Is Pattern Energy Group a Buy?

The wind and solar company has a plan to improve.

Matthew DiLallo
Matthew DiLallo
Mar 24, 2019 at 2:06PM
Energy, Materials, and Utilities

When Pattern Energy (NASDAQ:PEGI) ran into several headwinds over the past year, it pressed pause on its dividend growth plan to shore up its financial situation. Those issues weighed on shares of the renewable energy company, which sank 13% in 2018.

This year, however, has been a different story. Shares have been blistering hot over the past three months, soaring 18% since the start of the year. That big-time rally likely has investors wondering if the company has any power left to continue moving higher.

A man in a green field with wind turbines in the background.

Image source: Getty Images.

Why Pattern Energy stock has been scorching hot this year

While Pattern Energy's headwinds continued during the fourth quarter, the company sees better days ahead. That was evident on its fourth-quarter conference call, when CEO Mike Garland provided a two-year outlook. He noted that 2019 would be a building year for the company as it worked to overcome some headwinds. Cash flow, consequently, will increase by only about 5% this year, much slower than the 14% growth it delivered in 2018. However, Garland sees an acceleration coming in 2020. As a result, the company should grow at a 10% annual rate over those two years. That fast-growing cash flow stream would enable the company to improve its dividend payout ratio from a concerning 99% in 2018 to a more comfortable 80% by 2020. By formalizing a longer-term growth strategy that will shore up its balance sheet and improve dividend coverage, Pattern Energy was able to win back the support of investors

What could keep the rally going

Even with this year's rebound, shares of Pattern Energy remain attractively priced. The company currently expects to produce about $175 million in cash flow this year, which implies that shares trade at roughly 12 times cash flow, given its approximately $2.2 billion market value. For comparison sake, renewable rival Brookfield Renewable Partners (NYSE:BEP) currently fetches 14.5 times cash flow, which is around the peer-group average. A mid-teens multiple would make sense for Pattern Energy, since it expects to grow cash flow at around the same rate as Brookfield Renewable over the next couple of years. Thus, the company's stock could continue moving higher to align its valuation with its peers.

Check out the latest earnings call transcript for Pattern Energy Group.

One catalyst that could push Pattern Energy's stock higher is if it can achieve the high-end of its 2019 forecast. After producing $167 million in cash last year, the company anticipates that it can generate between $160 million and $190 million in cash flow this year, or $175 million at the midpoint. While the company has a few headwinds negatively affecting cash flow, several other factors should more than offset these issues. For starters, it believes that better production at its wind farms and lower costs will provide $16 million in incremental cash flow. In addition, the company plans on using some of its liquidity to make an acquisition around mid-year that could add another $5 million to its bottom line. If the company can exceed these targets, it could give Pattern Energy the power to rally further.

A person with a laptop inspecting wind turbines.

Image source: Getty Images.


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What could knock the wind out of Pattern Energy's sails

On the other hand, if the company fails to make an accretive acquisition or isn't able to get better production out of its wind farms, then earnings could come in toward the low end of its range. That would be likely to weigh on shares.

Another potential issue to watch is its headwinds. The company noted on its fourth-quarter call that an upcoming contract expiration at its Gulf Wind project, along with congestion in Texas' electricity grid, would reduce cash flow by $7 million this year. This impact, however, is lower than initially expected because of an improving outlook for electricity prices this summer. If those prices, on the other hand, don't increase as expected, these headwinds could hurt more than the company currently anticipates.

Pattern Energy also must figure out how to finance the acquisitions needed to support its two-year plan. While the company currently has $200 million of liquidity, it needs $300 million to $500 million to fund its growth. On the positive side, it has multiple options available other than selling more stock. However, the company has yet to tap into these sources and might not be able to do so at an attractive rate if market conditions deteriorate. High-yielding renewable rival NextEra Energy Partners (NYSE:NEP) set the standard for alternative funding by securing financing from two leading alternative asset managers for its last two acquisitions. NextEra Energy Partners' second funding agreement was even cheaper and more flexible than the first, which sets the bar even higher for Pattern Energy. If the company ends up raising capital at a much high rate because of its weaker balance sheet, that could weigh on shares.

Verdict: Pattern Energy isn't a buy just yet

Pattern Energy believes it can grow earnings at a double-digit rate over the next two years, which will improve its financial profile and dividend payout ratio. However, the company faces an uphill battle because it needs to overcome some notable headwinds as well as raise funding to make the acquisitions needed to achieve its plans. That increases the risk level quite a bit, especially since shares are already up sharply this year, powered by optimism on that plan. I'd therefore hold off on buying shares of Pattern Energy until there's a bit more certainty that it can achieve its rather ambitious growth plan.