Want to Play Renewable Energy? Focus on the New YieldCos

Even oil & gas perma-bulls — like myself — have to respect the worldwide growth in renewable energy sources. All across the globe, more and more nations are turning to solar, wind and other alternative energy sources to fuel their energy needs. And given that torrid growth potential, many investors have plowed head-first in firms that provide the panels, turbines and other equipment needed to produce this energy.

Light BulbsBut most alternative and renewable energy firms just haven’t lived up to the hype.

A lack of profits and the reliance on government subsidies have made most stocks in the renewable energy category pretty poor performers over the years. Just check out the performance of the broad PowerShares WilderHill Clean Energy ETF (PBW). It has lost about 7.5% annually since its inception in 2005.

The problem is that investors are going about it all wrong. The key to future renewable energy gains don’t lie within the firms that make solar panels or turbines, but in the companies that actually operate the plants. And with a recent trend, investors have the opportunity to make some serious dividends in the sector.

Bring On the YieldCos

While producing solar panels maybe sexy, the firms that own/operate the solar farms are the ones actually producing cash flows — see First Solar’s (FSLR) latest earnings as an example. As utilities continue to build and add these things, they’re taking a page right out of the master limited partnership (MLP) and real estate investment trust (REIT) playbook. That is, offering high dividends to investors willing to take the plunge into the renewable energy space via new funding/security type called a YieldCo.

Essentially, a utility places existing power plants and projects into new subsidiary and then sells a stake in the firm to the public. The kicker is that the power projects in the new subsidiary are tied to long-term and predictable power purchase agreements. Most of the cash is distributed to shareholders through dividend payments — hence the term YieldCo.

Basically, utilities are getting a MLP- or REIT-like holding.

However, due to various legal and regulatory constraints, most utilities can’t actually form a MLP or REIT. A YieldCo becomes the best option for utilities to raise much-needed cash, and since they still own a majority stake in the new firm, they still keep getting income from spun-off power plants. At the same time, the stable revenue from its holdings allows the YieldCo to buy additional plants from the parent utility.

And while the tax benefits of a YieldCo aren’t as strong as a MLP or REIT, they still have some big advantages for issuing firms.

The biggest has to do with the fact that most renewable energy projects don’t generate taxable income for many years, as deprecation often outstrips revenues. Without earnings or profits — on an accounting basis — a YieldCo’s cash flows and distributions are considered nontaxable returns of capital to shareholders. Basically, issuing utilities can defer taxes on these projects for up to 20 years.

Mom-and-pop investors are treated to high growing dividends and a dose of capital appreciation. It’s also the best way for them to play the renewable energy space. You get to leave the volatility and underperformance behind while siphoning off plenty of hefty cash flows.

Adding A Dose Of YieldCo’s Love

Utility NextEra Energy (NEE) is the nation’s largest solar and wind operator and just the latest firm to announce its intention to create a YieldCo. Moody’s estimates that about 30 utilities across the globe have the ability to create a YieldCo today based on current power plant holdings. Aside from the utility space, the various solar panel producers that also own/build grid-scale operations have also expressed their intentions about starting YieldCos. These include SunPower (SPWR) and SunEdison (SUNE).

Many of these firms’ initial public offerings (IPOs) are expected within the next year. So income investors should get ready to pounce.

For those investors looking to take the plunge today, utility NRG (NRG) was the first firm to actually do a YieldCo transaction. NRG Yield (NYLD) holds three natural gas plants, eight utility-scale solar and wind generation facilities and two portfolios of distributed solar facilities. All in all, that’s about 1,324 megawatts worth of generation capacity.

That portfolio of assets has managed to produce some stable cash flows, and NYLD has already raised its dividend in the short time it has been around. Back in January, NRG Yield raised its dividend 10 cents to 33 cents per share, and the stock currently yields 3.2%. And with a strong parent — NRG still owns about 65% of NYLD — willing to drop down assets, that dividend should continue to rise in the future.

At the end of the day, the rise of YieldCo’s give income investors a chance to participate in renewable energy without many of the risks associated with unprofitable Chinese solar stocks and the like. Expect more of these firms to IPO within the next few years.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2014/05/yieldco-nrg-nyld-nee-fslr-spwr/.

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