Over the next 25 years, global energy demand is expected to rise another 30%, according to a forecast by the International Energy Agency. That growing demand, along with increasing climate change fears, will drive investment in renewable energy. Because of that, companies operating in the space have the potential to expand at a brisk pace in the coming years, which could create significant value for their investors.
Three companies well positioned to benefit from this renewable powered growth are NextEra Energy Partners (NEP 2.99%), Pattern Energy Group (PEGI), and Enviva Partners LP (EVA). That's why they're at the top of my renewable-stock watchlist. Here's what I'm currently watching at each one before potentially adding them to my portfolio.
Image source: Getty Images.
A high price for its high-powered growth rate
NextEra Energy Partners owns clean-energy assets that currently consist of wind and solar power generating facilities in North America and natural gas infrastructure in Texas. The company sells the power as well as capacity on the gas lines under long-term contracts, which enables the partnership to generate steady cash flow. The company distributes a large portion of that cash back to investors in a dividend that yields 3.7%.
NextEra Energy Partners currently estimates that it can grow its high-yield payout at a 12% to 15% annual rate all the way through 2023. Supporting that outlook is the belief that the company can acquire clean energy assets from its parent, invest in organic expansions of its natural gas pipelines and the repowering of some wind facilities, and buy assets from third parties.
While that growth looks tantalizing, NextEra Partners' current valuation gives me pause. Shares trade at more than 20 times cash flow, which is much higher than most other yield-focused renewable energy stocks. That's why this high-powered renewable stock will remain on my watchlist until its valuation falls into my comfort zone.
So much for the streak
Pattern Energy Group owns wind and solar generating facilities in North America and Japan. These assets also produce stable cash flow backed by long-term contracts, the bulk of which Pattern Energy distributes to investors in a payout that currently yields 8.8%.
The company believes it can grow cash flow at a high single-digit to low double-digit annual rate on a per-share basis through 2020. Driving that outlook is the company's view that it can roughly double its renewable energy portfolio via acquisitions. The company has already identified about half the assets it needs to support that growth, which increases the likelihood that it will meet that goal.
What I'm watching is if the company has access to enough capital to achieve that ambitious target. One cause for concern is that the company recently broke its streak of increasing its dividend each quarter, so that it could retain more cash to finance growth. Because of that, I'd like to see more clarity on how it intends to finance expansion going forward before I'd consider adding Pattern Energy to my portfolio.
Image source: Getty Images.
Tight coverage at the moment
Enviva Partners is a master limited partnership that manufactures utility-grade wood pellets, which are used in biomass energy generating facilities in Europe. The company sells them under long-term contracts, which provides it with stable cash flow. Enviva distributes the bulk of that money to investors in a payout that yields 8.7%.
Enviva has three growth drivers that should support its ability to increase that distribution in the coming years. First, a combination of price increases under its existing contracts, cost reductions, and productivity improvements should yield 7% to 10% annual organic cash-flow growth. Second, the company has a visible pipeline of acquisition opportunities from its sponsor, including one production plant drop-down planned in each of the next two years. And last, it has the potential to acquire assets from third parties. These three growth drivers could nearly double its earnings over the next few years.
What I'm watching at Enviva is distribution coverage. Due to a fire at one of its facilities, coverage was a concerning 0.46 times during the first quarter, meaning the company distributed more than twice as much cash to investors as it pulled in during the quarter. Meanwhile, the company estimates that coverage will be below 1.0 times in the second quarter. While Enviva aims to get it back above its historical average of 1.1 times by the end of this year, that's still a tight level for a company that needs capital to make acquisitions. Because of that, I'd like to see the number rise above 1.2 times before I'd invest in this high-yield stock.
Nothing wrong with showing some patience
While I like the potential of all three companies, there's just something about each one that has me refraining from buying just yet. That's why I'm content to keep them on my watchlist for now. However, just because I won't buy these stocks doesn't mean I'm avoiding all renewables. Instead, I recently bought more of these two top renewable stocks.
