On the one hand, TerraForm Power Inc (TERP) has been a terrible dividend stock in recent years due to some financial woes at its former parent. Things got so bad that the renewable power company had to suspend its payout in late 2015. However, those issues are now in the rearview mirror, which has allowed the company to reinstitute a dividend this year. At the newly reset rate, the company yields an attractive 6.5%.
That said, the high-yield payout is only part of the attraction. That's because the company is instituting a strategic plan that should provide investors with a growing stream of cash flow in the years ahead, potentially providing it with the power to deliver double-digit total annual returns. That income with upside makes this clean energy stock one that investors won't want to miss.
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Adopted into a family that knows how to create value
Last year had its share of challenges for TerraForm, which recently reported fourth-quarter and full-year results. The renewable power company only generated $88 million, or $0.59 per share, in cash available for distribution (CAFD), which was down more than 40% from 2016 due to a range of issues. Because of that, shares have declined by double digits since the start of 2017, and are down even further from its peak a few years ago.
That said, 2017 also marked a critical turning point for TerraForm because it finally separated itself from its now-bankrupt parent company. Replacing that value-destroying entity is Brookfield Asset Management (BN -0.74%), which has a history of creating value for investors, especially in the renewable power sector. In fact, Brookfield's renewable power arm, Brookfield Renewable Partners (BEP -1.66%), generated a total return of 25% last year versus 22% for the broader market after delivering excellent results. With that performance, Brookfield more than met its objective to generate total returns of 12% to 15% annually with its namesake renewable power business.
The company has a similar aim for TerraForm Power, targeting 12% total annual returns backed by a plan to grow its recently restarted dividend at a 5% to 8% yearly rate. Powering that growth will be a combination of cost reduction efforts, reinvesting excess cash flow into expansion projects, and value-oriented acquisitions. In fact, the company estimates that its efforts to improve margins alone could power 6% annual dividend growth through 2020, giving it plenty of time to find the right expansion opportunities to propel the next phase of growth.
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Well ahead of schedule
That said, Brookfield has a knack for underpromising and overdelivering, which is just what it has done since taking control of TerraForm Power by helping it recently secure a needle-moving acquisition of a renewable power company in Western Europe. The deal will immediately boost TerraForm's CAFD by 24%, which allowed the company to bump its first dividend payment up by 6% more than its initial target. Further, the deal enhances the company's ability to increase the payout from that higher level by its target growth rate of 5% to 8% per year. It also accelerates TerraForm's plan to improve its balance sheet and provides additional cost-saving opportunities.
That deal somewhat overshadowed the fact that the company made substantial progress on its cost-cutting plan during the fourth quarter, keeping it on track to hit its goal to reduce expenses by $10 million this year. In addition to that, TerraForm already began working on phase two of that plan, which could cut another $15 million in costs by outsourcing some of its maintenance work. Finally, the company was able to refinance some of its debt, which significantly reduced its interest expenses and exposure to rising interest rates.
All signs point to a brighter future
Despite all this progress, shares of TerraForm Power are down double digits since Brookfield took control. Because of that, and the surprisingly higher initial dividend, the company offers investors an even more attractive yield that is increasingly likely to grow at a mid-to-high single-digit rate for the next few years. That steadily increasing payout, along with Brookfield's magic touch, could richly reward investors in the future.
