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Pattern Energy Group: Questionable Acquisitions, And Dividends Funded By Capital Raises

Dividends are increasing despite shrinking Cash Available For Distribution, earnings estimates falling considerably, and increasing share count. PEGI’s parent company, Pattern Development, is dumping shares while selling assets to PEGI at higher and higher prices and sharing a CEO and other executives with PEGI. PEGI’s acquisitions from PD and the dividends are funded by public offerings which are dependent on dividend-hungry investors. Something has to give. Pattern Energy Group (NASDAQ: PEGI ) is an “independent power company focused on owning and operating power projects … [they] 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.” Pattern is part of a recently developed genre of so-called “YieldCos”, which also includes companies like TerraForm Power (NASDAQ: TERP ), Abengoa Yield (NASDAQ: ABY ) and Nextera (NYSE: NEP ). These companies generally buy energy projects from a parent company and then distribute the proceeds from their operations as dividends. There are three things about Pattern that in my eyes sets them apart from other YieldCo’s. Any of these things individually isn’t necessarily a problem, but together they paint an interesting picture: Their portfolio is exclusively (with one small exception) wind energy projects and thus more susceptible to irregular weather patterns like El-Nino. Pattern’s parent has only a 25% (and shrinking) ownership interest in Pattern. Pattern shares executives with their parent company. This article is nothing more than a close reading of PEGI’s 2014 10-K. ( https://www.sec.gov/Archives/edgar/data/1561660/000119312515073104/d842437d10k.htm ). Let’s get to the 10-K, where PEGI discusses another company, Pattern Development (I will refer to them as PD): We are party to the Management Services Agreement, pursuant to which each of our executive officers (including our Chief Executive Officer), with the exception of our Chief Financial Officer and Senior Vice President, Operations, is a shared PEG executive and devotes time to both our company and Pattern Development as needed to conduct our respective businesses. As a result, these shared PEG executives have fiduciary and other duties to Pattern Development. Conflicts of interest may arise in the future between our company (including our stockholders other than Pattern Development) and Pattern Development (and its owners and affiliates). .. Pattern Development’s general partner and certain of its officers and directors also have a fiduciary duty to act in the best interest of Pattern Development’s limited partners, which interest may differ from or conflict with that of our company and our other stockholders. Emphasis mine. PEGI and PD share a CEO and other officers. This may be a problem since PEGI acquires power projects from PD. In fact, acquiring from PD is PEGI’s stated growth strategy. It is also worth noting that many of their executives immediately before Pattern worked at Babcock and Brown, an investment firm that went bankrupt in 2009. 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. I have assembled the data about Pattern’s acquisitions. Here is what I have observed: (click to enlarge) As you can see, they are generally pretty fair regarding prices paid to PD versus prices paid to other parties, with one giant exception, that being K2 which was announced in early April of this year. The average price paid to PD per MW of the above is $1.09M. The average price paid to others is $0.97M, and the average price paid to PD, excluding K2, is $0.76M. In other words, the recent K2 acquisition sticks out like a sore thumb and I would be curious to know their rationale for paying such a high price, especially given that it is the largest acquisition in absolute dollars as well as $/MW but one of the smallest in terms of MW of capacity acquired. Maybe they got a high $/MWh power purchase contract out of it. I should note that $/MW isn’t the end-all-be-all of metrics, but it’s all we have, and as Berkshire Hathaway’s Charlie Munger has said, roughly, “If we see someone who weighs 300 pounds or 320 pounds, it doesn’t matter-we know they’’re fat.” The cost paid per MW for acquisitions from PD has steadily risen, whether we include K2 or not: Meanwhile, PD is dumping PEGI shares while PEGI does public offerings. Additionally, PD is using their PEGI shares as margin on a loan: In May 2014, we completed a follow-on offering of our Class A shares. In total, 21,117,171 Class A shares were sold. Of this amount, we sold 10,810,810 Class A shares and Pattern Development, a selling stockholder, sold 10,306,361 of our Class A shares . In addition, in February 2015, we completed another follow-on offering of our Class A shares. In total 12,000,000 Class A shares were sold. Of this amount, we issued and sold 7,000,000 Class A shares and Pattern Development, a selling shareholder, sold 5,000,000 of our Class A shares … …In addition, on May 6, 2014, Pattern Development entered into a loan agreement pursuant to which it may pledge up to 18,700,000 Class A shares to secure a $100.0 million loan . If Pattern Development were to default on its obligations under the loan, the lenders, upon the expiration of certain lock-up agreements, would have the right to sell shares to satisfy Pattern Development’s obligation. Such an event could cause our stock price to decline… Last year, PEGI paid about $52M in dividends. This year, they converted their Class B shares to Class A, and issued more class A shares as mentioned above, so they’ll have to pay more in total dollar terms for the same amount of dividends per share. They recently reported Q1 2015 quarterly Cash Available for Distribution (CAFD) of $9M and announced a quarterly dividend of around $23M. Thus, CAFD as they define it wasn’t enough to cover their recent dividend. On the recent conference call, they mentioned that they have some “CAFD-like” cash-flows that aren’t included in CAFD but can be used to cover the dividend. This seems to me to be “moving the goalposts” but it is perfectly possible that it is the case. PEGI’s earnings have been consistently below estimates, and their future earnings estimates are falling considerably, creating doubt in my mind that they can hit their growth targets. The following shows their Q4 2014 calculation of “Cash Available For Distribution”, or CAFD, which they just announced will grow at a 12-15% CAGR for the next 3 years ( http://files.shareholder.com/downloads/AMDA-25NBHH/80126018x0x814874/0629F770-71BB-47FE-83CD-658E363DCA8B/03.03.15_PEGI_presentation.pdf ): (click to enlarge) You will notice that in their calculation of Cash available for distribution, they account for Operations and Maintenance (O&M) capex. Somehow, this may not be enough to maintain their operating performance. From the same document: However, cash available for distribution has limitations as an analytical tool because it excludes depreciation and accretion, does not capture the level of capital expenditures necessary to maintain the operating performance of our projects , is not reduced for principal payments on our project indebtedness except to the extent it is paid from operating cash flows during a period, and excludes the effect of certain other cash flow items, all of which could have a material effect on our financial condition and results from operations. Emphasis mine. If “O&M capex” isn’t enough to maintain the operating performance, then either they are skimping on O&M capex, or more capex should be considered O&M capex for their calculation of CAFD. Either way, by their own admission, CAFD doesn’t reflect the amount of CapEx necessary to maintain operating performance. Long term, wind energy is of questionable value compared to solar in my view. However, Pattern has locked in fixed purchased power agreements where they get to sell all of the power produced at a price that either is fixed or escalates with CPI. Thus, they have protected themselves from falling electricity demand. On the flip side, if demand rises they don’t have pricing power. Fixed prices are not advantageous if inflation ever picks up, since their costs would rise much faster than revenues. Near term, there are not major threats to wind production, but in the very long term, distributed solar generation could make it difficult for utilities to add more fixed purchased power contracts, or to follow through with their fixed power purchase contracts. The cost of solar power decreases (see Swanson’s Law ) by roughly one-half every 10 years. Wind energy does not have the same advances in efficiency: There may be a time in the future where solar power is efficient to the point that wind power is rendered too expensive to use, the cash flows from wind projects may not run as far into the future as expected when they are built. One last interesting bit I noticed in the 10-K: Our proportional MWh sold in the year ended December 31, 2014 was 2,914,810 MWh, as compared to 1,771,772 MWh in the year ended December 31, 2013, representing an increase of 1,143,038 MWh or approximately 65% . This increase in proportional MWh sold during 2014 as compared to 2013 was primarily attributable to the commencement of commercial operations at South Kent, El Arrayán, Panhandle 1 and Panhandle 2 at various times during the year and an increase in production from an additional 42 MW at Ocotillo for the full year of 2014. Our average realized electricity price was approximately $88 per MWh during the year ended December 31, 2014 as compared to approximately $88 per MWh in the prior year. Between 2013 and 2014 prices per MWh remained constant while proportional MWh sold increased a whopping 65%! However, as far as I can tell, no meaningful part of their revenue grew 65%. Perhaps they use a simple average rather than a weighted average, but that wouldn’t make sense in my view. In conclusion, while the ~5% dividend yield may look attractive, it would be inadvisable to buy this stock for a sustained dividend, in view of the above. There are of course risks to the concerns raised in this article. It is possible that the wind picks up substantially, they are able to generate enough cash from their new acquisitions to sustain the dividend, they can tap the capital markets to cheaply raise more cash, and that the amount of capex necessary to maintain operating performance is negligibly larger than the O&M capex they use to calculate CAFD. Perhaps they are able to diversify into more solar projects. Trading at over 7x Sales, though, a lot has to go right to justify their valuation in my view. I reached out to their IR department through their website about conflicts of interest, the Conflicts Committee, their acquisitions, O&M Capex, and why revenues didn’t grow as much as Average Price times MWh sold. I received no response. Disclosure: The author is short PEGI. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Despite Slow First Quarter, Duke Energy Remains A Safe Dividend Play

Summary Duke Energy’s first quarter 2015 EPS of $1.24 beat estimates by $0.10, while Revenue of $6.06 billion missed expectations by $240 million. The company’s residential retail energy market declined as a result of more efficient energy practices and the company’s international business segment declined due to issues n Brazil. I believe Duke Energy stock presents a safe dividend play with opportunity for slow stock appreciation going forward. On May 1, 2015, Duke Energy Corporation (NYSE: DUK ) reported their first quarter of 2015 earnings results and provided an update on their four financial objectives for 2015 and beyond-(1) current year earnings guidance, (2) long-term earnings growth, (3) dividend growth, and (4) balance sheet strength. In this article, I will review the company’s four financial objectives and analyze their progress in obtaining them. Achieve 2015 earnings per share within guidance range of $4.55 and $4.75 Capital expenditures are expected to fall within the range of $7.4 and $7.8 billion for the year. In the first quarter of 2015, the company had $1.45 billion in capital expenditures putting the annualized projection to $5.8 billion. While the capital expenditures projection is lagging behind projections, management expects the economic development usage of the expenditures to result in almost 3,000 new jobs as the company makes commitments to pursue alternative energy generation sources. The company saw retail load growth of 0.5% to 1.0% for the year. The weather normalized retail growth rate decrease 0.2% year-over-year largely due to the 2014 polar vertex. The strong performance in the industrial market was offset by the disappointing residential market performance. The residential market experienced lower usage year-over-year due to changes in energy efficiency and conservation, polar vertex in 2014, and higher use of multi-family housing. There were 700M average shares outstanding at 12/31/2015. The company had 708M outstanding shares at 3/31/2015, up from 707M at 12/31/14. The company does not have any planned equity issuances through 2017. We saw $65 per barrel average Brent crude price for 2015. Oil price projections have remained consistent to projections as the expected Brent crude oil prices have increased from EIA’s February 2015 report of $57.56 to $61 in May 2015’s report . The joint venture, National Menthol Company (NMC), which runs through 2032, is 25% owned by Duke Energy. NMC’s earnings are positively correlated with crude oil prices and an approximate $10 per barrel change in the average annual price of Brent crude oil has roughly a $0.01 to $0.02 EPS impact annually. There was an exchange rate of approximately 2.85 BRL/US dollar. The exchange rate has increased above this expected rate to $3.01 on 5/13/2015 as the Brazilian economy struggles and the US economy rebounds. The continued drought conditions, struggling Brazilian economy, and weaker foreign currency exchange rates are the largest factors behind the $0.13 year-over-year quarterly earnings per share decline in the company’s international segment. The ongoing drought in the country has caused the company to dispatch higher cost thermal generation instead of the low cost hydro generation. Additionally, the struggling economy has caused the company to lower demand growth for 2015 between 0% and 2%, which is much lower than the greater than 3% seen over the past several years. Deliver earnings per share growth of 4% to 6% through 2017 There was retail load growth of 1% going forward. The company has been stagnant with a 0.6% retail load growth from 2012 and 2014. As seen by the decrease in the first quarter of 2015, I think it is going to be very difficult for the company to achieve a 1% growth going forward. I think it is going to be difficult to achieve because of the lower energy usages in homes. I don’t see this trend reversing and allowing this 1% growth rate to be achieved. The company expects total wholesale net margin to increase due to the new 20-year contract with NCEMC at Duke Energy Progress (began in 2013) and 18-year contract with Central EMC at Duke Energy Carolinas growing to a load of 900MW in 2019 from 115MW in 2013. FY2015’s total wholesale net margin is expected to be approximately $1.1 billion with an anticipated 5% compound annual growth rate. The regulated earnings base growth is expected to follow the $2 billion growth trend in 2015 that was seen in 2014. Continue growing the dividend within a 65% to 70% target payout ratio On May 7, 2015, Duke Energy declared a quarterly cash dividend of $0.795 per share, in line with previous quarterly dividends. Management expects the dividend to rise to $3.24 per share in 2015 (almost 2% increase year-over-year). With the Company achieving a payout ratio close to 70% and management’s commitment to paying out a quarterly dividend to investors, I do not see the company’s current 4% dividend yield to be at risk. Management has paid 89 consecutive years of dividends with increases coming the past 7 years. This is largely possible due to the Company’s strong balance sheet and no planned equity issuances through 2017. In addition, the company announced a strategically tax-efficient way to repatriate $2.7 billion back to the U.S. during the fourth quarter 2014 earnings call, which will help fuel the dividend increases going forward. Maintain strong, investment-grade credit ratings. While the company’s credit rating was recently upgraded by S&P, I believe there are three primary risks for the company going forward. The exposure to Brazil is a significant risk for the company’s future, which was seen in the 2014 financial results. In 2014, there was a decrease in sales volume as well as higher purchased power costs due to the interruptions in the hydrology production. Per the earning’s call, they are assuming normal hydrology despite the rainy season starting slowly. Brazil is a major story to follow for Duke Energy in 2015 and beyond as the Company is predicting EPS growth from this business segment despite recent downward trends in profits there as well as the Brazilian economy. I think the company will have difficulty increasing the retail load growth to 1% given the increased technologies and social initiatives to decrease electric use. Oil prices will continue to be a wild card going forward. Forecasting a price on such a volatile asset is a difficult task. If oil prices continue to fluctuate widely, it will significantly impact the company’s bottom line. Conclusion Duke Energy faces some difficult obstacles including a slowing Brazilian economy, lower residential energy usage, and volatile oil prices; however, I believe that the company gave conservative and very obtainable estimates in each of the key assumptions used to allow them to meet their financial objectives for FY 2015 and beyond. While I don’t see Duke Energy being a rapid growth story going forward which can be seen in the lagging capital expenditures, I do believe they have the ability to present slow stock appreciation with the safety of a consistent dividend. Disclosure: The author is long DUK. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Warning Lights Flashing Brightly At REC Silicon ASA

REC Silicon is an industry leading FBR poly vendor but the Q1 results show many red flags. The company’s sales dropped dramatically as the company shipped product into inventory in light of the steep ASP drops in Q1. We discuss why REC Silicon ASA is a stock to avoid. There are three top tier polysilicon manufacturers in the US – Hemlock Semiconductor, Wacker Chemie, and REC Silicon ASA (OTCPK: RNWEF ). While Wacker and Hemlock are part of larger companies, REC Silicon is the only major independent polysilicon company manufacturing polysilicon in the US. The Company, headquartered in Moses Lake, Washington, is listed on the Oslo exchange under the ticker REC. In The US, the Company’s ADS trades under the ticker RNWEF. REC Silicon ASA is a long standing polysilicon manufacturer and has pioneered the low cost polysilicon manufacturing method called Fluidized Bed Reactor, or FBR. It took the Company many years to perfect the FBR process and, in the recent past, the Company has demonstrated one of the lowest cash costs for producing polysilicon. At the current cash cost structure of sub $11 per kg, REC Silicon appears to be second only to DAQO New Energy (NYSE: DQ ) in terms of polysilicon costs. In 2014, the Company reached a joint venture agreement with Youser Group in China to build a FBR polysilicon facility in Yulin, China. While the Company’s FBR leadership and the China JV appears to be good news, recently announced first quarter results do not inspire confidence in the Company’s future. REC Silicon reported abysmal first quarter revenues of $74.4 million, compared to $126.2 million in the previous quarter. EBITDA declined from $38M in Q4 to $24.8 million in Q1. The Company attributed the sales decrease and lower EBITDA to lower sales volumes and lower prices. On the positive side, REC seems to be executing well on the production side (image below) and the Company’s FBR cash production cost continues to come in at sun-$11 per kg. (click to enlarge) However, the production information is one of the few positives to come out of the Company’s earnings call. The Company’s product sales, both in polysilicon and silicon gas sales, have underperformed guidance. In terms of silicon gas sales, the Company claimed that its sales dipped (image below) due to US west coast port slowdown issues. However, given that the port strike has been an ongoing factor for many months, we believe that competitive issues played a larger part in the decline than the Company is willing to admit. In terms of polysilicon sales, the Company claimed that prices ranged from $15 to $18 a kg in the first quarter and the Company decided not to accept business at this low level because it expects polysilicon pricing to firm up during the second half of the year. Readers should note that the Company’s claimed price range is well below that of the $18+ ASP reported by DAQO New Energy in the recent earnings call. While the FBR poly produced by REC Silicon has commanded lower ASPs than Siemens poly that most of the industry produces, the gap between the prices has been increasing in the recent quarters. Instead of selling at the low prices of poly the company saw in Q1, the Company decided to produce and hold its product in inventory. In a stunning development, the Company held about half the product it manufactured in the last quarter in its inventory (see image below). (click to enlarge) Holding this amount of product in inventory has immediate balance sheet implications. The Company’s cash position declined dramatically in the quarter as can be seen in its cash (see image below). Unfortunately, for the Company, polysilicon prices declined further in Q2 compared to Q1. Given its cash position, the Company cannot afford to build further inventory, which implies that the Company will likely end up selling its product at even lower prices than what the Company could have gotten in Q1. Further complicating the financial picture is the forecasted expiration of “process-in-trade” loophole that the Company has been using to export its polysilicon production to China. This loophole appears set to expire in August of this year and the Company is lobbying US Congress and China’s Department of Commerce, MOFCOM, to extend this deadline. If this deadline is not extended, the Company is faced with tariffs as high as 57% which essentially make the Company’s polysilicon sales in China untenable. With about 80% of the Company’s market residing in China, the Company’s business is unlikely to survive such a development. Deciding to hold product in inventory seems to indicate that the Company is optimistic about its prospects in extending the deadline or having the tariffs reduced but we consider this a risky bet. Even if the Company is able to get a favorable decision in terms of this tariff, new polysilicon production coming online (see image below) in 2015 is likely to put a cap on the upside to ASP improvements in the second half of the year. Given these capacity improvements, and given the discount that FBR poly is trading compared to Siemens poly, we think it is likely that the Company’s ASP in 2015 may not exceed the $15-$18 level the Company witnessed in the first quarter. This level of pricing can put considerable burden on the Company’s P&L and dramatically impact the Company’s future. While the Company does not have any major debts becoming due in the near term (see image below), we find the Company’s near-term future tenuous at best. Given the likely low polysilicon prices, impending new capacity, FBR poly price discount, and the Company’s cash position, investors in the Company may be looking at an abyss. Our View on RNWEF: Avoid. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: The author is long DQ. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.