Earlier this year, TerraForm Power (TERP) laid out an ambitious long-term plan. The renewable-energy company wants to increase its dividend -- which currently yields 4.7% -- at a 5% to 8% annual rate through 2022 while maintaining a healthy payout ratio. That dividend growth strategy potentially sets it up to generate market-beating total returns.
While TerraForm is only a few months into its growth plan, it has already delivered strong results. That was one of the key themes of the company's second-quarter conference call. Here's why the company believes it's well positioned to achieve its dividend growth plan.
Our previous actions are paying dividends
TerraForm's CEO John Stinebaugh led off the call by saying:
Earlier this year, we provided a road map for our growth plan to achieve a 5% to 8% annual dividend increase through 2022 with a payout ratio of 80% to 85% of CAFD [cash available for distribution]. During the quarter, we're pleased to report that we continued to deliver upon this growth plan, including the following highlights. First, we generated CAFD of $47 million or $0.22 per share for the quarter and $91 million or $0.44 per share for the first half of the year, reflecting per share growth of 16% and 29%, respectively.
As Stinebaugh points out, TerraForm's cash flow has surged this year, which is increasing the probability that it will achieve its dividend growth plan. He noted that "these results were primarily driven by the accretion from the acquisition of our European platform and our margin enhancement initiatives." The company's cost-cutting moves alone added $5 million to the bottom line during the quarter and should boost its cash flow by $30 million this year and $53 million at their full future run rate. Add that to the boost it's getting from the acquisition, and it has all the power needed to achieve the low-end of its dividend growth plan.
We opportunistically added a bit more power to the plan
While TerraForm already has everything in place to deliver on its growth plan, that didn't stop it from pouncing on an opportunity to enhance its prospects. It did that by acquiring a 320-megawatt portfolio of distributed generation (DG) assets -- which are those that produce energy near end users -- for $720 million. Stinebaugh noted that the deal "nearly doubles our DG business and provides significant opportunities for future cash flow growth through operational and commercial synergies."
He pointed out that the company "expect[s] to generate returns on this investment within our targeted range of 9% to 11%, and we expect the acquisition to be modestly accretive to CAFD in 2020 and over the next five years." It will therefore enhance the company's ability to deliver on its dividend growth plan.
Meanwhile, TerraForm sees lots of upside potential with this transaction. While the assets will provide it with predictable revenue backed by long-term contracts that lock in power rates, it has several opportunities to boost cash flow. First, Stinebaugh noted that "our business plan is to reduce costs by leveraging the scale of our combined 750-megawatt distributed generation portfolio." He then stated that "we will also seek opportunities to extend the life of our existing contracts at rates that exceed our underwriting assumptions and to extract incremental value from the portfolio by cross-selling products such as storage and back-up generation to commercial and industrial customers." The company's ability to drive down costs and increase revenue will enable it to turn a modestly accretive deal into an even bigger needle-mover.
Plenty of power to deliver on its plan
Last year's acquisition of a European renewable company will provide TerraForm with most of the cash flow growth needed to achieve its dividend enhancement strategy. However, it couldn't pass up on an opportunity to get an additional boost by making another deal. So it's increasingly likely that TerraForm will be able to grow its dividend toward the high-end of its target range. That makes it an excellent stock for income-seeking investors to buy for the long term.