2023-04-03 23:38:09 ET
Summary
- HASI held an investor day on the 21st of March 2023.
- The main purpose was to explain the story, tackle the complexity perception and explain how the company is navigating current markets.
- It's a simple business model with a massive and growing opportunity ahead.
- HASI is a strong buy with a target price of $45.00 and a dividend yield of 5.6%.
Hannon Armstrong Sustainable Infrastructure Capital ( HASI ) has been a battleground stock over the last year or so. Short seller Muddy Waters criticized the company last year for its complex accounting, calling the financial statements meaningless. Fellow and well-respected contributor Brad Thomas stepped up to defend the company after this calling the subsequent sell off a buying opportunity.
I like dividends and I like value type situations and HASI seems to tick both those boxes. Much has already been written on what the company does so for this note I’d like to focus on the recent investor day and the current opportunity.
On the 21 st of March 2023 HASI held an investor day. The main purpose I think was to explain the HASI story to the market, debunk some issues around the perception of complexity and explain how the company is busy navigating its way through the current interest rate cycle. The timing of this event turned out to be quite opportune given the stresses in the financial sector post the Silicon Valley Bank ( SIVBQ ) collapse a couple of weeks ago.
The HASI Story
The strategy is simple, provide finance to green infrastructure investors and or invest in green infrastructure. HASI is seen as a source of capital to help fund the road to a zero-carbon and a green future. They collaborate with clients, ensuring that each potential investment is scrutinised to ensure it meets several hurdles. Assets need to be aligned to social and scientific evidence of lower regulatory and social cost. They need to be viable and profitable and of course have a meaningful impact on the environment. The results speak for themselves:
Medium term performance (Company Presentation)
The company has grown steadily over the years and amassed roughly $10bn of managed assets. It’s an integrated model which covers client relationships, funding, investment, contracted cash flows and even offtake agreements.
Company Model (Company Presentation)
Debunking Complexity
The Complexity I think stems from the fact that the market doesn’t know what box to put the company in. Is it a Mortgage REIT? Is it a Private Equity Investor? Is it a utility? Is it a finance company or bank? Or is it an Energy company? I could ask the same question of Blackstone ( BX ) to be honest, but nobody does that. The overlaps are similar, they raise capital from banks and private investors, deploy that capital into loans or assets, generate returns and then redeploy those and newly raised capital into new investments whilst retaining profits for the balance sheet and distributing a portion of them to shareholders as dividends. Perhaps this is an oversimplification but as the saying goes if you can’t explain the investment on one page it's too complicated. This is straight from the website:
Source of Business (Company Website)
Not too complicated to me? They gather capital and deploy it in a way that aims to combat climate change with the intention of turning a profit at the same time.
Navigating Interest rate risks
So as an asset gatherer and capital allocator the company looks to make its money by earning a spread on the cost of the capital it collects and subsequently deploys. The primary hurdle for returns is a spread of 3.5-4.5%. as rates rise its capital costs increase and so must the return on each new investment to maintain this spread.
Worth noting here is the following. The capital stack is diversified and hedged it's also evolved over time as the company has scaled.
Sources of Capital (Company Presentation)
So, like any business navigating the cycle, the company adjusts its funding and hedging to protect itself from adverse events. In a recent batch of such moves HASI moved to match its long-term liabilities to its long term contracted cashflows, they swapped $400mn of floating rate debt to 10-yr fixed debt. In addition, the company locked in a forward swap to fix the base rate for the anticipated 2026 bond maturity refinancing. This should create certainty and help alleviate any interest rate risk fears out there in the market.
As the leader in its niche, they also have an extensive list of available projects to invest in and can also ensure that each investment is accretive and profitable on a case-by-case basis. Investing in assets is done in manner to ensure a return that meets its cost of equity/capital. It’s not just a shot gun approach to capital deployment. Leverage can be scaled up or down depending on the quality of the investment too an investment grade rated asset or project might attract slightly more leverage than one that isn’t as an example. It's all about risk adjusted returns here.
Looking forward though, as the company continues to scale up it builds a larger and larger chunk of retained earnings too. Retained earnings are expected to be an ever-larger source of capital over time from which additional equity can be generated. The recipe is a sweet one where dividends can continue to grow whilst the pay-out ratio declines incrementally. This creates a positive feedback loop of more cash to invest and more cash to pay out. There is evidence of this in the actual numbers:
Earnings and Dividend Bridge along with pay-out ratio (Company Presentation)
Both earnings and dividends rising whilst the pay-out ratio declines. This is impressive and as the company moves to reduce the pay-out ratio to a 50-60% target range the dividend safety becomes stronger and stronger.
So, by 2030 we should see the pay-out ratio decline from 72% today to a range of 50-60%. That frees up a lot of capital to ensure that the majority of future incremental investments come from retained earnings rather than new equity.
What is the company worth?
So now that we’ve digested the analyst day let’s look at what the company is worth. We can start by looking at past performance and future expectations.
Past Performance has been sound despite obstacles in various forms especially over the last several years.
Distributable Earnings per share (Company Presentation)
Coupled with this the company has reiterated its growth targets of 10-13% CAGR in Distributable Earnings per share (DEPS) for 2021 to 2024 which at the low end of the range would imply DEPS of $2.29 in 2023 and $2.52 in 2024. This forecast should keep the CAGR in earnings of 11% per annum intact for the last decade.
Looking at the dividend, its being guided to 1.58 for 2023 and a range of 1.65-1.85 in 2024. At current prices of $28.00 a share your current yield of 5.6% is expected to grow to 6.3% at the end of 2024.
Turning to longer term earnings growth what does this market look like? Well in my previous article on Constellation Energy ( CEG ) I spoke about the Inflation reduction act (IRA) and the impact that its likely to have on the renewables space. In short, its massive but it’s not the only catalyst here. Investment into green energy and renewables has been a growing trend for years. The company was founded in 1981 and IPO’d in 2013. It’s delivered an annual total shareholder return of 15% since IPO so this isn’t a new or nascent market it’s a long-term trend that the business has been cultivating for many years.
At the same time however, the addressable market is enormous and growing. According to the EIA, in 2021 renewables accounted for 20% of US electricity Generation.
Sources of US electricity generation (EIA)
So, the path for renewables is long and likely to take decades to achieve. The world will need to spend about $275 trillion to achieve net zero by 2050 according to McKinsey. That sum of investment is quite eyewatering and tough to even contemplate, but essentially it means trillions of dollars in investments per annum for the next 27 years. This is a huge investment. Many companies can benefit, and I’d expect HASI with their track record and expertise to be one of them.
I’d be bold enough to suggest that with the sums of money being pushed into the space the company’s ability to sustain its 11% per annum growth rate is fair for the next few years at least (perhaps even longer to be honest as this is a multidecade opportunity) but nonetheless we’ll use this figure. Assuming growth falls post that to the forecast rate of inflation of 2% per annum and we use the long-term average return of the S&P500 (8.5%) as the discount rate I get the following DCF value:
DCF Valuation (Author)
Because the market is finding it tough to ‘box’ HASI finding the right type of peer group valuation is difficult. The company highlighted the following broad peer group comparison slide in its recent presentation.
Broad Peer group comparison (Company Presentation)
The company has grown its earnings by roughly 11% per annum since IPO and including dividends has delivered a total shareholder return of 15% per annum over the last 10 years. Its current FPE of 12x feels a bit too low for company that’s delivered like that. Considering the long-term growth prospects for the company and its track record of delivery I’d imagine a PE closer to 20x is fair. Whoever you choose to compare it too might influence your multiple for this type of valuation technique, so deciding on the right value here may be more subjective.
Relative PE comparison (Author)
Coincidentally my assumption of 20x earnings being a fair PE coincides with the average of the PE group the company sighted in the slide above.
The average of my DCF and PE valuation would imply a target price of $45.00
With a current price of $28 this implies 60% upside alongside a dividend yield of 5.6% for a total potential return of 65.6%. This makes HASI a strong buy in my opinion.
Risks
It would be remiss to not cover the risks that the company is likely to face over this period.
Although not yet hindering performance high inflation and input costs on the projects it finances or invests in directly, may have an impact on the company’s ability to generate its required returns.
Higher interest rates could also increase return hurdles and the concomitant risk associated with repayments of loans for investments made and for capital raised. The sharp and sudden rise in interest rates in 2022 and 2023 is yet to be fully felt in the economy and end markets so this needs to be watched closely.
The risk of a US recession could stall funding for projects as companies pull back on Capex to weather an economic downturn. The collapse of SVB bank and the subsequent turmoil in the banking sector could also potentially cause banks to reign in lending until the situation has stabilised. (This has the potential to become a tailwind for the company as competition fades it must be said.)
Conclusion
I see HASI as a medium risk investment giving investors relatively low risk exposure to the energy transition theme in a diverse and well-structured way.
As a truly integrated company it has end-market exposure to diverse and mature clean energy technologies too and coupled with a major drive-in green investment, the company should be able to generate consistent earnings and dividend growth for years to come. The potential for reduced competition on the back of recent financial sector turmoil combined with the Inflation Reduction Act (IRA) policy support and conventional demand growth sets the company up well for significant margin expansion and growth.
HASI is a strong buy with a target price of $45.00 accompanied by a 5.6% dividend yield.
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