John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Buying solid companies whose shares have been hurt by short-term factors can be a profitable investing strategy. With that in mind, today I'll provide an update on Brookfield Renewable Partners LP (BEP.UN).
I own BEP.UN personally and have been pleased with its performance. The renewable-power producer has posted an annualized total return – assuming all distributions had been reinvested – of about 13.4 per cent for the five years through June 30. That easily tops the total return – also including dividends – of about 8.7 per cent for the S&P/TSX composite index over the same period.
BEP.UN pays an attractive yield of 5.7 per cent and aims to raise its distribution at an annual rate of 5 per cent to 9 per cent. A high – and growing – income is exactly what I look for in an investment, which is why I expect to be in BEP.UN for the long run.
But with any investment, there will be short-term setbacks.
BEP.UN's units took a tumble in late June, sinking 4.5 per cent in a single day. The reason? The partnership announced a $550-million equity offering – consisting of a $350-million bought deal with a group of underwriters and a $200-million private placement with parent Brookfield Asset Management Inc. The issue was priced at $42.15 a unit, representing a 3-per-cent discount to the market.
It's normal for a stock to fall to reflect the dilutive impact of a share offering. But investors with a long-term view should look past the sell-off and focus on the positive aspects of the deal.
BEP.UN plans to use the proceeds to repay amounts on its credit facilities and to fund previously announced investments such as the acquisition, with institutional partners, of 100 per cent of TerraForm Global and 51 per cent of TerraForm Power. These deals would mark BEP.UN's first meaningful investments in solar power to complement its hydroelectric (currently about 81 per cent of earnings), wind (17 per cent) and thermal (2 per cent) generating assets.
The equity offering also gives Brookfield Renewable greater financial flexibility to pursue future acquisitions, which – in addition to new project developments and investments in its existing businesses – are central to its long-term growth plans.
"We believe BEP.UN is now better positioned to act on future [mergers and acquisitions]. There appears to be strong deal flow currently and this enhanced flexibility should allow the company to execute when appropriate," Desjardins Capital Markets analyst Bill Cabel said in a note.
The fact that Brookfield Asset Management agreed to participate in the equity offering also "sends a strong message to investors of the value it sees in BEP.UN at current levels," Mr. Cabel said. (BAM owns about 60 per cent of BEP.UN).
One of the world's largest publicly traded renewable-power producers, BEP.UN's $28-billion portfolio consists of 218 hydro plants, 35 wind farms, four biomass facilities and three natural gas-fired plants spanning North America, Brazil, Colombia and Europe. More than 90 per cent of its generation is contracted on a long-term basis to utilities, industrial users and other buyers, which limits BEP.UN's exposure to volatile spot power prices and enhances the stability of its cash flows.
With demand for renewable power increasing – reflecting concerns about climate change, a shift away from fossil fuels and falling costs for wind and solar generation – BEP.UN is well positioned to take advantage of these trends over the long run, analysts say.
"We continue to view BEP units as a core holding for investors seeking exposure to the long-term renewable power growth cycle. Asset quality is strong, and we like the above-average dividend yield," BMO Nesbitt Burns analyst Ben Pham said in a note.
For all of BEP.UN's strengths, however, there are a few cautions to keep in mind.
One is the stock's valuation. Even after the pullback, many analysts consider the units to be fully valued. Of the 14 analysts who follow BEP.UN, there are six "buy" recommendations, six "holds" and two "sells." The average 12-month price target is about $41.50 – slightly lower than Tuesday's closing price of $41.56 on the Toronto Stock Exchange – indicating that analysts don't expect much, if any, share-price growth over the next year.
Another thing to keep in mind is the unpredictability of Mother Nature. Power from wind and water varies depending on the weather, and BEP.UN has in recent years seen its generation fall below long-term averages, although conditions have improved recently.
A final consideration is BEP.UN's elevated payout ratio. For 2017, analysts estimate that the company will pay out about 100 per cent of adjusted funds from operations – well above BEP.UN's target payout ratio of 70 per cent of FFO. However, BEP.UN has assured investors that the payout ratio will gradually fall even as the company continues to increase the distribution.
"As we continue to deliver both organic and acquisition-driven cash flow growth we would expect [the payout ratio] to normalize over the medium term," BEP.UN chief executive officer Sachin Shah said in his first-quarter letter to unitholders.
"In the meantime, given our robust operating cash flows, investment-grade balance sheet and strong liquidity position, we continue to have more than adequate resources to fund our growth, capital expenditures and development program, and grow distributions by 5 to 9 per cent annually."
With proceeds from the recent equity issue in hand, BEP.UN is now in an even better position to deliver on its promises.