2024-01-22 01:46:20 ET
Summary
- Atlantica Sustainable Infrastructure is a green energy company with a portfolio of 2.2 GW operating assets, primarily in renewables.
- At first glance, AY's dividend of 9% could be viewed as speculative considering its level and the fact that the share price has dropped by ~30% in the last year.
- Despite the above and the history of dividend cuts, I provide three reasons why the dividend is actually safe, making the overall investment thesis attractive for yield-seeking investors.
Atlantica Sustainable Infrastructure plc ( AY ) is a green energy company carrying a portfolio of 2.2 GW operating assets, which are spread across renewable, natural gas, transmission line, and hydro assets.
The bulk of the assets is associated with renewables, which account for ~70% of the total portfolio.
AY's business model is quite similar to any peer, which operates in the green/renewable energy space by focusing on energy generation. In other words, the key business activity of AY is to develop and hold a green asset portfolio through the use of project finance that is accommodated by retained cash flows providing the initial equity component in JV and/or ring-fenced vehicles.
The produced energy is mostly sold via PPAs (or power purchase agreements) that help mitigate the market risk and increase the attractiveness of AY projects in the eyes of lenders, who seek certainty when it comes to cash flow generation.
Then we have to factor into the equation the AY's 27% asset exposure to natural gas and transmission lines that act as solid diversifiers to the renewable asset base.
Objective of the article
With the overarching introduction of AY's portfolio (and business) overview in mind, I will provide 3 reasons why I consider AY's current dividend yield of 9% safe despite the following facts:
- A yield that is close to 10% is usually associated with an elevated risk of distress and/or forthcoming dividend cut.
- Over the TTM period, AY's share price has dropped by ~29%, which could send a signal that financial risks are brewing.
- AY's dividend track record is not clean, where a major cut was made back in 2016.
- The current dividend yield is close to AY's all-time highs (as can be seen in the chart below).
I will not put directly a high emphasis on exploring the price appreciation prospects of AY's stock as the current yield level (if maintained) would be attractive enough for long-term and dividend-seeking investors to justify a bull thesis. Granted, the same aspects that substantiate the thesis of AY's dividend stability are very likely to act as catalysts for the stock price appreciation.
#1 Stable and predictable cash flows
Typically, one of the usual drivers behind dividend cuts is a declining cash generation that makes dividend distributions after CapEx and financing costs unsustainable.
In AY's case, however, the top line is fairly stable and predictable without being overly subject to market risk. We can see this if we look at the table below:
The quarterly adjusted EBITDA has been very stable and slightly growing since Q1, 2021 without experiencing major hiccups along the way.
The key enabler of such results has been the presence of PPAs, which have been attracted for almost the entire renewable asset base (only three ~50MW assets do not have PPAs):
While we do not have the details on a single PPA level around the key underlying terms (e.g., ceiling price, floor price, indexation, etc.), we can safely draw the following conclusions based on the data we have now:
- In aggregate, the PPAs are structured at a relatively tight pricing range, which is evident looking at the historical EBITDA figures (i.e., the swings have not been significant despite the volatile nature of electricity price).
- All of the stipulated PPAs carry a duration profile that exceeds the project-level debt, which means that once the financial risk is neutralized (on a specific asset level), only then AY could run the risk of being more exposed to volatile market prices.
Here, one might argue that to understand the actual situation in distributable cash generation we have to contextualize the EBITDA figure with the interest expense. This is true, especially considering the fact that AY's business is on the growing green portfolio based on loads of leverage.
Let's tackle this aspect together with the AY's leverage profile in the following point.
#2 Well-structured leverage with almost neutralized financial risk
As stated earlier in the article, AY relies on ring-fenced project financing structures, which means that on a corporate level, AY does not have to assume heavy burdens of external debt.
Instead, AY takes relatively minor chunks of debt on its books, mixes it with retained cash flows (i.e., equity), and injects this mixture in joint ventures or fully owned subsidiaries as equity that is later used as a base for an attraction of new borrowings in an isolated manner from AY's structure. Typically the ratio between equity and debt in these separated project entities, where specific renewable assets are placed is between 30:70 and 20:80.
So, we are talking about a notable amount of leverage.
Yet, before I address this issue, let's quickly take a look at these two tables below.
Here we can see that almost the entire chunk of AY's debt is either fixed via the issuance of fixed rate project finance debt or hedged via interest rate derivatives that effectively provide the same outcome as the former component.
In this table, we can notice how AY's YTD financial expense position has remained flat despite higher interest rates and more constrained access to sound financing.
In a nutshell, the key takeaways from AY's leverage profile are the following:
- AY has neutralized financial risk on its renewable asset base level by attracting PPAs that are sufficient to cover the financial costs.
- The financial costs are calibrated in line with the incoming cash flow levels from PPAs, effectively ensuring a neutralized interest rate risk as well.
Finally, we have to also pay attention to the corporate-level debt of AY. Currently, AY has assumed ~1$ billion of debt on its books that is mostly constituted of fixed rate financing. Most of this financing has been taken before the Fed started to aggressively increase the interest rates in the economy.
For example, the largest issuance - "Green Senior Notes" - took place in mid-2021 and was signed at an interest rate of ~4.1% with a maturity date in 2028.
So, from the corporate debt structure perspective, AY is nicely positioned, where the majority of debt could be actually deemed as an asset (i.e., at interest rates below market levels). Plus, the fact that the first major refinancing takes place only in 2025 buys AY a sufficient amount of time, where it can de-risk the balance sheet even further or wait for lower SOFR before stepping into refinancing activity.
#3 Portfolio that is poised to generate incremental cash
The final element I want to emphasize in the context of AY's ability to cover the dividend is the underlying growth potential. Currently, AY has a pipeline of ~2GW, which is almost the same level as its current generation capacity.
However, there are two caveats I would like to make:
- Most of these pipeline projects are at an early stage, which means that it will most probably take many years before they reach their CODs (commercial operations date).
- These projects will require a significant load of capital to finance the construction phase, which in turn will create temporary pressure on AY's cash flows before the PPAs start generating cash to cover the financing costs and feed into AY's bottom line.
With that being said, AY has eight assets under construction that have already made their impact on the leverage profile and this year (some of them in early 2025) should start contributing to AY's cash flows.
While I do not think that AY will accommodate all of its pipelines, the fact that it is so large allows the Company to really cherry-pick the asset with the greatest spreads (difference between PPA yield and cost of capital) and then only take a final investment decision. Against the backdrop of ~ $450 million in available liquidity and ~ $45 million in retained cash flows (on an annual basis and excluding the effects from projects with COD in 2024), AY seems to be well-positioned to finance several new projects.
The bottom line
In my humble opinion, AY's dividend yield of ~9.2% at a CAFD payout of ~85% could be deemed safe.
The well-structured leverage profile coupled with "locked-in" positive cash flows that have the potential to grow should provide the right tailwinds for AY's ability to not only cover the existing yield but also to increase it going forward.
For me, AY is a buy.
For further details see:
Atlantica Sustainable: Demystifying The Sustainability Of The Dividend