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Is Wall Street Undervaluing Renewable Energy Yieldcos?

By Travis Hoium - Apr 29, 2017 at 9:38AM

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Yieldcos are being valued like they have a limited lifespan, but that may not be the case.

One of the great challenges in valuing yieldcos today is deciding whether or not they're temporary assets with limited lifespans or long lived entities that'll be around for many decades to come. The way yieldcos are priced today, the case can be made the investors see a 20 year lifespan and almost no value thereafter. But that doesn't necessarily make sense. 

When a hydro or coal plant was built in the mid-1900s, you could have argued that they were designed for a limited useful life as well, but they were built to last many decades or even a century. And once the infrastructure is in the ground it'll be easier to generate value long-term. 

Solar farm shown at dusk with a wind turbine in the background.

Image source: Getty Images.

The useful life of renewable energy projects

One of the strange phenomenon in the renewable energy sector today is that yield based companies with consistent cash flows are being treated like they have very short lives. 8point3 Energy Partners (CAFD) has an 8.4% dividend yield, NRG Yield (CWEN 2.27%) is slightly better at 5.9%, and Pattern Energy Group (PEGI) sports a 7.7% yield. Meanwhile, many midstream energy MLPs are being treated like their assets will generate cash forever, sporting yields below 5%, despite the fact that investors will have to pay a higher tax rate on MLP dividends. Utilities also regularly trade below 5% dividend yields, despite having little growth opportunities and disruption from renewable energy on the horizon. 

The core of the problem is that investors think infrastructure and utility assets as ongoing businesses. If you know a company will pay you a 4% or 5% dividend yield for decades to come, potentially with slight increases each year, you're willing to accept a lower yield. 

Yieldcos are currently viewed like assets that'll generate cash flow until their power purchase agreement is up and then be worthless. 20 years of dividends is great, but investors have to think about how companies will pay off debt by the time their PPA contract is up and then discount remaining cash flows to today's present value. Often the result is a dividend yield of 7% or higher. But that may not be the right way to think about yieldcos at all. 

The ongoing value of yieldcos

It's true that most renewable energy projects are built with initial contracts to sell energy to a utility for 20 or 25 years. And after that cash flow is uncertain. But the assets won't be worthless in 20 years. There will still be transmission lines running to the project and wind turbines, solar racking arrays, and even solar panels themselves won't be worthless. They may just need to be upgraded to maximize cash flows. 

But in a world where energy is based on costs, it'll be less costly to buy energy from an aging wind or solar power plant or upgrade it to newer technology than build a greenfield plant. By then, there may even be opportunities to add new technologies like energy storage that will create even more value. 

8point3 Energy Partners has probably been affected by this misunderstanding of its asset than any other yieldco. Management actually set up its debt structure to be an ongoing business, taking out term debt and intending to get traditional corporate bonds eventually. Competitors have used amortizing debt similar to a mortgage, which reduces principal as a project gets older. And the amortization is a nod to the fact that investors don't put much value in these projects after their initial contract is over. 

Yieldcos are still set for a comeback

For patient investors, the yieldco structure should create a consistent dividend and if assets indeed generate cash flow for decades to come, it'll lead to cash flows long after initial PPAs run out. That's not being priced into a lot of yieldcos today and that creates a buying opportunity for long-term investors willing to ride out this current wave of pessimism in the yieldco market. 

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