Fast-growing industries like alternative and renewable energy can be exciting to follow, and some stocks can turn into multibaggers for your portfolio. But a fast-growing industry can also be filled with companies that have little hope of making it, so investors always need to tread carefully and not just buy anything with the words "renewable energy" associated with it.
We asked three of our Motley Fool contributors to look across the alternative-energy landscape and pick three stocks worth buying today. They chose TerraForm Power (NASDAQ:TERP), SolarEdge Technologies (NASDAQ:SEDG), and Brookfield Renewable Partners (NYSE:BEP).
Getting its act together
John Bromels (TerraForm Power): Solar- and wind-farm owner TerraForm wasn't in great shape when Brookfield Renewable Partners, a subsidiary of Brookfield Asset Management, took a majority stake in the company. But since then, TerraForm has done a remarkable job getting itself back on track, to the point that it's now looking like a top pick in the solar industry.
Thanks to Brookfield's expertise, TerraForm has made several operational and financial changes that have set it up for outperformance. Operationally, TerraForm completed its purchase of Spanish wind and solar company Saeta Yield, and has begun handing over operations and maintenance duties for many of its wind farms -- including some of Saeta's -- to the farms' wind turbine manufacturers, which should save it some $24 million in operational costs.
Financially, TerraForm looks on track to reduce its leverage ratio to management's target of between 4 and 5 times cash flow by the end of 2019. That should help the company make good on its projected annual dividend increases of 5% to 8% through 2022 while maintaining a payout ratio of just 80% to 85% of cash available for distribution. Put together, TerraForm's moves should give its management team the financial flexibility to pursue additional growth projects.
The market has caught on to TerraForm's excellent prospects, bidding its stock up more than 25% so far this year. But it is still yielding about 5.6%, a higher rate than most utility stocks. It's not too late to buy into this great turnaround story.
An easily overlooked player in the future of renewables
Jason Hall (SolarEdge Technologies): When it comes to solar, the panel makers tend to get a lot of the headlines. And rightly so, since they are on the front lines of meeting the demand for this high-growth sector of global energy.
But at the same time, they haven't really proven to be the best investments as a category, with many of the biggest panel makers taking huge losses in recent years as supply and demand pressure has taken its toll on panel prices.
I think to some extent, that has caused many investors to overlook the potential for SolarEdge, which makes a living mainly supplying solar panel power-management components, like inverters and power optimizers. These key parts are the go-between pieces that convert power from panels so that your home and the power grid can use it, and also maximize and balance the power that panels generate.
And over the past few years, business has been really good:
SolarEdge is recognized by panel makers and independent installers as a go-to partner for these components, and its market share continues to grow.
And while that's probably enough reason to buy SolarEdge, there's even more to like. More recently, management took a bold step to build a more diversified business in segments that overlap its strength in solar -- specifically, energy storage systems, and electric vehicle powertrain and recharging systems.
It's early in the company's plans to fully develop these new segments, but it has made enormous progress already on moves that should start adding to the bottom line very soon. Based on this management team's past success, I expect those moves will pay off for investors for years to come.
Staying disciplined in a high-growth, low-return world
Tyler Crowe (Brookfield Renewable Partners): There is no denying the immense growth opportunities in renewable and alternative energy right now. What the industry lacks, though, are new projects and developments that can generate high rates of return over the long haul. According to the Bloomberg new energy finance report, the internal rates of return for a renewable energy project in North America or Europe ranges from 7% to 10%. That's not great when you consider that many of these projects require large amounts of debt.
This is what makes Brookfield Renewable Partners unique. While it is a major player in solar, wind, and hydroelectric power, it eschews chasing high-valuation, low-return projects for growth's sake and instead focuses on special value situations when they arise.
The deal to acquire a portion of TerraForm Power was a great example of this as it was able to buy the controlling stake in TerraForm Power and TerraForm Global when their parent organization went bankrupt. Since 2014, the company has executed three special-situation deals like TerraForm Power that have all produced returns in excess of 18%.
Deals like this don't come up every day, but Brookfield makes up for it by using its scale and operating expertise to squeeze more out of these assets once purchased. Management estimates it can get 6% to 11% annual growth in cash from operations from these improvements alone, so any deals on top of that can lead to significant boosts to returns.
One of the hardest things in a fast-growing industry is to stay disciplined. Companies tend to get calls for growth lest they "fall behind" their peers. But Brookfield has been able to prove over the years that it doesn't have to chase growth to produce respectable returns for its investors, and that bodes well for the long-term future of this renewable energy stock.