2023-09-11 03:09:32 ET
Summary
- Hannon Armstrong Sustainable Infrastructure Fund is a unique REIT focused on investing in renewable energy projects.
- The company generates two-thirds of its earnings from interest on outstanding loans and the remaining earnings from managing third party assets and equity stakes.
- The stock has underperformed, declining by about 8% due to fears of fraud allegations and stock issuance at low prices.
Dear readers/followers,
Hannon Armstrong Sustainable Infrastructure Fund (HASI) is a unique REIT focused on investing in renewable energy projects. Its projects are roughly split in half between behind-the-meter projects, where energy is both created and consumed on-site (think solar panels on a roof of a warehouse), and grid-connected projects (think large solar and wind power plants).
The company's business model is quite similar to that of a traditional mortgage REIT (mREIT) in that it generates roughly two thirds of its distributable earnings from interest on outstanding loans. The remaining earnings come from fees for managing third party renewable assets and from income on equity stakes worth about $2 Billion that the company holds in various renewable projects.
I started covering the stock back in February with a HOLD rating at nearly 2x book value. Then, in May and following Q1 earnings, I upgraded the stock to a BUY at $26 per share (1.5x BV). Since then, the stock has underperformed, declining by about 8% due to (largely unfounded) fraud allegations and significant equity issuance at arguably low prices. Today, the stock trades at 1.3x book value and remains attractive post Q2 2023 earnings .
Recent Results
HASI has had a fairly good first half of the year with regards to growth, increasing their portfolio by a record $815 Million to $4.9 Billion, up 14% YoY.
If you recall my previous articles, HASI primarily makes money by earning the spread between the interest they charge on their loans and their cost of capital. And over the first half of the year, they have achieved a record average yield of 8.5% on their newly funded investments, which has contributed to an overall portfolio yield increase from 7.5% to 7.7%.
Portfolio growth and a stable cost of capital of 4.8% has increased the spread that the company earns from 2.7% to 2.9% and has driven strong 12% YoY growth in net interest income. In turn, Q2 distributable EPS came in at $0.53 or $2.12 annualized.
HASI has historically grown their portfolio and distributable earnings by a double-digit CAGR and management expects this level of growth to continue as guidance calls for a 10-13% annual growth until at least 2024. On a portfolio level, a large part of this growth is highly visible thanks to a large diverse $5 Billion pipeline with expected yields above 8%.
While the company will likely have no shortage of projects to add to their portfolio, it's important to realize where the money that will be used to fund these acquisitions is coming from. HASI has two ways of sourcing capital. It can either issue stock or take-on debt, each has its unique implications.
During the first half of the year, it has focused on the former by issuing $300 Million worth of shares at $23 per share. The market didn't seem to like this very much (likely because the share price has fallen a lot, and issuing shares at low prices is never a good look). But since the stock continues to trade above book value and HASI is able to invest the proceeds in 8%+ yielding proceeds, I don't have an issue with reasonable equity issuance at this level and actually prefer it to taking on more debt at current high interest rates. Management has also increased their revolver limit by $240 Million to $840 Million to provide additional liquidity if needed.
During the second half of the year, it's expected that management will focus more on debt raises, rather than further equity offerings. This will likely increase the cost of capital over time, but the increase should be offset by higher yield that the company is able to achieve on its new investments. Going forward, I will continue to closely monitor the spread that they earn.
The company maintains a BB+ rated balance sheet, which although not the strongest in the REIT sector, does provide significant protection from the higher for longer scenario as there are no material near-term maturities and over 85% of debt is fixed-rate.
HASI is a growth play, but one that also pays a solid dividend. Currently, the quarterly dividend stands at $0.395 per share and yields about 6.5% with a payout ratio of 74%.
Management has guided towards a 5-8% dividend growth going forward, which is somewhat below their target EPS growth. The reason is simple, management wants to gradually decrease the payout ratio to 70% by 2024 and to 50-60% by 2030 to retain more cash-flow to enable the company to grow without the need for equity/debt raises.
Before diving into valuation, I want to touch on a recent announcement that the company will no longer be classified as a REIT, starting in 2024. While still subject to board approval, the proposal is a result of management's detailed evaluation of their tax and corporate structure and crucially should not impact the company's dividend policy nor strategy. I don't see it as a major change to my thesis.
Valuation
Following the same methodology as in my original article , the best way to value HASI is on an adjusted book value basis. My thinking is that the best way to value a mortgage REIT is to compare its enterprise value (market cap + debt) to its book value (loans outstanding). Ideally, if we think that all loans will perform, we want to buy an mREIT at <1x BV.
In the case of HASI, however, there are factors that justify an adjustment upwards. In particular, the company makes money from managing third party off-balance sheet assets and holds equity stakes in projects that are reported at cost, even-though they have likely increased in value since acquired. As a result, last time I estimated that the book value is understated by about $400 Million. Following recent earnings, I see no reason to change this estimate.
That's why I see the current 1.33x BV valuation as fair and reiterate my BUY rating for HASI at $24 per share with an expectation of returning up to 16% per year (6% dividend + 10% EPS growth). I see HASI as a worthy alternative to traditional mortgage REITs, such as Blackstone Mortgage Trust (BXMT), because it has no commercial real estate exposure and provides way superior EPS growth prospects.
For further details see:
Hannon Armstrong Remains Attractive Despite Issuing Equity At Low Prices