The global economy needs to pour trillions of dollars into renewable energy in the coming years so that it can transition to more sustainable fuel sources. Because of that, the sector has lots of growth potential, making it appealing to investors.
While there are several well-established renewable energy companies worth buying, others are emerging as attractive opportunities. Three that investors might not know just yet are Atlantica Yield (AY -1.49%), Covanta (CVA), and Enviva Partners (EVA). Here's why investors should consider adding them to their renewable energy watch list.
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A high yield from sustainable infrastructure
Atlantica Yield operates a diversified portfolio of clean energy facilities and other infrastructure assets. The company makes most of its money (66% of total cash flow) producing energy from wind, solar, and mini-hydro facilities in the U.S., Spain, South Africa, Uruguay, and Peru. The rest comes from natural gas power plants in Mexico (16%), power transmission lines in Peru and Chile (14%), and water desalination facilities in Algeria (4%).
Atlantica Yield has long-term contracts in place for 100% of the capacity of these assets. Because of that, they generate predictable cash flow, the bulk of which the company uses to pay a 6.7%-yielding dividend.
It uses the cash it retains and its strong balance sheet to invest in expanding its portfolio. Atlantica currently anticipates that it has enough growth opportunities to increase its dividend by 8% to 10% annually through 2022. On the downside, it does need outside capital to fund some of this growth, which increases risk. But if it can get the financing it needs, then it has the potential for strong total returns in the coming years.
Turning trash into cash
Covanta is a world leader in energy from waste. It operates 41 facilities worldwide that transform 21 million tons of garbage into 10 million megawatt-hours of clean power. The company also recycles metals.
Covanta's businesses generate relatively predictable cash flow, with 75% of its revenue backed by long-term contracts. That gives it the funds to pay an attractive 5.6%-yielding dividend. The company complements that payout with solid growth prospects. It currently anticipates that earnings will grow at a 3% to 5% annual rate as its existing operations improve and it benefits from the expansion of a joint venture in the U.K.
These initiatives have the company on track to grow its free cash flow from a range of $120 million to $145 million this year to as much as $250 million by the middle of the next decade. That will improve the long-term sustainability of its high-yield dividend while also helping bolster its balance sheet, which has an elevated leverage ratio. As its cash flow rises and debt comes down, Covanta will be on a more sustainable footing, which is what investors will want to watch.
Money can grow on trees
Enviva Partners is an MLP that produces wood pellets that utilities can burn as a cleaner replacement for coal to produce electricity. The company sells most of its production to customers in the U.K. and Europe under long-term fee-based contracts. That enables it to generate predictable cash flow, which it uses to fund an attractive distribution that currently yields 8.2%.
Enviva has lots of visible growth ahead. Organically, price increases on existing contracts and expansion projects at some of its legacy assets should help boost cash flow at a 7% to 10% annual rate over the next several years. The company can also acquire wood pellet processing plants and export terminals that its parent has under development. In the company's view, these two power sources could double its earnings by 2021.
What's not entirely clear, however, is how it will finance this growth since it pays out around 80% of its cash flow to support its distribution. If its unit price declines, for example, it won't be able to issue equity to fund drop-down transactions. That's why investors should keep a close eye on Enviva's ability to finance growth since that could hinder its lofty expansion potential.
Enticing renewable energy options
All three of these companies offer investors outsize yields and compelling growth prospects. But with those higher yields and growth rates comes a bit more risk. That's because it's not entirely clear how these companies will finance all the expansion opportunities they have in front of them. So investors will want to watch these stocks for now and consider buying once there's more clarity on how they'll fund growth.
