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The Long Case For NextEra Energy Partners

Summary NEP is a first-in-class YieldCo with robust fundamentals and a strong sponsor. The upside is driven by long term contracts from diversified energy projects, with double digit distribution growth. NEP trades at a discount to intrinsic value with upside of 55%. By Cillian Huang and Ryan Ren Rating: Buy Market Cap: $732.9M Price Target: $ 37 . 01 Shares Outstanding: 29.67M Price(10/23/2015): $2 3 . 9 5 52 – week High/Low: $48.23/$19.34 Potential Upside: 55 % Dividend Yield: 3.8% Investment Thesis Nextera Energy Partners, LP (NYSE: NEP ) is a growth-oriented Yield Co that acquires and manages clean energy assets with contracted long term cash flows. Affected both by macro market volatility and by sector factors, NEP is currently trading at a discount to its intrinsic value, presenting an attractive buying opportunity with an upside of 55% . We see NEP as a premier Yield Co with strong fundamentals bolstered by a portfolio of existing assets operated by topnotch operators; and by a slate of upcoming assets supported by the development capabilities of North America’s largest clean energy developer NextEra Energy, Inc. (NYSE: NEE ). Why Does The Opportunity Exist? Solid renewable s pipeline : Supported by its sponsor NEE, NEP has been provided with Right-of-First-Offer (ROFO) on a portfolio of clean energy assets that are currently being developed by NEE. NEE is the leader in the clean energy space. It has developed over 12GW of renewables and is the largest clean energy developer with 17% of the current market share. NEE continues to grow its renewable development pipelines, creating a visible stream of projects to propel NEP toward its growth target of 12-15% until 2020. Extended growth runway : NEP recently acquired NET Midstream, which owns and develops seven gas pipelines that are strategically located in the Eagle Ford play. The transaction is immediately accretive to shareholders and contributes approximately $150M adjusted EBITDA and $115M CAFD in 2016. Adding gas pipelines to NEP’s existing renewable portfolio offsets its exposure to resource variability caused by wind and solar. The transaction furthermore provides the platform for NEP’s future expansion into the gas pipeline space, considering NEE is building its presence in the business by developing three pipeline projects that would be dropped down to NEP. Robust renewable s growth prospects : The renewables have presented a robust growth path during the past decade. The momentum will continue with the improving renewable economics, the increasing Renewable Portfolio Standards, the enactment of the Clean Power Plan, and bipartisan support for extension of the production tax credit and investment tax credit. Viable Yield Co model : Yield Co’s growth is dependent on their regular access to the debt and equity market to fund projects acquisitions. Present market conditions have been adverse to the entire Yield Co space, making it challenging for Yield Cos to raise funds by issuing equity that should fairly reflect fundamental values. However, we are confident in the validity of the Yield Co structure, as this model has worked successfully in the MLP space. With effectively managed cost of capital and solid project pipelines, we believe Yield Cos like NEP will continue to deliver stable cash flow in the long run despite a difficult short term trading environment. Proven management track record: The parent company NEE has provided NEP with a high quality management team with extensive experience in developing and financing clean energy projects. With prudent capital market discipline, the management team led by CEO James Robo has demonstrated a track record of success in delivering value to shareholders. Valuation NEP’s unit price has tumbled as a result of market concern over the Yield Co sector and negative market response to the NET acquisition. However, we still see NEP as a premier Yield Co with strong fundamentals. Ultimately, a Yield Co with high distribution growth, strong and stable cash flow, and efficient capital structure deserves high valuation. We reached the one year price target of $37.01 by blending two methodologies – distribution discount method and EV/EBITDA multiple method . Due to the recent financing need for the acquisition of NET Midstream and Jericho Wind Energy, the dilutive effect incurred by potential NEP’s equity issuance has been baked into our valuation models, increasing the total LP units from 93M to 96M. The DDM – Gordon Growth method reflects NEP’s robust distribution profile to satisfy investors’ appetite for income growth. Our view on NEP’s sustainable capacity to deliver growth is reinforced by NEP’s near-term execution on planned drop-down wind energy assets acquisitions and its long-term strategy to expand into the natural gas pipeline space. Supported by a deep assets pipeline developed by its sponsor NEE, NEP is on track to achieve 12.0% to 15.0% distribution per unit growth rate through 2020. In the DDM – Target Yield method, we applied the 2016 target yield to our 2016 estimated distributions per unit. We assumed NEP will maintain a 3.80% yield, which is in line with the pure play peers’ 2016 estimated average yield. Our EV/EBITDA Multiple starts with 2015 estimated adjusted EBITDA of $459.75 million that is driven by 2072MW renewables generation capacity with 19 years average PPA; and by the recently acquired 7 gas pipelines with aggregated capacity of 3 BCF/day binded to 16 years ship or pay contracts. Due to NEP’s stable long term cash flow and better growth prospects, we applied the median EV/EBITDA multiple of 15x derived from trading comps, reflecting a reasonable premium to NEP’s current trading multiple of 12x. Caveats Rising Interest Rates : Interest rates hike presents a downside risk by diverting yield-hungry investors to U.S treasury notes that offer competitive yield with lower risk. High interest rates further undermine NEP’s ability to maintain an efficient cost of capital due to the increasing financing costs. Unfavorable financial markets : The Yield Cos are vulnerable to volatile financial markets. Depressed share prices hinder the Yield Cos’s ability to accretively fund new acquisitions by issuing new shares. Conversely, a healthy financial market is advantageous to the Yield Co, making it easier to raise equity at a proper valuation. Unpredictable resource variability: Although all of NEP’s wind and solar assets are contracted with Power Purchase Agreements, the wind does not always blow and the sun does not always shine. Weak wind together with dimming sun diminishes cash flow estimates. Corporate governance : The sponsor NEE controls the major voting rights of NEP. Besides third party acquisitions, NEP’s growth is largely contingent on its ROFO rights to projects developed by NEE. This could present a risk to NEP’s shareholders when NEP is unable to negotiate favorable terms by catering to NEE’s interest. Conclusion We are confident NEP is the first-in-class Yield Co with robust fundamentals supported by its strong sponsor NEE. The upside is bolstered by contracted cash flow, double digit distribution growth, and experienced management. The downside is indicated by potential interest risk hike, unfavorable financial markets, and possible conflict of interests between NEE and NEP.

YieldCo Index ETF: The YieldCo Model Breaks – It’s A Bigger Lesson Than You Think

YieldCos were supposed to do for utilities what LPs did for energy companies. The potential appeared huge, with increasing investment in renewable power. Only the model just broke, and Global X YieldCo Index ETF is the evidence. The postmortem here is more instructive than you may think. Investors appear to always be on the lookout for the next big thing that will make them rich. Wall Street, meanwhile, is always ready to sell investors something that appears to meet that desire. Only time and time again, the opportunity doesn’t pan out. YieldCos are the current asset melting down. The Global X YieldCo Index ETF (NASDAQ: YLCO ) is proof of it. What’s the bigger picture lesson? What’s a YieldCo? A YieldCo is basically a company created or spun off by another company with utility assets that it would like to sell, but not necessarily lose control of. The YieldCo raises capital in the markets by issuing shares and debt, and then buys the assets of its erstwhile parent. The assets usually come with long-term contracts, so the revenues are reasonably certain to materialize, and the parent normally has operational control. The allure for investors is a stated goal to pay out large, growing distribution streams backed by more acquisitions. If this sounds roughly similar to the model that pipeline owners have used in the limited partnership space for years, it should. That’s basically the building block on which YieldCos have been created. It sounds like a win for everyone involved. Only, there’s one small catch. Access to capital markets. Talk about timing Wall Street’s financial alchemists have a habit of pushing things too far. And YieldCos now appear to be falling into that category. The best example I can provide is YLCO, an ETF that came public in late May of this year. Its shares have fallen by nearly a third since that point. YLCO stands as a warning to investors to not get caught up in the hot new thing. That can be hard to do, I know. Hot new things always seem to come with really compelling stories about how they are a “can’t lose” investment. Which is why you should always ask yourself why something you are looking at could blow up on you. In the case of YLCO, the answer to that is pretty clear: the fund would tank if the YieldCo space in which it invests doesn’t hold the promise that Wall Street believes it does. However, that’s not a deep enough answer, and it would be too easy to glass over the issue and stop there. After all, YLCO is buying a basket of YieldCos, which reduces risk through diversification. That’s why you need to go further and ask: What would kill a YieldCo’s potential? And could that happen across the YieldCo space? We know the answer now Looking at these questions in reverse order, we know that the chances of a broad YieldCo meltdown was pretty high. But what was the problem on the individual company level? The answer is access to capital. For a company that pays out most of its revenues to investors via distributions, growth has to come from acquisitions. But acquisitions can only happen if the company can sell more debt and equity at decent prices. If investors aren’t willing to provide that capital at desirable rates, the YieldCo loses its ability to grow. That will likely lead to a stagnant distribution and even fewer reasons for investors to buy its shares. The parent company, meanwhile, is stuck with a child that isn’t nearly as desirable to have around. And more or less everybody winds up a loser. For evidence of this take a look at the current troubles of NRG Energy (NYSE: NRG ) and NRG Yield (NYSE: NYLD ). NRG Yield makes up around 7.5% of YLCO, by the way. Commenting on NRG Yield, credit watcher Moody’s is taking a dim view of the future. Moody’s vice president Toby Shea noted, “The review for downgrade is prompted by NYLD’s lack of access to the equity markets due to the large, approximate 30 percent fall in its stock price in recent months. The ongoing inability to access the equity market creates uncertainty regarding the company’s financial strategy going forward.” Basically, the model is broken. Don’t stop there But what are the real takeaways? First, Wall Street’s hot new products are often better for Wall Street than main street and shareholders. I don’t want to be cynical, but this is as true today as it has always been in the past. And I find it hard to believe the future will be any different. It’s difficult, but try to keep this in mind whenever you see something new offered up as the next big thing. Second, YieldCos are probably not worth owning right now. And clearly, neither is YLCO. The risks far outweigh the rewards for all but the most aggressive investors. Third – and this is the one you really need to think about – what about other companies that have business models built on accessing the capital markets for growth? Limited partnerships are the most salient example, since they are facing their own demons right now. But they aren’t the only ones. For example, Student Transportation Inc. (NASDAQ: STB ) is rolling up the school bus space. But if it couldn’t access capital markets, its growth prospects would quickly fade. Then there are real estate investment trusts, or REITs. As a whole, I wouldn’t be too concerned about REITs. But not all REITs are created equal. I doubt that an industry leader like AvalonBay Communities (NYSE: AVB ) will be completely shut out of the capital markets. But what about apartment competitor NexPoint Residential Trust (NYSE: NXRT ), which is a relatively new entrant buying up second-tier assets with the intent of sprucing them up? It’s already leaning hard on the debt markets, if it can’t do that anymore, what does it do for growth capital? These two companies obviously sit at opposite ends of the spectrum, but there are variations all along the way. It’s worth taking a moment to ask the question for both new companies like NXRT, and also more established names – just in case. Stapled Shares One of the reasons why I brought up Student Transportation is because it came to market in a very different form. At the IPO, it was a stapled share, essentially pairing a share of stock with a piece of debt. The distribution was a combination of dividend and bond interest. It was a hot Wall Street idea not too long ago, meant to sate investors’ desire for income. Only, it didn’t work out as planned. And now most, if not all, of the handful of companies that came out as stapled shares have either gone away or converted their shares to plain old regular stock. The end result was usually a dividend cut for shareholders on top of capital losses. I watched stapled shares come and go. I owned a few. I got burned. It’s one of the reasons why I’ve been sitting on the sidelines with YieldCos. And why I’m watching single family home REITs with extreme interest, but I’m not buying any. Too new, too much of a fad, and the model could break down. It’s better to give Wall Street’s big ideas time to prove themselves. You certainly could miss out on gains, but you’ll also protect yourself from ideas that end up enriching Wall Street at your expense. YLCO is a symptom of a bigger issue, but it offers up an important lesson. Could YieldCos work out in the long run? Sure. Could YLCO turn out to be a great income opportunity in the ETF space? Yes. But for anyone who bought into the YieldCo story early, things aren’t working out quite as planned right now and there’s real potential that the idea is fatally flawed. It’s hard to resist the temptations of Wall Street, but when it comes to new things (corporate forms, IPOs, new products like esoteric ETFs) you are far better off stepping back and waiting. At the very least, take the time to consider what happens if the rosy projections offered up don’t pan out. In other words, always look for a reason why you shouldn’t buy something as you are reveling in the reasons why you want to.

The Fed’s Delay On Rates Makes SDY A Good Buy

The Federal Reserve has delayed raising rates, giving a boost to dividend funds. Rates are likely to remain at historically low levels well into 2016. SDY is heavily weighted towards the financial sector, providing a nice hedge against any rising rates. The purpose of this article is to evaluate the attractiveness of the SPDR Dividend ETF (NYSEARCA: SDY ) as an investment option. To do so, I will evaluate recent market performance, its unique characteristics, and overall market trends in an attempt to determine where the fund may be headed going into 2016. First, a little about SDY. The fund seeks to closely match the returns and characteristics of the S&P High Yield Dividend Aristocrats Index. This index is designed to measure the performance of the highest dividend-yielding companies in the S&P Composite 1500 Index that have also followed a policy of consistently increasing dividends every year for at least 20 consecutive years. This is unique in that many dividend ETFs focus solely on high-yielding companies while SDY has a focus on high yield, but also a track record of a raising payment. Currently, SDY is trading at $77.04 and pays a quarterly dividend of $.49/share, which translates to an annual yield of 2.54%. Year to date, SDY is down 2.2%, not accounting for dividends, which lags the Dow Jones Index’s return of (1.5%) year to date. However, once dividends are accounted for, SDY has slightly outperformed the Dow for the year. There are a few reasons why I feel SDY is a good buy at current levels. The main reason has to do with the Fed’s unwillingness to raise rates from historically low levels. At the beginning of 2015, investors were fairly confident that rates would rise at some point this year, some believed as early as June. This negatively affected dividend ETFs, as investors had piled into funds such as SDY at record levels in search of a higher yield in a low rate environment. Because of this, SDY, along with similar funds, underperformed the Dow and other investment options. However, as we near the end of the year and an official rate hike has yet to be announced, investors are beginning to buy back into SDY as they realize that the low rate environment is here to stay for a little while longer. This is apparent in SDY’s recent rise, as the fund is up almost 7% in the last month. I believe the ETF will continue to move higher, as investors are continuously pushing back their expectations for a rate hike. According to data compiled by the Chicago Mercantile Exchange, “traders now put just a 7 percent chance of a rate move at Wednesday’s Fed meeting and a 36 percent probability for the final one of the year in December”. Traders now give a 59 percent chance of a rate hike during the March 2016 meeting, almost six months away. If that expectation turns in to a reality, SDY could be a very profitable bet in the short term. A second reason I prefer SDY over other funds has to do with its exposure to the financials sector, at roughly 25% of its total portfolio. Below is a breakdown of the sectors, by weighting, that make up SDY’s holdings : Financials 25.47% Consumer Staples 14.95% Industrials 13.54% Utilities 11.83% Materials 11.15% Consumer Discretionary 7.56% Health Care 5.92% Energy 3.41% Telecommunication Services 3.05% Information Technology 2.88% Unassigned 0.22% As you can see from the chart, financials are the top sector weighting in SDY’s portfolio. I view this as a positive, because it provides the fund with a nice hedge against rising rates, when they do eventually rise. General logic will say that these dividend funds will take a large hit once rates rise, because investors will now be able to command higher yields from less risky assets. However, SDY’s exposure to the financials sector will continue to make this fund attractive as financial companies, such as banks and insurance companies, tend to perform better in a rising rate environment. This occurs for a few reasons. One, banks will typically increase the amount they charge for loans at a faster rate than what they pay for deposits, which widens their spread and overall profit. Additionally, these firms typically have to write-off fewer bad loans, as rates generally rise during a time of economic growth. This means companies are performing better and are more likely to meet their debt obligations, and thus, no default on their loans. Therefore, SDY should experience capital appreciation from this exposure, which would cater to investors who are more concerned with the overall return, (stock price and yield), as opposed to just the yield. Of course, investing in SDY is not without risk. Investors could be wrong and interest rates could rise at a much quicker-than-anticipated pace. If this occurs, the market could move sharply lower, or investors could flee dividend funds. SDY’s yield, at only 2.50%, does not provide much of a cushion if the fund were to move rapidly lower. Additionally, SDY also has a strong weighting towards the US consumer, with weightings of 15% and 8% towards the consumer staples and consumer discretionary sectors, respectively. If the US consumer stops spending, or US job growth weakens, these sectors could be dragged lower and take SDY down with them. However, neither of these scenarios are what I expect to occur. Even if rates do rise, Yellen has made it clear that the increases will be slow and gradual. She does not intend to spook the market, and the past few years have showed investors that the Fed is being extremely cautious with regards to rates. Additionally, consumer spending continues to increase, with a 0.6 percent rise last month (September) according to the Commerce Department. Therefore, I expect SDY to perform strongly despite these headwinds. Bottom line: SDY has had a lackluster year, but has rallied recently as the Fed has delayed raising rates. With this scenario continuing, the fund continues to provide investors with an above-average yield in a low-rate environment. Until rates do rise, dividend ETFs will continue to be profitable for investors. With a fee of only .35% and exposure to the financials sector, which will serve as a hedge when rates do rise, SDY provides investors with a cheap way to profit in the short and long term. Going into 2016, I would encourage investors to take a serious look at this fund.