In this episode of Industry Focus: Energy, Nick Sciple chats with Motley Fool contributor Jason Hall about the renewable energy space broadly and Brookfield Renewable Energy (NYSE:BEP) in particular. Discover what makes it an attractive buy for investors, its various operations, and some recent acquisitions. Learn about its corporate culture and the opportunities it presents for the long term.

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This video was recorded on August 13, 2020.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. We've got a great show for you this week. By overwhelming listener demand, we'll be discussing Brookfield Renewable Energy and the renewable energy space at large. My guest today is Motley Fool contributor Jason Hall. Jason, welcome back on the podcast.

Jason Hall: So nice to be on with you again, Nick, so nice.

Sciple: Yeah, we were just saying before the show, I have been visiting some family, and away from my podcast material. So last time we chatted, when we recorded that college football show back on July 17, then you know things have changed, but we might have called it a little bit, Jason.

Hall: No, we didn't just call it, we absolutely nailed it.

Sciple: Yeah. But our topic today, as I mentioned, is Brookfield Renewable Energy. One of our many listeners asked us, said, "Hey, for Industry Focus, could you take a look at renewables, especially Brookfield Energy Partners, ticker BEP. An interesting LP with investments in many countries, many forms of renewables. Big Motley Fool fan." This is James McVeigh.

And, yes, we're going to talk about that company today. We've got Brookfield Renewable Energy Partners, which is ticker BEP. And now we have Brookfield Renewable Energy Corporation [sic] [Brookfield Renewable Corporation] which is ticker BEPC, which we'll talk about later. But before we get into that, Jason. We've talked about Brookfield Renewable a bunch on the show. For folks who aren't familiar with this company, what does it do, what is this company and what do you buy when you invest in it?

Hall: So Brookfield Renewable Corporation, there's a lot of Brookfield stuff out there, so it's part of the Brookfield Asset Management group of companies that deal with alternative assets. So when you buy Brookfield Renewable Corporation, this is a business that buys, develops, and manages renewable energy production infrastructure assets. So you think about solar and wind, these big utility-scale projects that generate power. And they generate that electricity, then they sell it to utility customers. What a lot of people don't think about, that's actually still the largest part of Brookfield Renewables' business, is hydroelectric. So that's the OG of renewable energy, is hydroelectric. And that's the core of the business, and that's where it started, I guess a little more than a decade ago.

So you're buying these predictable, long-term, cash cow businesses that kick off cash flows that Brookfield Renewable then returns to investors through a very sizable dividend that it targets growing at a high-single-digit rate every year. That's like the stated goal, is to grow that payout to investors about 8% every single year. And it has absolutely crushed it in terms of total returns since it went public.

Sciple: Yeah. You talk about the hydroelectric part; I know folks get really excited about solar and wind. I think one thing to note there with hydro, though, is, you know the sun keeps shining more every day, there's only so many hydro places you can set up a dam on the face of the planet, that is a really scarce asset. And one of Brookfield's really big advantages is there's only so many companies that can manage these types of assets. They just bought a massive -- and we can talk about one of their more recent deals -- they just agreed to acquire a 1,200-megawatt solar development project in Brazil. It's going to be one of the largest solar development projects in the world. Brookfield is one of the only companies that could actually do that project and handle that, which is a huge advantage for this company.

Hall: It absolutely is. This is a business where I think scale certainly pays off, and that's one of the reasons why you think about Brookfield Renewable, it is one of the biggest of these yieldcos or these independent energy producers; it's one of the largest. But I think the opportunities for it to continue -- its total returns are over 500% since IPO; it's just absolutely crushed it. But I think the future is still just as bright, because its scale is a benefit, it's a global business. And this type of asset is going to be in more and more demand. There's going to be a billion more people in the global middle class over the next decade. The global middle class is where energy gets consumed, right. So there's just tremendous demand that's going to continue to grow for what these guys do.

Sciple: Right. I think if you want to bet on a trend, I think two trends are pretty safe to predict: that energy demand, people are going to continue using more and more energy every year. And given attitudes around the world and scarcity of hydrocarbons and all these other things; global warming --

Hall: Energy security...

Sciple: Yeah, exactly. That a lot of those dollars are going to be invested in renewable energy. And you have a company here, in Brookfield Renewable, that is one of the few that has the scale, the expertise to invest in this in the way that they can. Then we can talk about another big news announcement from this quarter, moving them more into the solar energy space. We've talked about this a few times on the show. They completed their merger with TerraForm Power. Jason, what can you tell us about these assets and the significance of it for the company?

Hall: Yeah. I mean, there's a couple of things, right? I think this really tells us a lot about where Brookfield sees the future and the opportunities. You go back several years ago, and Brookfield acquired a majority stake in TerraForm Power, which came out of -- you're going to have to help me out, Nick -- TerraForm Power was SunEdison, I believe.

Sciple: That sounds right.

Hall: It was a subsidiary of SunEdison. It was its yieldco that it used to kick off these projects after they were developed; these sun and wind assets. And SunEdison kind of fell apart. TerraForm Power and TerraForm Global, these two separate businesses that were part of it, really, they weren't being leveraged properly. Hey, look at that background, look at that, what is that, a hydroelectric dam, that's pretty nice isn't it?

So long story short, the value investing guys that allocate capital at Brookfield saw an opportunity to become the sponsors of TerraForm Power. And they also saw an opportunity to make money in wind and solar. And that has been an issue for the majority of the history of solar and wind is that it just wasn't economic, right? You'd have to have all these subsidies and just there wasn't really a good way to make money there.

And the technology has gotten better, costs have fallen, there are still subsidies, but its cost competitive aspect has changed. And these folks saw that opportunity. So they acquired a majority stake of TerraForm Power in 2018, I believe. And the writing was kind of on the wall pretty early that this was eventually going to get rolled up and fully acquired. And so, they've just recently closed the deal to fully acquire the rest of TerraForm that they didn't own, and rolled it into Brookfield Renewable Partners.

And it kind of created a bit of a quandary. Brookfield Renewable Partners is a partnership, it's a publicly traded partnership, it gets lumped in with MLPs. So the problem with MLPs is that a lot of indexes won't include MLPs in the index. They only want corporations for tax reasons. And a lot of retirement accounts are not -- MLPs are not always suitable, because there's tax implications because of something called UBTI, unrelated business taxable income. They can leave you owing the taxman from earnings from an MLP inside of a tax-advantaged account. So it's not ideal. Brookfield has said for years and years that we're not going to pay UBTI, you can own, it's fine. But some brokerages they just like, it flags the ticker, [laughs] it won't even let you buy it.

So you get back to TerraForm Power. TerraForm Power is a corporation. When the decision was made to acquire TerraForm Power in total, it created a situation where you were potentially going to be pushing shareholders out. So the decision was made to take Brookfield Renewable, and also Brookfield Infrastructure is another similar business, and create corporate equivalents. So the economic ownership's share-to-share is the same, what you own is the same, the dividend that it pays is the same, but the difference is, it's a corporation.

So now BEPC is the corporate equivalent and I think it's going to expand the addressable potential investor base. And also, for those TerraForm Power investors who didn't want to own that MLP unit, they wanted to own a stock, a corporate stock, so that's why it now exists.

So I would not -- again, this is not individual to anybody specific, but anybody that owns Brookfield Renewable Partners and has a large capital gain, I don't think it makes -- again, a large capital gain in a taxable account -- I don't think it makes sense to sell that and to buy Brookfield Renewable Corporation, because you're going to have a realized taxable event. But going forward, there are some benefits to owning that corporation versus the Brookfield Renewable Partners ticker. So did I answer that?

Sciple: Well, yeah, let's make sure we, kind of, orient directly on this Brookfield Renewable Corporation issue, because as I mentioned earlier on July 30, the company decided -- or that was when they finally issued those shares. And so, for every 100 shares of Brookfield Renewable Energy Partners, ticker BEP, that you own, you would receive 25 shares of Brookfield Renewable Corporation.

And we got a number of questions from listeners about what to do with that particular distribution, which you touched on earlier. Jason, these are questions from Tyler K., Tim H., with some others as well. So just kind of walk me through the dynamics of, if you held Brookfield Renewable Partners, ticker BEP, on July 30, what happened to your shares?

Hall: Right. So the way that they created this new entity, is it creates a nontaxable event, where essentially you are awarded, it's like a distribution of these shares of the corporate entity. The same thing happened to Brookfield Infrastructure Partners' investors earlier this year. They did a similar thing when they created Brookfield Infrastructure Corporation, where when they created this entity, they spun it out and they awarded existing unitholders a stake in this new entity. So what should have happened is, your brokerage account should just show up with those new stocks in addition to your existing position that you also held.

Now, I think it will affect the per-share dividend that they pay. I think they'll have to kind of normalize that a little bit. That's what happened with Brookfield Infrastructure. But then, if you carry the total dollars of dividends that you would have received just on that Brookfield Renewable Partners plus the dividend that you'll get on the new shares that you were awarded, it will equal out to the total economic value. So it looks a little bit squirrely, but now that this new entity exists, it's going to create a larger potential shareholder base.

Sciple: Right. And so, if you're a shareholder on, say, you know, July 30, before this went effective, you owned BEP, say, 100 shares in your account on the 1st of August, you owned 100 shares of BEP and 25 shares of BEPC. And so now, the question is, what do I do with these BEP shares, what do I do with these BEPC shares? And that goes back to what you said earlier, Jason, about whether you have it in a taxable account or not. And if you have a large gain in a taxable account, you need to weigh those tax costs relative to any convenience, benefits you might gain from not having to do the special tax forms, etc., etc.

If you own it in a nontaxable account, then there really is no downside if you would like to have the corporate form, not get that special tax form every month, just be able to treat this investment like any other investment you have. Then you can go ahead and sell that BEP and buy BEPC, and you won't cost yourself anything.

Now, all these decisions are going to be specific to you and your financial situation. So if you have any questions about that, talk to a personal financial advisor, but that is my view on the situation. So is that fair to say?

Hall: It is. And I think that really the key thing that underpinned it was, again, the TerraForm Power acquisition is that they gave TerraForm Power shareholders the option to choose which stock or unit that they wanted to take in exchange, because it was a share, you know, that it was paid for with Brookfield Renewable shares. So for anybody that had TerraForm Power, to me, the obvious choice would have been to go with Brookfield Renewable Corporation's shares going forward, just because it's a lot cleaner.

Sciple: Right. So we've talked about Brookfield Renewable. Going forward, you know, significant opportunities to invest in renewable energy. When you look at the stock today, what do you think of it from a valuation perspective long-term opportunity?

Hall: Well, I mean there's no doubt about the fact that it's done incredibly, incredibly well. And it should, because this is like a classic recession-proof kind of business. And it cratered like basically everything else did when the market fell 35% from late February through the end of March, but it's recovered quite strongly. But I think it's actually still, at this time, it's still, like, 3% below its peak in late February, so it's still cheaper than people were willing to pay based on where everybody thought the world was six months ago. So I think it's still a very reasonable value.

And I don't want to say this is a buy-at-any-price business, but I think this is a business that certainly, if you're going to pay a premium for any of these yieldcos, any of these independent renewable energy companies, I think Brookfield Renewable is the one that's worth paying a premium for. Because if you look at the track record of total returns, you look at their capital allocation history, how good they are at investing new capital, how good they are at finding assets that maybe don't have the growth prospects they did selling those assets, and then redeploying that cash, kind of, that cash recycling model, they're just really, really good at it. And they don't get caught up with chasing the stock price quarter to quarter to manage Wall Street's expectations. They focus on the long-term trends to develop meaningful returns and consistently grow per share cash flows that they can distribute back to investors.

So I think it's an absolute buy at this price. I think it's a mistake to look at what the stock's done and to anchor on where it was in March or April or to anchor on where it was a year ago and how much it's run up. I think it's a business you buy now, you dividend reinvest the shares if you don't need the income. And 20 years from now, you can buy me a cocktail and thank me for [laughs] the suggestion.

Sciple: Yeah. I mean, I think one thing we haven't mentioned that I think is important to note is that relationship with Brookfield Asset Management, that ability to access permanent capital, and really significant amounts of permanent capital at that. I mean, you throw that on top of the renewable opportunity and then the management and all that sort of thing, and that really, really helps the thesis as well.

Hall: Yeah, there's no doubt about it. Brookfield Asset Management is one of the largest, you know, alternative asset management companies in the world. They have trillions in assets under management for sovereign wealth funds and institutional class investors and high-wealth individuals and families. In addition to their publicly traded entities, like, Brookfield Property and Renewable and Brookfield Infrastructure, that us retail investors can invest in. And it's just a tremendously well-run organization all through.

So you think about corporate culture, you think about that culture of disciplined capital allocation. You know, these guys will talk about deals that they lost, right? And I think that really informs a lot about how they think about it, because they're not just out there crowing about the deals that they won, they lose deals because they're disciplined, right, because they will not pay more than they think it is worth, because they're looking to capture, again, meaningful cash flow growth. And they know what a deal is worth, what a property is worth, what an asset is worth to them. And I mean, they stick to their knitting really, really well when they do allocate capital.

Sciple: So I think it's fair to say we like Brookfield, we like the Brookfield family of companies. Moving on to renewable energy, maybe more broadly, Jason, we talk about a lot on the show these yieldcos, we've talked about Brookfield, we talked about Clearway Energy, Atlantica Yield, a lot of these companies that touch the renewable energy space in some way. And they're often these yieldco-type companies.

I guess my question for you is, why are these companies attractive to you relative to other folks in the renewable energy space? So I guess what are the good things about these yieldcos? And maybe on the other side, what are the bad things about some of these other areas or more challenging things about some of these other areas of renewables that lead to this is your, kind of, fishing ground? Like Charlie Munger might say.

Hall: Yeah. So I think the first thing is that you think about the value predictability. These companies, they develop and acquire these assets, and they own them and then they sign long-term contracts to sell the power that they generate over, you know, 10-, 20-year, sometimes even longer periods of time. So you get that predictability of their earnings, and you know a large portion of that's going to flow back to you as the shareholder. So that's tremendously valuable in a really dynamic, dynamic space.

The other part of it, too, is these are businesses that absolutely benefit from the two biggest trends in renewables. And No. 1 is the growth of demand, and the other one is the falling costs. The technology continues to get better, the cost per watt for wind and solar both continues to fall. So that's a normalized way to determine how much an asset is going to cost you and what it's going to give you, so that competing against coal-fired power plants or natural gas power plants or nuclear, what have you, cost per watt helps you figure out how competitive you can be when you need to sell that energy. Those costs continue to fall.

Now, those falling costs are not great if you're in the business of [laughs] manufacturing solar panels, for example. Because the low cost, it's kind of like being a steelmaker. He who can make it for the cheapest wins. So that dynamic is very, very much at play. And as we've seen in the steel industry and other industries, when you're competing against China, for example, where there is a very real long history of the government managing the industries and providing subsidies that aren't [laughs] necessarily always legal, and they can fly in the face of fair-trade agreements, but they still happen. It can make it a lot harder if you're manufacturing solar panels in Mexico or Canada or the United States to compete, or if you're an American solar company that has manufacturing somewhere in Southeast Asia, it can undercut it substantially.

And then you have the cyclical aspect of that industry, you have these massive capital investments you have to make, these really high fixed costs. And then year over year, demand for solar or wind can fall off sharply. So these utility-scale projects, they drive the market, and if demand falls off from one year to the next, and you're making the solar panels, you still hold the bag on the costs for all of your facility. So it can really affect your ability to make money.

If you're just selling power on assets that you've already deployed; again, that's that predictability, right? So I think that's one of the reasons that I really, really like this space the most, because you get the benefits of things that hurt [laughs] the other players, but also you continue to ride that long-term path of increased demand.

Sciple: Yeah, Jason, as you're explaining those dynamics in the solar panel manufacturer industry, I couldn't help but think about, you know, Berkshire Hathaway. The legacy of that company was a textile manufacturer and you can look at some of Buffett's quotes from back in the late 1960s about the question of, should we invest in new manufacturing capacity? It will make us more efficient and it'll make us more competitive, but all our competitors are going to invest in that too. And the margins are driven down, and it's really difficult to recoup your fixed-costs investment you made to upgrade your facilities. And as soon as your facilities are upgraded, guess what, you need to upgrade them again. And so, the dynamics of that industry just make it unattractive to invest in.

But, again, if you're the industry that that's a supplier for, then you can benefit from those falling prices.

Hall: That's right. Exactly. It's the reason I like Phillips 66 but I don't like ConocoPhillips, right? ConocoPhillips is drilling the oil and selling it at whatever the market demands; Phillips 66 benefits because they're a buyer of oil and they're just supplying the end user demand on the other side. So you look across industries, and you can find the same thing, you can find who suffers and who benefits and invest in the ones that benefit, and that's the way you can make money.

Sciple: Yeah. So we're going to be talking about renewable energy a lot more on this show. We're getting questions about it all the time. So keep sending us in some companies you want us to dive into. This isn't the last you'll hear us talk about renewables, but that type of seeing who owns the leverage in the market, see where's the margin getting higher and where's the margin getting lower, where's the part of the market where there is a limited supply of players versus a large supply of players, that's where you can find some opportunities.

Hall: Yeah, and we haven't even talked about, you know, one of the big benefits for the yieldcos and those guys right now. I think it lifts everybody, but it's certainly a benefit for them is energy storage, right. As those costs come down, the addressable market for a renewable yieldco gets even bigger, because then they're going to be able to meet those baseline and those peak power demands, because they'll have the power stored in a battery that they can send off to the grid as needed.

Sciple: Yeah, I mean, the opportunity for these yieldcos, the role they play in the market, I think, is significant. I think one other area we might mention too is just who are the yieldcos the supplier for? OK. So they're the supplier to the local utility company or, you know, [laughs] bigger and bigger utility company these days. What are the dynamics at play there? Because the yieldcos do you have an interesting advantage in that part of the market as well, relative to their customer.

Hall: I think so. I think one of the things that we've seen that started to happen, that's going to continue to happen is I think the utility model is going to change. So I think you have a lot of utilities that are focused on owning assets as much as they can, the power-generating assets as much as they can. And I think over the next 20 years, we're going to see them shift more just to managing the distribution of that electricity and relying more on yieldcos to provide them the electricity that they need to meet that demand.

So I think, especially as we see more, like, these coal plants get retired, I think we're at the risk of we're going to see more nuclear plants get -- we need to build more nuclear plants, [laughs] but you know, that's another two or three shows' worth of material right there that we're not going to touch. So I think yieldcos are going to provide -- their addressable market is going to continue to grow, and utilities are going to look to leverage that more and more, I think, over time, as they need to become a little bit more nimble about how they operate their businesses.

Sciple: Yeah. And there are some dynamics in play there when it comes to how those industries have to charge regulated rates and how those are computed and things like that. And again, that really is a whole 'nother show [laughs] that we'll have to get into next time. But, Jason, I can't wait to have you on next time to dive into it.

Hall: Absolutely. Sounds fantastic.

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 Tim Sparks for making us sound so nice. For Jason Hall, I'm Nick Sciple. Thanks for listening, and Fool on!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.