How I Defossilized My Portfolio – Part 1
Summary Alternative energy is growing more rapidly than I expected. I decided to sell Chevron and buy two “clean energy” stocks. This article is Part 1, which focuses on Pattern Energy Group. Part 2 will focus on Enviva. The growth of alternative energy The world is embracing alternative energy sources faster than I expected. I’ve seen the worldwide growth of rooftop solar energy panels. I’m aware of the growing number of hybrid and electric cars. I hear the financial media’s conversation about whether Tesla (NASDAQ: TSLA ) is an auto company or a battery company, heightened by Elon Musk’s announcement that Tesla’s proprietary technology for electric autos would be available to others. When I read that Musk envisions electric-powered airplanes , I thought he was dreaming the impossible dream . The possibility of a post-fossil fuel world seemed too far in the future to be a factor in my investment decisions. My fossilizing knees seemed to be saying there’s no need to defossilize the portfolio in my lifetime. My first clean energy investment – Hannon Armstrong Sustainable Infrastructure Capital (NYSE: HASI ) The change in my energy sector thinking began when I read about “yieldco” stocks. A July 17 2014, Seeking Alpha article by Tom Konrad about 15 Clean Energy Yieldcos led me to Tom’s April 22 2013, Forbes article about A Clean Energy REIT: Hannon Armstrong Sustainable Infrastructure . From July 2014 to January 2015, I made four purchases of HASI’s shares at prices ranging from $14.11 to $14.46. At the time of my first purchase, I decided to put 25% of my energy sector allocation into alternative energy stocks. You can read about that decision in my August 5 2014, article, Hammon Armstrong Added To Portfolio . After Brad Thomas’ February 13 2015, article about HASI, this REIT has appreciated by 35%. HASI’s price action for the trading days before and after Brad’s article (as recorded by Yahoo Finance ) provides some interesting insight: Date Closing Price Volume February 6, 2015 $14.16 133,200 February 9, 2015 $14.30 191,900 February 10, 2015 $14.44 200,200 February 11, 2015 $14.57 275,200 February 12, 2015 $14.73 443,000 February 13, 2015 $15.07 816,400 February 17, 2015 $15.28 671,700 In 2015, prior to Brad’s article, there were no 200,000+ volume days. In the eighteen trading days after Brad’s article was published (February 13-March 11), there was only one day with less than 200,000 shares traded and the average volume was 385,400. On March 11, HASI closed at $18.05. Brad’s article gave HASI a new level of visibility. Chevron (NYSE: CVX ) and Helmerich & Payne (NYSE: HP ) I made five purchases of Chevron’s shares between July 2014 and January 2015, for an average price of $117.87. I thought this relatively safe dividend champion would be a good balance for the relatively risky HASI. I made the comment during this period that HASI might be my riskiest investment. Tom Konrad rightly took issue with that and said HASI probably was the safest investment in his portfolio. The rise in HASI stock paralleled the decline in CVX. In an unusual decision for me, I sold CVX on June 9, 2015, for $100.58. Helmerich & Payne was a happier story, which I wrote about in a November 30 2014, article . I made four purchases of HP between November 2014 and January 2015, for an average price of $63.43. I sold this stake in five installments between February and June 2015 for an average price of $72.32. The two investments were essentially a wash. In terms of price, I lost .0016%. If dividends are included, I made a slight profit. Moving to a 100% energy sector allocation of alternatives The recent decline and partial recovery of oil-related companies has hastened an adjustment in my approach to the energy sector. Rather than allocating just 25% of my energy sector investments to alternative energy, I decided to make it 100%. Here are the reasons: I found myself hoping the price of oil would go up (so my oil-related investments would appreciate), even though declining oil prices generally are good for the economy and for most of the companies in my portfolio. I realize some parts of the US and some parts of the economy benefit from higher oil and gas prices, but one day while pumping gas I asked myself why I was cheering for higher oil prices. I realized it was so my loss in CVX would be reduced and my gain in HP would be increased. When I calculated that I was essentially at break-even for these two investments, I decided to get out of the oil and gas business. When I purchased HP, I mentioned in the article that I was stepping outside my comfort zone. As the “oil crisis” continued to unfold and as the price of oil (apparently) found a bottom, I realized that the best and the brightest operators in the oil business did not foresee this crisis. There were a few voices in the investment community warning that oil was overpriced, but by and large the rapid drop in oil prices caught investors by surprise. I realized that I was not in a position to be among those who could anticipate such events in the future, so I decided to exit the fossil fuel world while I was at break-even. No harm; no foul. Meanwhile, my investment in HASI was enjoying some success. The average purchase price was $14.23. During March-April 2015, I sold 70% of the shares for an average price of $18.64. I intend to hold the remaining shares as a core investment. HASI currently is 2.0% of the portfolio. My goal is for HASI to comprise 40% of my energy sector holdings. The current yield is 5.2%. I began to do more reading about alternative energy investments and I found two companies to join HASI in the energy sector. This article is an introduction to one of them: Pattern Energy Group (NASDAQ: PEGI ). Revisiting Yieldco Opportunities As I pondered how to defossilize the portfolio, I thought perhaps a good yieldco opportunity had developed since I last studied this sector. Yieldcos are subsidiaries of clean energy producers. So, I revisited Tom Konrad’s articles, including his May 27 2015, article, My Yieldco Raised Its Dividend With This Weird Trick . The “weird trick,” in short, is that because the fledgling yieldcos have been popular, their yields have come down, thus allowing them to issue more shares at prices that are very advantageous to the company. Here’s the way Tom put it: Although yieldcos are not getting better returns on dollars invested, they are getting more money for the shares they sell. Tom then gave the example of NRG Yield (NYSE: NYLD ): NRG Yield raised $11 per split adjusted share in its July 2013 IPO. In its July 2014 secondary offering, it sold shares at a split-adjusted $27 per share. Every dollar invested in the Energy Systems Company acquisition in 2013 produces 6.7¢ of annual cash flow. At $11 per share, that is 73¢ cash flow per share. In contrast, NRG Yield’s 2015 investment in the second group of Right of First Offer assets from its parent, NRG, produces a very similar 7.3¢ per dollar invested. But the shares it sold in July produce $1.97 of cash flow per share when invested in the ROFO assets. While NRG Yield’s return on invested cash has barely budged since 2013, its return on each new share sold has grown almost three-fold. The key to NRG Yield’s massive dividend per share growth is not better investment opportunities. The key to its dividend per share growth is selling stock to the public at ever increasing prices. Many other yields are projecting per share dividend growth based on similar share price growth. Tom said one way to avoid this situation is to look for yieldcos with high yields (or yieldcos that have not seen such dramatic appreciation in price). Tom’s article includes a review of NRG Yield and Pattern Energy Group as well as a Canadian company, TransAlta Renewables (TSX:RNW) ( OTC:TRSWF ). Tom’s disclosure indicated that he was long PEGI and TSX, but short NYLD. So, I decided to study Pattern Energy Group. Pattern Energy Group Pattern Energy listed simultaneously on NASDAQ and the Toronto Stock Exchange in September 2013 at an initial share price of $22 and a projected dividend yield of 6.25%. The key sponsor for bringing PEGI public was Riverstone Holdings . PEGI netted $318.6 million in proceeds on the sale of a 36.8% interest in eight wind farms in the US, Puerto Rico, Canada and Chile, with a total owned capacity (at that time) of 1,041 megawatts. It retained 63.2% of the voting rights. Six of the projects had been operating between two and four years at the time of the initial public offering. The remaining two were still under construction at the time of the offering. Ninety-five percent of the output is committed under long-term power purchase agreements with an average remaining contract life of approximately 19 years. At the time of the IPO, Pattern Energy had a right of first offer through 2018 to make bids on any projects in the 3,000-megawatt development pipeline that old Pattern (Pattern Energy Group LP) plans to sell. The option is extended automatically for additional five-year periods unless terminated by old Pattern or PEGI. It would terminate early if PEGI failed to make offers on at least three projects that old Pattern was able to sell. PEGI had the option to buy old Pattern if the current owners of old Pattern, including private equity fund Riverstone, decided to sell a material portion of the equity or substantially all of the assets. (This was taken from an article by Chadbourne & Parke LLP from December 2013.) As stated in PEGI’s 10-K Annual Report filed on March 2, 2015, the company is ” an independent power company focused on owning and operating power projects with stable long-term cash flows in attractive markets with potential for continued growth of our business .” ” We hold interests in twelve wind power projects located in the United States, Canada and Chile that use proven, best-in-class technology and have a total owned capacity of 1,636 MW. The projects consist of eleven operating projects and one project under construction. Our one construction project, the Logan’s Gap project, which we acquired from Pattern Development on December 19, 2014, is scheduled to commence commercial operations prior to the end of 2015. ” PEGI’s initial public offering was completed on October 2, 2013. The company’s head office is located at Pier 1, Bay 3, San Francisco CA 94111 (415) 283-4000, (415) 362-7900 fax. The Investor Relations Contact is Sarah Webster (415) 277-3488, ir@patternenergy.com. The company’s website is: patternenergy.com . Again from the Annual Report, part of Pattern’s business model is to contract ” to sell all or a majority of its output pursuant to a long-term, fixed-price power sale agreement with a creditworthy counterparty.” ” Eighty-nine percent of the electricity to be generated by our projects will be sold under these power sale agreements which have a weighted average remaining contract life of approximately 16 years .” PEGI disclosed that a PREPA, a counterparty on its Santa Isabel project in Puerto Rico, has lost its investment grade rating from S&P and Moody’s (to CCC and Caa3 respectively). The company website explains the name Pattern Energy : Our name … embodies the approach we take. We seek and find patterns in all aspects of our business: wind currents, electrical grids, risk mitigation, site locations and financial models. These patterns help us identify opportunities, build tools, select technologies, and create solutions that yield successful, high-performance facilities. By re-examining established practices, we discover new ways to approach them. We discern patterns through a systematic and scientific approach, but we count on our practical know-how and industry experience to convert them into facilities that perform. When we find profitable patterns, we repeat them. This cycle of discovery, deduction and development is a pattern we’ll keep repeating. Pattern Development Pattern Energy Group LP (Pattern Development) owns a 25% minority stake in PEGI. As described on the PEGI website, Pattern Development is ” a leading global power developer with an extensive development pipeline. …Our continuing relationship with Pattern Development provides us with access to their pipeline of acquisition opportunities. We believe Pattern Development’s ownership position in our company will incentivize Pattern Development to support the execution of our objectives and business strategy through the successful preparation of projects to the construction-ready stage .” Prior to a secondary offering in February 2015, Pattern Development owned more than 33% of the outstanding PEGI shares. As part of that secondary, Pattern Development sold 5 million shares, thus reducing its stake below 33% and thus giving up some controls that had been written into its minority ownership agreement. (Pattern Development now owns 25%.) Pattern Development is the “nuts and bolts” part of PEGI as stated on the PEGI website: Pattern Development has a dedicated team of professionals with significant experience across the spectrum of power project development: Site selection Meteorological and market analysis Land acquisition Project contract negotiation Government relations Community outreach Environmental permitting. Our growth strategy is focused on the acquisition of operational and construction-ready power projects from Pattern Development and other third parties that we believe will contribute to the growth of our business and enable us to increase our dividend per Class A share over time. We expect that our continuing relationship with Pattern Development, a leading developer of renewable energy projects, will be an important source of growth for our business. PEGI described their “Core Values and Financial Objectives” with these words: Pattern’s financial objectives, which it believes will maximize long-term value for stockholders, are to: Produce stable and sustainable cash available for distribution; selectively grow our project portfolio and our dividend; and maintain a strong balance sheet and flexible capital structure. Quarterly Dividends Initiated in January 2014 The following “snapshot” gives you the sequence of steady dividend increases and links to the earnings calls that accompanied these announcements. PEGI initiated a quarterly dividend with an announcement on November 26 2013: $.3125 payable January 30 2014. In the company’s Q4 2013 earnings release on February 28 2014, a $.3125 dividend was declared payable on April 30 2014. In the company’s Q1 2014 earnings release on May 2 2014, a $.322 dividend was declared payable on July 30 2014. In the company’s Q2 2014 earnings release on August 5 2014, a $.328 dividend was declared payable on October 30, 2014. In the company’s Q3 2014 earnings release on October 31, 2014, a $.335 dividend was declared payable on January 30 2015. In the company’s Q4 2014 and FY 2014 earnings release on Mar 2 2015, a $.342 dividend was declared payable on April 30 2015. The release included these highlights: Cash available for distribution (CAFD) of $62.1 million, up 46%. Adjusted EBITDA of $198.1 million, up 40%. Proportional GWh sold of 2,915 GWh, up 65%. Revenue of $265.5 million, up 32%. Declared a first quarter dividend of $0.342 per Class A common share or $1.368 on an annualized basis, subsequent to the end of the period, representing a 2% increase over the previous quarter’s dividend. In the company’s Q1 2015 earnings release on May 7 2015, a $.352 dividend was declared payable on July 30 2015. The release included these highlights: Cash available for distribution of $9.3 million, down 48%. Adjusted EBITDA of $46.7 million, up 26%. Proportional GWh sold of 929 GWh, up 70%. Revenue of $64.9 million, up 31%. Declared a second quarter dividend of $0.3520 per Class A common share or $1.408 on an annualized basis, subsequent to the end of the period, representing a 3% increase over the previous quarter’s dividend. Added three new projects to the identified Right of First Offer list consisting of Amazon Wind Farm (Fowler Ridge), Mont Sainte-Marguerite and, subsequent to the end of the period, North Kent; the identified ROFO list stands at 814 MW of owned capacity. Entered into definitive agreements to acquire four wind power facilities, subsequent to the end of the period, K2 and Amazon Wind Farm (Fowler Ridge) from Pattern Development and Post Rock Wind and Lost Creek Wind from Wind Capital Group, LLC. Increased its CAFD per share compound annual growth rate (CAGR) target to 12-15 percent from 10-12 percent over the next three years, subsequent to the end of the period. Pattern Development acquired a majority stake in Tokyo-based Green Power Investment Corporation (GPI), which has approximately 1,000 MW in near- and longer-term wind and solar projects in development and Pattern Development’s interest in GPI’s projects is subject to Pattern Energy’s ROFO. Pattern Development signed a joint venture agreement with CEMEX Energia, a subsidiary of CEMX S.A.B. (NYSE: CX ), to develop renewable energy projects throughout Mexico and Pattern Development’s interest in the joint venture’s projects is subject to Pattern Energy’s ROFO. Completed a $351 million follow-on primary and secondary equity offering. “We continue to grow our portfolio of high-quality assets which now stands at 2,112 MW of owned capacity with the recent addition of four new projects, including our first acquisition from a third party. At the same time, we continue to add new projects to our identified ROFO list, like the recent North Kent announcement. The identified ROFO list and Pattern Development’s pipeline of development-stage projects in North America, Japan and Mexico provide clear visibility into our growth trajectory. As such, we have increased our cash available for distribution per share CAGR target to 12-15 percent through 2017,” said Mike Garland, President and CEO of Pattern Energy. “It’s a great portfolio in strong markets. Despite the short-term wind variability in the first quarter, the underlying business continues to perform well – as we grow our portfolio and a strong pipeline of near-term projects.” In his comments during the earnings call, CEO Michael Garland noted that production and cash available for distribution in Q1 2015 were down compared to Q1 2014 despite the new power projects that were added. He said, “This was almost entirely due to lower wind speeds experienced across the industry in the West and in Texas.” The lower winds in Q1 resulted in a 20% variance in electricity production from those turbines. This illustrates one of the risks with wind energy – intermittency. For a new public wind company, the pipeline of production (or the availability of existing wind farms to buy) is vitally important, along with the fiscal strength to finance this development. In the years leading up to the IPO, Pattern Energy created a good working relationship with Pattern Development, which will eventually be folded into one operating company. PEGI’s key sponsor prior to their initial public offering was Riverstone Holdings, a private equity firm that specializes in energy start-ups. The IPO was well-received, the company appears to have solid financial backing and a conservative financial structure (for a new company), and a strong developmental arm in Pattern Development. Other views of Pattern Energy Group I found a March 30 2015, SA article by Dividends, Growth & Value entitled PEGI Following Industry Tailwinds In Wind Generation Growth . I also found a May 13 2015, SA article by DivCut Capital, Pattern Energy Group: Questionable Acquisitions, And Dividends Funded By Capital Raises . As indicated by the title, the article was originally negative about PEGI, but was updated. The author generally is critical of yieldcos because ” since yieldcos pay a fixed runrate CAFD multiple on their acquisitions, the project upside is absorbed by the parent development company when they sell a project to the yieldco, while the downsides like potential cut subsidies are absorbed by the yieldco .” DivCut Capital had overlooked ” that Pattern Energy, unlike the other yieldcos, will eventually share in the project upside because Pattern Development’s team will drop down into PEGI once the market cap is above $2.5B. In essence, PEGI and its shareholders will be able to internalize the benefits of Pattern Development’s development expertise. This future unlocking of value explains Pattern Development’s shrinking ownership share in PEGI as well as the management arrangement. ” He concluded the update with a gracious admission: “Strangely enough, if I were to buy shares in a yieldco, PEGI would be the one to buy. … So while I am bearish on yieldcos generally, my criticisms of Pattern Energy were misplaced, and my hat is therefore eaten.” The article is worth reading for several reasons, including DivCut Capital’s critique of the yieldco sector as a whole. One should know as many sides of an argument as possible before making an investment. DivCut Capital followed this with a June 15 2015, article, Pattern Energy – An Attractive Value , which presents the bullish case for PEGI, with the following summary: Unlike the other yieldcos, Pattern has a management agreement in place such that once the market cap hits $2.5B, the management of their parent company (Pattern Development) will drop down into Pattern Energy for free. When this happens, instead of earning a fixed Return on Capital like the other yieldcos, Pattern can use their development expertise and relationships to earn potentially much higher returns on capital, and at worst they will continue earning the fixed 9-10% ROC. I would expect them to develop localized wind solutions like their Fowler Ridge development for large data-centers and other tech-focused facilities that need a reliable source of clean energy. Secondly, their first quarter was ridiculously unlucky due to El Nino winds illustrated below, particularly on the panhandle of Texas and Southern California. Anyone like myself selling the stock due to this performance was and is sadly mistaken. Evaluation of Pattern Energy Group According to Morningstar via BetterInvesting.org , PEGI has 65.9 million shares outstanding. Total capital is $2210.4 million. Book value is $11.68. The 52-week high was $34.51 and the 52-week low was $22.68. Here are financial data for 2011-2014: Fiscal Year 12/31 2011 2012 2013 2014 Sales (millions) 135.9 114.5 201.6 265.5 Pre-tax Profit (millions) 26.6 -17.0 14.6 -36.9 Net Income (millions) 8.9 -6.3 – -110.2 Earnings Per Share – – .33 -1.90 The company has “married” the financing of its projects with long-term contracts to provide energy to dedicated customers, such as the recently announced contract with Amazon Web Services, a subsidiary of Amazon.com (NASDAQ: AMZN ) to provide electricity to Amazon’s data centers. Persons considering an investment in Pattern Energy Group should be aware of the risks inherent in a newly formed enterprise. Earnings will be erratic. Pattern has established a stream of growing revenues and it has a solid pipeline through its relationship with Pattern Development. It has benefited in its pre-public offering period from the financial backing of Riverstone Holdings. PEGI, as with all wind energy companies, faces the issue of variation in winds. It has committed extensive resources to study long-term wind patterns, but there is no way to 100% guarantee a steady wind stream. While a relatively new public company, PEGI’s management team has an average 20 years of experience in the energy industry. The team has worked together for 10 years in PEGI and its predecessor company Pattern Energy Group LP. PEGI CEO Michael Garland was CEO of PEG LP since 2009. Prior to that, he led Babcock & Brown’s North American Infrastructure Group. From 1975 to 1986. he was Chief of Energy Assessments for the State of California. I am aware of the risks involved in this technology (intermittency and the resulting variance of income) and with a start-up company. I have confidence in the management team, in the company’s pre-IPO track record, in Pattern Development’s technical expertise, and in its strong initial relationship with financial institutions and contracted customers. There are no guarantees, of course. Caveat emptor! My initial investment in Pattern Energy Group On June 9 2015, I made an initial investment in PEGI at $28.40. It currently comprises 1.0% of my retirement income portfolio and 20% of my energy sector holdings. Since this is a new public company, I have given you more than the usual number of press releases and statements by management. I believe the first step in evaluating a company is getting a sense of its business model and company culture. The purpose of this article is to introduce you to an alternative energy company and to give you a flavor of PEGI so you can decide whether to do your own due diligence. I find it very helpful to listen to a company’s quarterly earnings calls. Transcripts of all the company’s earnings calls are available on the company website , as is a webcast of the Q1 2015 earnings call. Potential investors in PEGI or any wind energy company need to be familiar with environmental concerns. Wind turbines are viewed by many persons to be unsightly and fraught with hazards to the health of people and animals. Several videos are available for viewing on the PEGI website. Pattern Energy also has a YouTube Channel with several videos that address various environmental concerns. Some of the videos also provide insight into the meteorological aspects of the industry. This is Part 1 of a two-part article. Part 2 will be about Enviva. This article is the journal of my retirement income portfolio. It is not intended as a recommendation to buy or sell any security. This is presented to offer ideas for stocks to study. Please do your own due diligence. Disclosure: I am/we are long PEGI, HASI, EVA. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
