TerraForm Power (NASDAQ:TERP) has transformed into an excellent dividend stock since Brookfield Asset Management (NYSE:BAM) took control of it a couple of years ago and implemented its turnaround strategy. Overall, the renewable energy company has generated a more than 18% total return since Brookfield came on board.
One of the big drivers of that return has been TerraForm's dividend, which it reinstated last year. The company has already boosted its payout twice, and the stock currently yields 5.5%. Management expects to increase the payout at a 5% to 8% annual rate through 2022. However, higher-end growth rates just became more likely due to the company's latest move: On Monday, it announced its second major acquisition since parent Brookfield initiated its transformation plan.
Bolstering its solar platform
TerraForm Power will purchase a distributed, 320 megawatt (MW) generation platform from AltaGas for $720 million. The assets, which consist primarily of solar panels attached to commercial and industrial buildings, are spread across 20 states, and sell power under long-term, fixed-rate contracts to more than 100 customers.
This deal does several things for TerraForm Power. First, it increases the size of its distributed generation portfolio to 750 MW. That larger scale will lead to lower operating and maintenance costs on a per-MW basis, improving the profitability of the entire platform. Meanwhile, the portfolio will generate stable, long-term cash flow for the company. Management expects the deal will be modestly accretive to its cash flow available for distribution per share in 2020, as well as over the next five years. That cash flow boost will enhance the company's ability to accelerate its dividend growth.
On top of that, TerraForm sees additional upside potential in cross-selling more services to its commercial and industrial customers, such as energy storage and back-up generation.
Eventually enhancing its balance sheet
TerraForm Power initially expects to finance the acquisition with debt. On the one hand, that's a bit of a concern since the company's balance sheet isn't one of its strengths. With its leverage ratio above its targeted level, it currently has a non-investment-grade credit rating.
However, with Brookfield's assistance, TerraForm has significantly improved its financial profile over the past year. Its leverage ratio has been dropping, and should be closer to its target by year-end. Those improvements recently earned it a credit rating upgrade that put it closer to investment-grade territory.
The company's wider strategy around this deal is intended to further improve its financial profile. The plan is to sell a minority stake in some of its North American wind assets, and use the cash to reduce debt. TerraForm anticipates that it can generate $245 million in proceeds from this capital recycling program. That strategy of selling more-mature assets and reinvesting the proceeds in higher-returning opportunities is quite common among Brookfield's affiliates. It enables them to make needle-moving acquisitions without diluting existing investors or carrying too much debt. Once TerraForm completes those sales, it will allow the company to structure this deal to investment-grade levels.
Doing so would put the company another step closer to its goal of restoring its bonds to an investment-grade rating level. That's vital for TerraForm's long-term sustainability since it's easier to borrow money at cheaper rates with an investment-grade credit rating. Lower interest rates on its debt would allow the company to generate even higher cash flow, which it could use to grow its dividend.
A solid deal for TerraForm Power
TerraForm Power's latest purchase will immediately boost its cash flow per share while adding longer-range upside potential. On top of that, the transaction will enhance the company's financial profile once it completes its capital recycling initiatives. That combination could enable the company to grow its already high-yielding dividend by percentages near the top of management's forecast range over the next few years, making it an even more appealing stock for income-seeking investors.