TerraForm Power (TERP) is a global renewable energy company that has made the news recently with talks of a possible merger with Pattern Energy Group (PEGI). Not all energy companies are created the same, and I'll compare Terraform Power with two of its competitors: Canadian Solar (CSIQ 1.33%) and American Electric Power (AEP 1.30%).

Image source: Getty Images

Image source: Getty Images

  TerraForm Power American Electric Power Canadian Solar
Yield 4.84% N/A 2.95%
Dividend per Share $0.20 N/A $0.67
Capacity 3.7 gigawatts 4.6 gigawatts 2.6 gigawatts

Canadian Solar

Founded in 2001, Canadian Solar manufactures solar panels and generates and sells energy from solar projects throughout the world. There are three reasons why I would stay away from this stock. 

First, it's getting cheaper and cheaper to buy panels, and this is hurting Canadian Solar's revenue. Q1 2019 revenue was $484.7 million, compared to $1.42 billion in Q1 2018. The decline was in part due to its sale of assets in the first quarter, but the pricing pressure remains a long term concern.

Canadian Solar has difficulties lining up enough work to keep their factories in steady production. The feast or famine production cycle hurts their ability to retain their talent and increases costs of producing the next run. This, combined with the decline of the price per unit, hurts Canadian Solar's margins. 

At the beginning of 2019, the Chinese government announced that it wouldn't support any further large solar or wind farms until the prices of renewable energy fell in-line with electricity generated from coal. Proposed renewable energy projects will also need to demonstrate they will not overload the Chinese power grid. As a result, Canadian Solar's ability to generate new revenues from new projects in China is hampered. 

All of these developments hurt Canadian Solar's bottom line, which is why I'm avoiding this stock. 

American Electric Power

American Electric Power (AEP 1.30%) is one of the largest electricity producers in the United States and serves over 5.4 million customers. It's invested heavily in renewable energy projects and continues to expand its transmission capabilities.

American Electric Power's stock has experienced a steady increase in the past twenty years. It's what an electric company is supposed to be: stable with moderate growth and an eye on developing further assets and a regular dividend.

The concern with American Electric Power is that it is exclusively focused on the United States' domestic market. There are indications of a looming recession, and with recessions comes declines in the use of electricity. This exposes American Electric Power to certain geographic risks that Canadian Solar and TerraForm Power are not as exposed to.

A closer look at American Electric Power's balance sheet shows it's holding a lot of debt. As of June 30, 2019, the company had a debt-to-equity ratio of 1.29. To put this number in context, in 2018, Moody's ranked the average debt-to-equity ratio for the utilities sector as 0.68. American Electric Power's debt accrued because of its investment in transmission and generation, but when going into a recession, having significant debt hurts a company's ability to weather the storm. If it had to sell assets to raise cash, again, during a recession, it would receive lower prices.

Terraform Power

TerraForm Power was created by SunEdison as a holding company for wind and solar farms. The company had a difficult start, was brought to IPO, and had negative growth for years, until Brookfield Asset Management stepped in and bought a majority stake. Brookfield created a turnaround plan, and it appears to be paying off. In 2018, TerraForm Power bought Spanish renewable energy company Saeta and added over 1,000 megawatts to its capacity.

Despite TerraForm Power's rocky start, it's the strongest company of the three. TerraForm Power has consistently lowered its debt ratio. Five years ago, its debt was 317%, and in August 2019, it was 215%. Those are big numbers but when combined with its non-US-based revenue, it should have the ability to further pay down its debt.

The difference between TerraForm Power and American Electric Power are the trends. American Electric Power is accumulating more debt in the coming years, but the company's revenue is projected to remain even through 2023. However, TerraForm Power is on a trajectory to repay its debt and grow revenue by 2021.

Another critical distinction between the two stocks is TerraForm Power's management is committed to an annual dividend increase of 5% to 8% through 2022. Neither Canadian Solar's nor American Electric Power's management teams have made that commitment.

TerraForm Power can gain from falling manufacturing costs, whereas that will hurt Canadian Solar. TerraForm Power isn't as exposed to the Chinese market as Canadian Solar and has adopted a strategy of focusing on fragmented energy markets.

When these factors are taken into consideration, TerraForm Power is the strongest performer of the three companies.