Renewable energy remains red-hot even after a scorching 2020 where renewables trounced the broader market's gains. From small pure-play wind and solar stocks to large companies looking to diversify their revenue mix, now seems to be a great time to look for premium renewable energy stocks. But there's a problem. Many of the industry's leading companies are now trading near record highs -- which can be off-putting for investors looking for a lower entry point.
With that, we asked some of our contributors which renewable energy stocks they thought were cheap now. They came up with American Electric Power (NYSE:AEP), Dominion Energy (NYSE:D), and Hubbell (NYSE:HUBB).
Power your portfolio with a utility player
Scott Levine (American Electric Power): While politicians debate the role that green energy has played in the Texas power outages, smart investors recognize that the political wrangling doesn't detract from the fact that renewable energy stocks represent significant growth opportunities. The challenge for clean-energy-minded investors, though, is where to turn. Although solar, wind, and geothermal stocks all represent viable options from which investors can choose, American Electric Power (AEP) provides a less obvious approach. And fortunately for investors, they can currently find shares in the bargain bin.
Branding itself as "the premier regulated energy company," AEP has a presence in 11 states and provides electricity to about 5.5 million customers, making it one of the largest regulated utilities in the United States. Management has articulated a clear commitment to environmental, social, and corporate governance (ESG) values. For example, the company is targeting a 42% reduction in its coal capacity by 2030, and it plans on supplanting this, in part, with ample green energy additions. Over the next 10 years, AEP expects to add 3.8 gigawatts (GW) of solar power to its power portfolio and 4.2 GW of wind power.
Unlike the majority of renewable energy stocks that don't reward shareholders by way of a dividend, AEP has demonstrated consistent interest in returning capital to investors. Over the past decade, AEP -- currently offering investors an attractive 3.8% dividend yield on its stock -- has steadily raised its distribution, and it seems intent on continuing that trend.
Management expects to return $2.96 per share to investors in 2021 -- about 4.2% more than it dished out in 2020. Allaying concerns that the company is jeopardizing its financial well-being to please investors with the dividend, management has targeted a payout ratio of 60% to 70% -- a range that seems reasonable considering the company's average payout ratio over the past three years has been 62%.
Currently, shares of AEP appear attractively priced from a couple of different angles. For one, the stock is trading at 20.3 times earnings, representing a discount to its five-year average multiple of 27.3. Similarly, the stock is trading at 2.6 times sales. While this is slightly higher than its five-year average ratio of 2.4, the valuation is still reasonable considering the S&P 500 P/S ratio is 2.9.
Transitioning from natural gas to renewables
Daniel Foelber (Dominion Energy): Dominion energy is the latest utility stock to launch an aggressive push into renewable energy. The company is a leading energy provider in Utah, Ohio, Virginia, North Carolina, and South Carolina. Although Dominion's portfolio is still mostly fossil fuels, it has done a good job of moving away from coal toward natural gas over the past 15 years. Its sale of the Atlantic Coast Pipeline and other gas transmission and distribution assets to Warren Buffett-led Berkshire Hathaway last year marked the first major step in its push to transition away from gas and toward renewables.
That push accelerated further when the company reported fourth-quarter results. Bigger than the numbers themselves was the company's brand new $32 billion five-year capital spending program, 52% of which is devoted toward zero-carbon through offshore wind, solar, energy storage, and nuclear relicensing. Offshore wind, in particular, is a big catalyst for Dominion's growth, led by the company's 2.6 GW megaproject that is expected to go into service in 2024.
Impressively enough, Dominion is confident that even with the hefty spending plan it will be able to grow earnings per share by at least 6.5% over the next five years. This forecast should be fairly accurate considering 88% of Dominion's existing portfolio is state-regulated. The company also plans to grow its dividend at 6% over the long term. In an effort to fund its renewable aspirations, Dominion cut its quarterly dividend from $0.94 per share to $0.63 in December of last year. Even with the cut, Dominion yields an impressive 3.5% -- much higher than the current market average of 1.5%.
Given the company's strong existing portfolio, aggressive and profitable renewable investments, and the fact that shares are on sale for 20% less than a year ago, Dominion looks to be a worthwhile renewable energy stock to buy now.
Renewable energy provides growth for Hubbell
Lee Samaha (Hubbell): The words "cheap" and "renewable energy stock" don't often fit together these days. Therefore, if you are looking for a value option you will have to think outside the box, or rather outside the sweep of a wind power turbine.
In this context, what about buying a highly cash generative value stock with some exposure to renewable energy related spending? That's where electrical and electronic products company Hubbell comes into play. If you are going to have investment in renewable energy farms, you are going to need investment in the transmission and distribution (T&D) network, as well.
Hubbell's exposure comes through its utility solutions segment, responsible for 57% of adjusted operating profit in 2020 with electrical solutions making up the rest. Commenting on the fourth-quarter performance on the earnings release, CEO Gerben Bakker said, "In the fourth quarter, utility facing markets remained resilient, with grid modernization and renewable energy trends driving ongoing strength in demand for T&D components and mid single digit growth in Power Systems."
Looking ahead, management expects its utility T&D components end market to grow 2% to 4% and utility communications and controls to grow 4% to 6%. Coupled with a recovery in the electrical solutions end market, management expects Hubbell's sales to grow 6% to 8% with organic sales up 3% to 5%. Management's guidance implies around $495 million in free cash flow (FCF) putting Hubbell on a forward price-to-FCF multiple of 18.5 times.
That's a good value, particularly if growth in spending on utility T&D will support mid-single-digit revenue growth over the medium term.