification reduces the risk for BEP relative to NEP given that BEP is less dependent on strong wind and sunshine conditions in a single geographic region like NEP is. Additionally, while NEP's wind and solar assets are considered finite, BEP generates a large amount of its cash flow from its hydropower assets which are nearly impossible to replace and effectively perpetual, thereby leading to them appreciating over time rather than depreciating like a typical renewable power asset. As such, lenders typically view them as being similar to real estate and BEP can routinely execute up-financings on these assets, thereby generating additional capital that it can reinvest to further enhance its return on equity.

While both NEP and BEP enjoy lengthy power-purchase agreements with high-quality counterparties that give them very stable cash flow profiles, another major strength of BEP's business model is that it has focused on structuring its contracts such that 70% of its revenue is inflation-linked. Additionally, BEP aggressively implements an opportunistic capital recycling program that involves buying assets on a value basis and improving their operational efficiencies, before eventually (in some cases) turning around and selling them at a significant profit. This helps to accelerate the compounding process, thereby driving much of its long-term outperformance.

While BEP is engaged in pursuing the continued growth and diversification of its business model - as illustrated by its recent acquisition of nuclear energy business Westinghouse from Brookfield Business Partners ( BBU )( BBUC ) in partnership with Cameco ( CCJ ) - NEP is currently slowing its growth rate in an effort to strengthen its overstretched balance sheet and further focus its asset portfolio. It recently sold its STX pipelines to Kinder Morgan ( KMI ) and is looking to sell its last remaining non-renewable power asset (its Meade pipeline) in 2025. While it waits to complete its exit from the pipeline business, NEP will continue to enhance its large wind and solar portfolio (in fact, NEP is the seventh-largest wind and solar power generator in the world) primarily through high-returning repowering projects along with potentially some third-party acquisitions and/or drop-downs from NEE provided that it can generate an attractive enough yield on them to make them worthwhile despite NEP's high cost of capital.

Overall, BEP's business model appears to be lower risk than NEP's given BEP's much greater geographic and asset diversification, overall higher quality of assets, and stronger growth momentum.

BEP Stock Vs. NEP Stock: Balance Sheet

BEP's balance sheet is quite strong given its $4.4 billion in total liquidity, 97% fixed rate debt, relatively low corporate-level leverage (the vast majority of its debt is at the asset level and is non-recourse to BEP), and well-laddered debt maturities. As a result, BEP is not only able to pursue growth projects and acquisitions but is also able to buy back its own units whenever its price dips significantly, as it did this past quarter.

In contrast, NEP's balance sheet is currently quite overstretched as NEP pursued acquisitions and distribution growth at a breakneck speed during a prolonged period of historically low interest rates. Now the chickens are coming home to roost as NEP finds itself faced with a wall of CEPF and corporate debt maturities over the next several years at a time when its cost of capital has ballooned. As a result, management is having to try to execute a high-wire act that includes:

1. Suspended IDR payments to its parent through 2026
2. Selling its pipeline assets in a timely manner and at a sufficient valuation
3. Generating enough growth through high-yielding repowering projects and potentially a drop-down or two to sustain its targeted 5-8% distribution growth CAGR (slashed from 12-15%).
4. Successfully refinancing debt maturities without eating too deeply into its Cash Available For Distribution

Overall, BEP's balance appears to be in much better shape at the moment as BEP is able to play offense while NEP is currently trying to downsize its portfolio in order to repair its balance sheet. Moreover, BEP's BBB+ credit rating gives it a much more attractive cost of capital than NEP's BB credit rating affords it, particularly considering that NEP's unit price has been shredded recently.

BEP Stock Vs. NEP Stock: Distribution Outlook

Both businesses have similar distribution growth outlooks at the moment, with both management teams guiding for mid-single-digit distribution CAGRs for the foreseeable future, with the most likely annualized growth rates coming in at the 5-6% range. For BEP, this is because management wants to retain significant sums of capital to be able to take advantage of the plethora of growth opportunities in front of it.

For NEP, this is because management needs every spare dollar it can find to handle its avalanche of CEPF obligations, debt maturities, and growth capital demands. In fact, we think that NEP would be prudent to halt distribution growth altogether for the next few years so that it can maximize its ability to deal with its enormous capital obligations right now while its cost of capital - especially its cost of equity - is so huge. If nothing else, NEP could always repurchase its units while the CAFD yield is nearly 20%, generating a yield that is far higher than what it can get by investing in dropdowns.

Overall, we think that BEP's distribution growth outlook is more attractive than NEP's given that its target distribution growth rate is much less likely to be cut than NEP's is and in fact, we think that NEP's distribution could even be at risk if it fails to successfully navigate its large near-term financial obligations.

BEP Stock Vs. NEP Stock: Risks

BEP overall is a fairly low-risk investment as management has strategically structured the balance sheet and contracts to create pretty strong protections against interest rate and inflation volatility and the assets are inherently defensive in nature and contractual structure as well. Moreover, BEP's significant geographic and asset type diversification helps insulate it against additional risks.

The biggest risk for BEP is simply that if interest rates remain higher for longer, its capital recycling program may slow to a crawl, leading to reduced overall growth (though interest rates will likely only remain higher for longer if inflation remains elevated, which would lead to strong organic growth for BEP given its significant exposure to inflation-linked contracts).

In contrast, NEP is a high-risk investment right now due to its overstretched balance sheet and substantial upcoming financial obligations that could force it to cut its distribution. While we have touched on these risks in this article, for a deep dive into NEP's risks, read this article .

Ultimately, the NEP investment story will hinge on the direction of interest rates. If interest rates indeed fall meaningfully over the next few years, NEP's cost of capital should improve sufficiently, and its Meade pipeline should command an attractive enough price that it should be able to meet its CEPF obligations and refinance maturing debt without having to slash its distribution. However, if interest rates remain higher for longer - and with them its cost of equity capital - it is hard to see how NEP will be able to sustain distribution growth much longer and it will likely also be faced with some tough choices about even sustaining its distribution in the future. If such a scenario were to play out, NEE may change its mind about rolling up NEP, in which case NEP unitholders would likely get a price from NEE that is far less than what they think NEP units are worth, thereby locking in losses for investors who held units before the recent precipitous decline in valuation.

BEP Stock Vs. NEP Stock: Valuation

While BEP qualitatively appears to be a slam dunk choice over NEP, their relative valuations tell a very different story.

Wall Street analysts expect NEP's distribution to grow at a 5.9% CAGR through 2027, while they expect BEP's distribution to grow at a 5.4% CAGR over the same period. While the chances of BEP's projected CAGR coming to fruition are much higher than they are for NEP, this is more than priced into their NTM yields, as NEP's is a whopping 12.8% in contrast to BEP's 5.4%. On a P/AFFO basis, NEP's multiple is a dirt cheap 6.4x whereas BEP's is a much less attractive 14.13x.

Yes, BEP's distribution yield is trading at a discount to its five-year average of 4.5%, but this pales in comparison to NEP's discount to its five-year average distribution yield of 4.8%.

BEP Stock Vs. NEP Stock: Investor Takeaway

BEP is the clear qualitative winner in this comparison and its valuation does appear to be discounted relative to its history. However, given that interest rates have risen in recent years, its discount to its net present value is only pretty small in our view, earning it a Buy rating.

In contrast, NEP is a high-risk investment and should be viewed as a very speculative opportunity. However, the discount is extremely steep and management does have a path to sustaining and even continuing to grow its very high distribution yield. As a result, assuming the macro environment cooperates and management executes intelligently and competently over the next several years, we could see NEP quite possibly tripling in value and - when combined with its distribution yield - providing 4x returns for investors at current prices. As a result, we rate it a speculative Strong Buy.

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