Oil and gas stocks are so last year (at least, that's when lots of investors wish they'd sold their oil and gas stocks). With plenty of volatility in oil prices, renewable energy stocks are looking a lot more attractive to investors.
One top renewable energy pick is recent outperformer Brookfield Renewable Partners (BEP 1.16%). Managed by the capable team at Brookfield Asset Management (BAM 0.42%), Brookfield Renewable's unit price growth has skunked the market over the last three years -- up 51.3%, compared to just 23.8% for the S&P 500. And that's without factoring in its handsome yield.
But when a price rockets up so fast, it could be overvalued. Let's look closer and see if Brookfield Renewable still looks like a buy.
Barely a blip
Lots of companies have seen their operations hit hard by the coronavirus pandemic. Not Brookfield.
Brookfield Renewable is a master limited partnership (MLP) that makes money by selling the energy produced by its portfolio of renewable assets -- mostly hydropower, but also a growing collection of solar and wind farms. Ninety-five percent of Brookfield's generation is secured by fixed contracts, many of them long term. That insulates Brookfield from short-term fluctuations in energy prices and allows it to churn out a reliable stream of cash in good times and bad.
Brookfield's operating cash flow is seasonal: It tends to be lowest in Q3 or Q4 and highest in Q1. However, over the last five years, it's been on a clear uptrend:
While cash flow in the most recent quarter, Q1 2020, was down slightly from the year-ago quarter, it's still well above its Q1 2018 level, a testament to the company's reliability.
Paying the price
Investors have already taken notice of Brookfield's outperformance. Despite a steep 40% price drop during the March market crash, Brookfield's units -- MLP-speak for shares -- began to rebound almost immediately. The company's unit price is actually up about 5% so far this year, once again outpacing the S&P 500's 8.7% loss. That, coupled with its unit price appreciation over the last three years, should make investors wonder if the company might be overvalued.
When you find out that Brookfield is currently trading at 148 times earnings (!), you'll probably think it's incredibly overvalued. However, that number is misleading because of the amount of infrastructure assets the company owns. Companies with a lot of infrastructure assets also have a lot of depreciation expenses that depress their earnings, which skews the price-to-earnings ratio higher.
By other valuation metrics that don't include depreciation, Brookfield still doesn't look like a screaming bargain, but it doesn't look particularly overvalued, either. The company's enterprise value-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio of 17.2 is in the middle of its five-year range of between 13.9 and 19.4. Meanwhile, its price-to-free cash flow ratio of 8.9 is near the low end of its historic range:
So far, Brookfield looks like a decent -- if not an outstanding -- buy. But there are two other points to consider.
Debt, growth, and debt growth
The first thing investors need to be aware of is Brookfield's debt load. Like many other infrastructure companies, Brookfield has used debt to finance its construction and acquisitions, which has resulted in more than $10 billion on the company's balance sheet. Brookfield has been more interested in returning cash to unitholders or spending it on new projects than on paying down its debt.
This doesn't seem to be much of a problem for Brookfield, which still boasts an investment-grade credit rating of BBB+ from S&P Global. It also had more than $3 billion of liquidity available as of the end of Q1 2020, which should give it plenty of financial flexibility.
In 2019, Brookfield released a five-year plan to keep growing through acquisition and construction of $4 billion in renewable assets, while only taking on $800 million in new debt. Meanwhile, it anticipates annual growth in funds from operations per unit of between 9% and 16% through 2024. That will allow it to grow its distribution -- the MLP version of a dividend -- between 5% and 9% per year during that time frame.
Considering Brookfield's yield is already sitting at 4.3%, this looks like a win for dividend-focused investors.
Paying for quality
With Brookfield Renewable Partners, investors will get what they pay for: a growing renewable energy company with a superior yield, an impressive track record of success, and excellent prospects for outperformance. What they won't get is a bargain, but that's to be expected when a successful company seems poised to continue being successful.
However, investors shouldn't scoff at what appears to be a fair value. Brookfield looks like a buy at its current price.