Back in 2016, Brookfield Renewable (BEP +2.80%) (BEPC +0.00%) was an obscure, relatively unknown owner and operator of hydroelectric dams. While operating hydroelectric assets is a fine business, generating relatively steady cash flows on long-term contracts with utility customers, it's not exactly exciting or high growth.
But over the past half-dozen years, things have changed at Brookfield Renewable. At the end of 2016, it had 8,451 megawatts (MW) of hydroelectric capacity and only 1,590 MW of wind and no solar capacity at all. Since then, the numbers have shifted dramatically, with hydro falling to 8,175 MW and total wind and solar skyrocketing to 13,680 MW. This massive 760% increase in wind and solar capacity has been the key to Brookfield Renewable more than doubling its total capacity in less than seven years.
Let's take a closer look at Brookfield's shift to wind and solar, why it happened, and what it means going forward.
More important than growth: Making money
On its surface, it may be easy to assume that Brookfield Renewable made the move into wind and solar because of the growth potential. And sure, that's true, but it's only part of the answer. The more complete answer is, wind and solar became a big, growing market that was also becoming profitable.
Brookfield Renewable, a subsidiary of Brookfield Corporation (BN +4.52%), shares a deep culture of disciplined capital allocation. Its business model is about acquiring assets that can generate -- and ideally grow -- their cash flows in a sustained way for many years and paying a cheap price for those assets. And frankly, for most of the first four decades of the life of the solar panel industry, cheap wasn't a word you could apply to it.
NYSE: BEP
Key Data Points
According to the U.S. National Renewable Energy Laboratory, utility-scale solar costs fell from $4.75 per watt in 2010 to $1.53 in 2016. The biggest driver was the falling cost of solar panels, but other improvements have made it far cheaper to deploy solar than in the past. By 2020, the cost had fallen to $0.94 per watt.
Why does this matter? Because it means that solar had joined wind -- which has seen similar, if smaller, price declines since around 2008 -- as being cost-competitive with more traditional power-generation sources, primarily natural gas.
If there's one thing about the Brookfield entities that investors should understand, it's that they don't chase empty growth. Brookfield Renewable has a stated long-term goal of earning 12% to 15% in total returns, driven in part by growing the annual distribution (dividend) 5% to 9%. Since the beginning of 2017, it has delivered, earning a total compound annual growth rate (CAGR) of 14.2%. That's a market-beating return even with its shares falling 47% from their all-time high during that period.
BEP Total Return Level data by YCharts.
Can Brookfield Renewable keep delivering for investors?
Anyone who's bought in the past couple of years may not be so happy as longer-term shareholders. Part of the reason why Brookfield Renewable stock fell from the 2021 peak and has still not recovered is the sharp rise in interest rates over the past year and a half. The large-scale clean-energy assets that Brookfield Renewable acquires and invests in are very expensive, and debt is a major source of capital to fund them.
That makes the math pretty simple. For Brookfield to continue allocating capital to per-share cash-flow growth like we have seen in the past in a higher-rate environment, it must either sell the power from its assets at higher rates, buy assets more cheaply, or some combination of both. And of course, there's a difference between simple math and easy math. I think it gets back to Brookfield's long legacy of capital allocation. Interest rates are certainly higher than they have been in many years, and that's a real impact on its cost structure. The good news: This isn't the first time Brookfield navigated a complex, rising interest-rate environment. Here's a look at interest rates since parent company Brookfield Corp went public in 1997:
Overnight Federal Funds Rate data by YCharts.
Over that period, Brookfield Corp has earned a remarkable 1,680% in total returns, more than tripling the S&P 500. Yes, Brookfield Corp and Brookfield Renewable are different entities, with different aspects to their business. But their shared corporate culture and disciplined focus on value is a common thread that has created value for investors for many years.
Management has demonstrated its ability to navigate different markets, and their cost discipline as acquirers, along with expertise as operators has paid off for investors for years. After all, it was able to grow funds from operations (FFO) per share -- a useful earnings proxy -- 8% in 2022 and has increased FFO per share almost 10% halfway through 2023.
Management has also continued to prioritize a strong balance sheet. Average debt maturities are more than 11 years, with average interest rates of 4.3% for corporate-level debt and 4.3% for asset-level debt. Most of its debt (91%) is also fixed rate, positioning it well if rates continue to move higher.
A long-term winner set to keep winning
Looking beyond its moves into wind and solar once those areas became more clearly profitable, Brookfield Renewable is also investing in storage, has taken a small stake in Brookfield's 51% ownership of nuclear energy giant Westinghouse, and begun investing in carbon capture, renewable natural gas, and other more nascent, but potentially very profitable, clean energy businesses.
At recent prices, Brookfield Renewable looks reasonable, if not exactly cheap. The partnership units (Brookfield Infrastructure Partners, BIP) trade for around 15 times expected 2023 FFO, while the corporate shares of Brookfield Renewable Corporation (BEPC) trade for closer to 17 times. And based on the most recent dividend, investors will earn about 5.1% and 4.7% yield, respectively. Again, a reasonable price but certainly not dirt cheap.
But that shouldn't stop investors from buying. This is one of the few premium businesses in clean energy, with a track record of making money and rewarding investors. It may not be cheap, but it's certainly worth buying and holding for years to come.
