BRENF - Brookfield Renewable: More Reasons To Buy After Q2 Results

2023-08-08 05:38:00 ET

Summary

• Brookfield Renewable's share price has fallen in large part due to rising interest rates and unfavorable weather conditions affecting energy production.
• The company has seen modest increases in FFO per share and has commissioned new capacity, but weather conditions and higher interest rates have negatively affected results.
• BEP has a strong growth pipeline, with several projects in the advanced stage, and several acquisitions expected to close in the near future.
• We believe shares/units are trading below the company's intrinsic value.

The current environment has not been an ideal for utilities ( XLU ), as rising interest rates have proven a significant headwind. Seeking Alpha recently pointed out the utilities sector has been tumbling a Treasury rates reached a fresh nine month high. In our previous article we shared that we believed Brookfield Renewable would be a good place to hide if the economy entered a recession and the Fed was forced to lower interest rates. So far the economy has remained resilient and the Federal Reserve has maintained a relative hawkish stance. This has proven a headwind for the company, in addition to unfavorable weather that has resulted in below average energy production.

Brookfield Renewable ( BEP ) has not been immune to the higher rates, with its share price roughly 45% below its most recent high. That is despite delivering very decent results the last two quarters. FFO per share has increased ~10% in the past six months, although the increase has been more modest for the past three months with only a ~4% FFO per share increase year over year.

This was in part possible thanks to the company commissioning ~1.5 GW of capacity year to date, including the final phase of the 1.2-GW Janaúba solar complex in Brazil, which the company developed all the way from the permitting phase.

Q2 2023 Results

Looking at the Q2 2023 highlights, a couple of things that immediately caught our attention. The first is that during Q2 2022 the difference between FFO per unit and normalized FFO per unit were minimal. In the most recent quarter the difference was very significant at roughly 10 cents per unit. The main reason for this is that the company produced energy below its long-term average. This was due to several factors outside the company's control, including low hydrology levels due to relatively light rainfall, lower average wind and solar radiation. In other words, the weather did not favor the company this past quarter. That is why despite significant additions to the energy generation capacity of the company, FFO per unit did not experience a meaningful increase. Adjusting for the below long-term average generation, the business produced normalized FFO of $379 million or $0.58 per unit, representing a 23% increase on a per unit basis year over year. The other thing that caught our eye is the continuous increase in average revenue per MWh. This reflects the fact that a large part of the company's energy contracts have prices linked to inflation increases and the strong pricing environment.

Interest Rates

The average non-recourse interest rate the company is paying has been creeping up, and this will likely continue as the company refinances and issues new debt for new projects, while interest rates remain elevated.

The cost for non-recourse borrowings (most of the company's debt) has increased ~60bps in one year, from 4.7% a year ago to 5.3% currently. This is probably one of the reasons the company is adding equity financing to fund its growth after nearly seven years without relying on this option.

To help finance the Duke Energy Renewables acquisition the company executed its first equity financing in seven years, raising gross proceeds of $650 million. Brookfield Renewable strategy has normally been to finance growth via asset recycling, upfinancings and corporate debt or preferred equity. This is why it was surprising to see equity financing this time, but it is understandable given the current lending environment.

Still, it sounds as if the company will try to avoid new equity financings if possible by saying in its investor's letter that "following the offering, we are well positioned to continue to fund our long-term growth targets through a mix of our normal course funding sources". In fact the company is working hard on its asset recycling program to generate funds to finance growth. In 2023 it has generated roughly $600 million (~$400 million net to Brookfield Renewable) of proceeds from its asset recycling program. This was done at attractive prices, with the company more than doubling its invested capital on these asset sales. One example shared by the company was the sale of a ~120 MW wind and solar portfolio in Uruguay, for gross equity proceeds of ~$150 million (~$80 million net to Brookfield Renewable). The company generated returns on the investment of over 20% annualized, holding the asset for roughly six years.

Weather Effects

As we've already seen, this quarter there was a big gap between FFO per share and its normalized version, which assumes long-term average resource availability. Most of June the weather was pretty dry in North America, affecting hydro-power generation. Fortunately there has been significant precipitation through July helping refill reservoirs across the company's hydroelectric fleet. This should help the company really benefit from strong summer pricing in the third quarter.

Brookfield Renewable is taking actions to improve energy generation which should help counter the adverse weather effects. For example, the re-powering of its 200 MW Bishop Hill wind farm in Illinois should increase generation by ~15%. Previous re-powerings have boosted energy generation by almost 30% in some cases.

Accelerated Growth

The renewable power development pipeline has grown to an impressive 134 GW, with approximately 5 GW on track for commissioning this year and another approximately 19 GW in the advanced stage pipeline. It appears that significant new demand is coming from large technology companies.

Brookfield Renewable is well positioned to finance this growth with over $4.5 billion of available liquidity, asset sales, and up-financing opportunities. The company is also taking advantage of the more reasonable valuations in the sector to make some acquisitions. One such example is the agreement to buy Duke Energy Renewables for $1.05 billion in equity ($265 million net to Brookfield Renewable), which already generates strong cash flows, and is on track to deliver 5 GW of new capacity this year.

The company expects to close the Westinghouse, Duke Energy Renewables, and X-Elio acquisitions in the second half of this year. Meanwhile, the Origin acquisition is expected to close early next year.

Preferred Shares

Another interesting way to invest in Brookfield Renewable is through its 5.25% class A preferred shares (BEP.PA). They are currently trading at ~$19.75, and have a par value of $25. They are redeemable at the company's option on or after 03/31/2025 at $25 per share plus accrued and unpaid dividends, and they have no stated maturity date. At current prices they are yielding ~6.7%, with the dividends paid quarterly. These are Brookfield Renewable Partners L.P. preferred shares, and more details can be found here and in the their prospectus . These preferred shares were not rated by Moody's, and were rated BBB- by S&P at the time of their IPO.

Valuation

We continue to believe that fair value is currently around $30 per unit or per share, depending on whether we are talking about BEP or BEPC. At current prices of $26.76 BEP is yielding ~5%, and BEPC is trading at $28.68 and yields ~4.7%.

With its various growth initiatives, both organic and inorganic, and if the weather normalizes, it shouldn't be too difficult for the company to exceed $2 in FFO per unit/share. For a company targeting 12-15% annual growth we think a 15x FFO multiple to be very reasonable. We therefore think shares/units of BEP and BEPC are attractive under $30, and that intrinsic value will continue growing at a rapid pace.

Risks

We consider Brookfield Renewable to be a below average risk stock, given that most of the energy it produces is sold with long-term contracts and energy demand is relatively stable. There is some risk with respect to the weather, which influences its energy generation and which has negatively affected recent results. Renewable energy assets are also capital intensive, which means the company uses significant amounts of debt to finance these projects. Refinancing this debt will get more difficult and expensive if interest rates remain elevated, or if they increase even more.

Conclusion

Overall we believe the company delivered solid results despite weather that did not work in the company's favor. Still, the results reflected the company's strong organic development, contributions from acquisitions and re-powerings, and strong realized pricing. There is also visible growth coming from acquisitions that should close soon, increasing demand for green power from more and more corporations, and favorable pricing. The current interest rate environment has proven an important headwind, and one of the main reasons we believe shares/units have been under pressure. We believe current prices are below the company's intrinsic value, and that long-term investors buying at these prices will probably enjoy good returns. After reviewing the most recent results we are maintaining our 'Buy' rating for the shares/units.

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