In this episode of Industry Focus: Energy, Nick Sciple and Motley Fool contributor Matt DiLallo talk about energy stocks worth a look, why you need to understand what you're buying, and the ins and outs of yieldcos.
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This video was recorded on May 14, 2020.
Nick Sciple: Welcome to Industry Focus. I'm your host Nick Sciple. We've got a great show for you this week. It's been a rough few months for energy between the pandemic, the oil price war between Saudi Arabia and Russia. And we really haven't had a lot of nice things to say about a lot of energy companies. There's been a lot of rough-looking issues out there right now.
This week, we thought it might be fun to talk about some areas in energy where you might be able to invest today, not have to hold your nose, and maybe get a decent return over the next several years. To help me break that down is Industry Focus contributor, Matt DiLallo. Matt, how's it going?
Matt DiLallo: It's going pretty good; how are you doing?
Sciple: I'm doing alright, just like everybody else, you know, kind of, making it through day-by-day, but I am excited to talk about energy with you, as I am excited to talk about energy every week.
Before we dive into some renewable yieldcos that you think are attractive right now, let's just talk about the state of energy investing. As I said off the top of the show, it's been a rough few months, what's it been like to be covering this sector?
DiLallo: It's been interesting, to say the least. They bandied the word, "unprecedented" so many times, and that's really, probably, the only word you can describe negative oil prices and bankruptcies that are beginning and just the demand destruction, nobody has ever seen anything like this. And so, it's made for very interesting topics to cover.
Sciple: Yeah, just one of those companies you talk about, about demand destruction, we talked at the beginning of the year, January 9th, about Chesapeake Energy as a company that was in a particularly fragile position. Obviously, we didn't expect this global pandemic to take place and really decimate the company, but you look, we talked about this company as a bad place to invest your money; I saw really high Robinhood ownership back on January 9th. Since then the stock is down 95%, Matt, what has been going on? How has this stock collapsed so much? And why are we so smart?
DiLallo: Well, so when Chesapeake started the year, they had, I think, it was, like, $9 billion of debt and, I think, $300 million of that was due this year, and so they weren't going to be able to refinance that, they have terrible balance sheet, so they had to sell assets. Well, asset prices have collapsed with oil prices, so they can't sell assets. And without being able to sell assets, they just won't be able to pay this debt, they just don't have any options other than filing for bankruptcy. And that's going to happen, there's just no way around it.
Sciple: Right. And that was probably something that was going to occur whether or not this pandemic took place, but it was certainly accelerated over the past few months, as you said, by not being able to sell off assets, that sort of thing. Ironically, when you look at Robinhood ownership data through April 14th, Robinhood ownership of the stock was up roughly 80% over that period. And why isn't there no data after April 14th, they did a 1:200 reverse split. So, I think a lot of people flooded into the stock seeing oil prices had declined and maybe this is a chance to pick up something on value. It's a lesson to understand what you're buying, fundamentally what this company provides, and that, there's a lot of companies that might look cheap relative to where they traded three, four, five months ago but that doesn't mean it couldn't go even much lower.
DiLallo: Yeah. And the big thing with companies like Chesapeake is the asset values. Yeah, so oil prices will pick up, but still that's going to depress asset values. And so, they can't sell assets and banks can't lend them money based on the value of the oil and gas in the ground. But with oil at $30 a barrel, they just can't drill most of the wells that they have available. So, there's just no value there. And that gets into the solvency situation. They're just not worth -- you know, who knows what they're worth, because we don't know what oil prices are going to do tomorrow.
Sciple: Yeah. So, this is one of these founding companies of the shale boom. Aubrey McClendon was one of these iconic figures as the business grew up, but like a lot of these shale companies, when the rubber meets the road, structurally unprofitable, and so they're probably headed for bankruptcy. Ironically, you noted this to me, Matt, they just paid out a big bonus to their executives as they are preparing for bankruptcy or reportedly preparing for bankruptcy, similar to what Whiting Petroleum did.
DiLallo: Yeah, and it just shows that sometimes these companies, they're not looking out for shareholders, here they're giving 21 executives, $25 million for basically burying the company. And that's so, they can stay on and do what, you know, to destroy more shareholder value? And it's just been disappointing to watch what some of these companies do. Instead of protecting shareholders, they're protecting themselves and they really should be ashamed.
Sciple: Yeah. You see this a lot with companies going into bankruptcy. You know, it is what it is, I suppose. So, pivoting after what we talked off the top of the show, we want to bring some cheer and some happiness and some positivity to this show. I know it's been rough in energy. So, one sector that is showing some stability, is holding up well for shareholders during this period are renewable yieldcos. And our friend CamKayne on Twitter tweeted me asked us to talk about renewable yieldcos, so we're going to talk about them right now.
First off, for folks who aren't familiar with these businesses, what are they, what is a renewable yieldco?
DiLallo: Yes. So, renewable yieldco. If you're familiar at all with MLPs and that kind of thing, they do a similar thing, they're these investment vehicles that focus on owning assets that generate cash flows. In this case, it would be, you know, big solar farms, big wind farms, they sell the power primarily to other utilities or big companies like Facebook or Google [Alphabet] that need to run data centers. And so, they'll sell it on a fixed-price contract. So, they're basically guaranteed an offtake. So, whatever power they produce, these companies have to pay them a set rate. And so that insulates them from volatility.
And you know, that's been one of the big things that I've noticed just going through first quarter earnings, as companies that had exposure to volumes or prices, they're just doing terrible, but those that have these fixed-priced contracts, they are holding up really well. A lot of the utilities, you know, they're not making any changes to their plans. And so, that's, kind of, one of the things I like about renewable yieldcos is that they're holding up pretty well.
Their stocks went down, but they picked up back a little bit, but it's still, if you're looking for something that's going to be stable in what still looks like a pretty unstable environment, they're really interesting to look at.
Sciple: Right. This is one of these where you have contracted cash flows, where whatever energy you produce, your customers are required to provide, and importantly, these counterparties are going to be really strong, you mentioned these strong tech companies, probably going to be utility companies, these are businesses that are unlikely to default. Now, we'll talk about [laughs] one later, with PG&E, that did and that's a special circumstance, but generally, your counterparties here are going to be really strong. And you add in these stable cash flows, it's going to be difficult to not get paid out on those contracts.
DiLallo: Yes. So, Clearway Energy, they basically operate, kind of, three different businesses. They've got the renewables, your solar farms and your wind farms. And then they have a bunch of natural gas power plants that do similar things, they'll sell the power that these plants generate under long-term contracts to the utilities. And then they have thermal, which is district energy, you'll see these in a lot of big cities, where they have like a central heating and air conditioning type system and it provides energy to these buildings. And so, all long-term contracts and very stable.
They are owned by Global Infrastructure Partners. This is a very big P&E firm; they took control in 2018. And they also have what's called a sponsor, which is Clearway Energy Group that kind of like develops renewable energy projects. So, they've got this steady stream of projects that's going to come down. And so, they've got visible growth. So, you've got these two different aspects of this strong, underlying business and then these parents that, kind of, provide them with opportunities.
Sciple: Yeah, so when you look at this private equity as a large shareholder, how do you think about that as an investor, obviously, they want to manage that to a positive return, but then, there is some concern that maybe they want to divest that stake at some point in time. So, how do you think about that ownership stake when you think about investing in the stock?
DiLallo: Yeah, that's definitely a concern. Anytime you've got somebody else that has control. And in the case of Clearway, there are two share classes; an A. and C. And the A. class has much more voting power, and so they definitely have that control. And so, you really need to be able to trust that management.
And Global Infrastructure Partners, they are one of the really smart investors out there. They have their hands in a lot of different things. So, I trust them more than some of the other private equity firms out there, because they're really long-term investors.
Sciple: Absolutely. And so, I teased earlier that we might talk about one of these scenarios where there was a counterparty, who was one of these big utility companies that did get into some trouble that put the company in a little bit of hot water. In that case, for Clearway Energy, it's PG&E.
Obviously, many people are familiar with the California wildfires that were eventually attributed to PP&E [PG&E] (sic) in which they were found liable for, which led to the company declaring bankruptcy. How is that affecting Clearway Energy?
DiLallo: Yeah, so Clearway Energy had to cut their dividend, because a lot of the projects that they sell power to PG&E have financing components to them. And the lender said that they had to restrict the cash. And the concern is, in these bankruptcies, sometimes one of the outcomes is that they adjust the contracts. Now, that doesn't appear to be the case here and PG&E has continued to pay the contract, so that cash has been building up.
And so, once they clear through the bankruptcy, they'll have access to this cash and the cash flows going forward. So, they've actually said that they're going to normalize their dividend and then they're going to use it as cash to buy some wind projects that they are going to drop down.
But you know, that is a concern. And something that we probably don't even think about too much is counterparty exposure. And in this case, they had a lot of exposure to PG&E, which before all the bankruptcy issues and fire issues, it was a great counterparty; they are one of the stronger utilities. But it is an issue that investors really need to look at going forward is what is, like, worst case scenario risk, because as we've seen worst case scenarios can come before you expect them.
Sciple: Absolutely. Any of these contracts are only as good as your counterparty's ability to fulfil them; as appealing as they can look. Yeah. So, I think this is an important thing to understand about bankruptcy, what happens when a company goes into bankruptcy. As soon as the company declares bankruptcy, it has created this bankruptcy estate, which is this fictional entity that, kind of, replaces the company. A trustee takes over control of that, and the estate's job is to funnel all of the assets, pool all the assets that the company controls in order to divvy those out to all the different claims, both secured and unsecured on the company.
And so, what's happening in this case, is these payments to Clearway Energy are getting put in a lock box, while the bankruptcy is ongoing, to preserve those assets. And when the bankruptcy is cleared, the claims that Clearway Energy are determined to be entitled to will be divvied out to them. And as Matt mentioned, there's a chance that those contracts can be altered; that is one of the advantages of bankruptcies, you get some of these abilities to alter contracts, get out of leases that sort of thing, but by all indications, Matt, it appears these are unlikely to be modified in bankruptcy.
DiLallo: Yeah, that's what Clearway has, kind of, been indicated in the fact that there's been no discussion of that in the bankruptcy's proceedings. And they are very close to exiting; I think the judge is supposed to review it very soon. So, it looks like a pretty sure bet.
Sciple: Okay. And so, then coming out of this, what opportunities this creates for Clearway to grow its dividend and return value to shareholders?
DiLallo: So, right now they yield 4%, which is pretty decent and they're paying out about 50% of their cash flow. And a yieldco, they'll pay out up to 80%. So, you could actually see a pretty decent jump in the dividend once this happens. And then they're going to use some of that restricted cash to buy some wind projects, that's going to add another 5% to their cash flow. And so, I think you're going to see some significant growth over the next year out of that.
And then, with these relationships they have, and then the steady cash flow they're generating, I really think that you're going to see just steady growth from them going forward. They really look like one of the, kind of, interesting opportunities in the yieldco sector.
Sciple: Right. A nice, reliable, steady dividend that you can expect to increase meaningfully when this overhang from PG&E goes away?
Sciple: And just to layout those tickers to folks, we didn't mention them. So, it's CWEN and CWEN.A, and the voting shares are CWEN.A. Correct, Matt?
DiLallo: Correct, yeah.
Sciple: Okay. So, the second company, the second yieldco we're going to talk about today is Atlantica Yield. How is Atlantica Yield different from Clearway Energy?
DiLallo: Yeah. So, Atlantica Yield operates what they call sustainable infrastructure. A lot of similar assets, you've got the renewable energy aspect, the natural gas, power plants, but then they've got some other infrastructure; electricity transmission, water desalination, and then they're buying a Gulf of Mexico natural gas transportation business.
So, in a sense you've almost got like a mini Brookfield Infrastructure/ Brookfield Renewable Energy going on, because those are very similar businesses that those two own. So, they're really focused on what's sustainable. And going forward, a lot of growth in those types of businesses. Water is a huge growth business. A lot of investment is needed there. And of course, electricity transmission. You can build a wind farm out in Iowa, but then you'd need the transmission to get that to the cities. So, really interesting businesses.
Contractors secure cash flow, they pay almost a 7% dividend because they pay out much higher. So, really interesting business as far as what they own. And then they have a lot of growth too. They've got an option to buy a U.S. solar farm that will be meaningful, and then the Gulf of Mexico offshore business that they have the option to buyout, and then they just started a renewable energy partnership in Chile that just bought something. So, a lot of visible growth and that will fuel dividends.
Sciple: So, Matt, when you look at the water business. I think that's interesting to Atlantica Yield, obviously, it's different from Clearway. I don't see these all over the place. We mentioned the customer base for the electricity assets might be one of these big tech companies or a utility. For the water assets, would these be water utilities. Who are the customers in this case?
DiLallo: Actually, in this case, they're in Algeria, of all places, and it's a national oil company of Algeria they have these contracts with in this case. So, a lot of times your big industrial companies will need fresh water, whether they're processing -- the mining industry, for example, uses a lot of fresh water. So, there could be growth to, kind of, develop some of those types of assets or buy some of those type water assets. And again, long-term contracts, whatever they produce, the customer has to pay for.
Sciple: Yeah. And so, a reminder on the ticker here. it's AY. As between Atlantica Yield and Clearway Energy, do you have a clear preference there?
DiLallo: I think that there's a little bit more upside in Clearway right now, just because once the overhang of PG&E happens, you know, we're going to see a big dividend boost. And I think that could jump the share price a little bit.
Sciple: Yeah, a little bit of a special situation there going on. One thing I want to address, we did have one other attractive option in energy to talk about. But I think when we talk about yieldcos, we don't talk about this off the top.
When you're investing in renewables, what is the advantage of investing in a yieldco versus some other renewable investment options, whether it's a solar company or component maker that sort of thing?
DiLallo: Yeah. So, as we kind of talked about, top of the show, volume is a big thing, and you don't have the volume issues with yieldco, but with a solar power manufacturer. Right now, the demand for solar panels, for example, is down because, you know, we can't build things right now. And so, volume for them is going to be impacted. And they're very price sensitive when there's not a lot of demand for things. So, there's that volatility there. And you're not going to have that volatility in a yieldco.
And you know, there are some utilities that you could buy that have a lot of renewable exposure, but this is kind of as pure play as you can get in renewables without that volume issues. And now, yieldcos, they've had problems in the past, we mentioned with the counterparties and some of them got a little overextended, your TerraForm Power and Pattern Energy back in the day, they had some issues, but I think they've, kind of, learned from those issues of how can we operate these business as sustainable. We're all about sustainability and the environment, so we need to have sustainable businesses. So, I do think that they've, kind of, finally figured out the best business model that's sustainable for them. And I think that makes them more attractive for people that are just looking for steadiness in their portfolio.
Sciple: Right. You want exposure to renewable energy, but you don't want to have to time the market based on macro factors and that can really influence demand for the solar panels, in particular.
DiLallo: Right, yeah.
Sciple: So, OK. So, away from the renewable energy yieldco space, any other areas in energy that you would be, I don't know about super-excited, but you wouldn't have to hold your nose to jump in and buy shares right now?
DiLallo: Yeah. So, I cover a lot of pipeline companies, and I've been doing that for several years. And I've seen that there's a big difference in the, kind of, two different pipeline sectors. You've got the ones that have a lot of volume exposure. So, you know, they gather and process oil and gas from the wells and places like the Permian Basin. Well, they're cutting off the wells, because they are just no longer profitable.
But a lot of natural gas demand. Natural gas demand has been surprisingly steady, even though industrial has been down. So, TC Energy, it's a Canadian pipeline company. They're one of the biggest energy infrastructure companies in North America, major gas business in Canada, the U.S. and Mexico. A lot of their contracts are what they call take-or-pay contracts, which means the customers have to pay them even if they don't use the volumes, which is great for steady cash flow. So, again, counterparty, as long as the counterparties continue to pay them, you're going to continue to get that cash flow. And they actually, I think, would have probably the safest dividend in the pipeline sector, 40% of their cash flow, they use to pay the dividend. A lot of others, like your Kinder Morgans, you know, they're up 50%; Enbridge, closer to 60%. And then, some of the MLP, they're 80%, 90%.
So, a much more sustainable dividend, top-tier balance sheet and then growth. A lot of these companies don't have any growth anymore, but they've got, like, CAD$40 billion worth of expansion projects in the backlog, including the Keystone XL Pipeline, which is just moving forward. So, they actually expect to grow their dividend 8% to 10% next year and 5% to 7% after that. So, you've got a stable demand, lots of growth, it's probably my favorite right now in the pipeline sector.
Sciple: That's ticker TRP on the U.S. exchanges. So, Matt, when you look at their pipelines, where are they located geographically, what types of producers are they servicing?
DiLallo: Yes. So, they're all over. They've got natural gas pipelines, like I mentioned, Canada, the U.S. and Mexico. They're focused on a lot of the big gas plays.
So, the Marcellus Shale. They've got a big business that takes gas out of the Marcellus and ships it down to the Gulf of Mexico where you're getting those exports. The same thing in Canada, they're actually building an export pipeline to support Shell's LNG Canada project. So, they're connecting these gas basins to those types of regions.
Then they have an oil business. The Keystone Pipeline is a big one. And they also generate power, and they sell it, kind of, the same way, where it's that, those long-term contracts. However, nuclear. They're a big nuclear power producer in Canada. They have a big nuclear plant. So, a lot of diversification, a lot of exposure to different sectors.
Sciple: Yeah, and then, Matt, last thing, we talked earlier on the renewable yieldcos, the importance when it comes to these contracts of counterparties. Who would be TC Energy's major counterparties?
DiLallo: A lot of them are your utilities on the gas side. And then on the pipeline side, you've got a lot of the strong Canadian companies like Suncor Energy and Canadian National Resources for their pipelines. So, very strong counterparties. Any of them, they're going to have, you know, some weaker links, but overall, I think, it's something, like, 95% of their counterparties are investment grade or something similar. So, that's very good to see.
Sciple: And some of those companies you mentioned are pretty important to the Canadian economy when you think about it.
Sciple: Okay. So, concluding, I think those are three stocks that right now in the energy sector, you know, we could go buy and not worry about too much. Matt, when you're looking out over the next six months as an energy investor, how optimistic are you for conditions to improve for shareholders?
DiLallo: You know, it's really interesting out there, because you really need to see demand come back. And so, if demand for gasoline doesn't come back quickly, then we're going to continue to have this big overhang. And anecdotally there's some evidence out there where gasoline demand has started to come back in some places, if that happens, then they can burn some of the supply, and then you don't have the storage issues.
But you know, if there's a second wave or with unemployment being down where it is, there's just so much unknown. So, I'm particularly, like, being careful of things that are volume-driven.
And we just don't know what's going to happen, we've never been in this situation as a global economy, so I'd err on the side of caution.
Sciple: I agree with you completely. I think the phrase of the year is "I don't know."
DiLallo: [laughs] Yeah, definitely.
Sciple: Matt, thanks, as always, for hopping on the show.
DiLallo: Hey, thanks for having me.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Austin Morgan for making us all sound so great. For Matt DiLallo, I'm Nick Sciple, thanks for listening, and Fool on!