Please ensure Javascript is enabled for purposes of website accessibility

2 High-Yield Dividends That Are Almost Certainly Doomed, and 1 Great Alternative

By Adam Galas - Apr 13, 2016 at 11:25AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Learn the most important things about high-yield alternative energy yieldcos, including two you should steer clear of and one worthy of your hard-earned money.

Source: NextEra Energy Partners.

Yieldcos are a potentially wonderful way for long-term income investors to profit from the megatrend that is the renewable-energy boom.

But not all yieldcos are created equal. While it's true that NextEra Energy Partners (NEP 1.22%), has taken a beating over the past nine months, its share-price decline pales in comparison with the brutal carnage TerraForm Power (TERP) and TerraForm Global (NASDAQ: GLBL) have faced.

NEP Chart

NEP data by YCharts

The reasons for the vast difference in performance highlights one of the most important aspects of successful long-term yieldco investing. Let's take a look at why NextEra Energy Partners is a potentially great addition to your diversified income portfolio and why TerraForm Power and TerraForm Global are toxic  stocks you shouldn't touch with a 10-foot pole.

Distribution profile warns of TerraForm troubles

YieldCo Yield Last quarter's distribution coverage ratio (DCR) Projected 5-year annual distribution growth
NextEra Energy Partners 4.7% 9.0 12%-15%
TerraForm Power 14.9% 2.5 6.4%
TerraForm Global 44.4% 1.2 0.7%

Sources: earnings releases, Yahoo Finance, Fastgraphs, management guidance

Note that TerraForm Global recently IPOed, so because of its limited performance record, that table is for the last available quarter's data.

TerraForm yieldcos offer payouts that are simply too good to be true. In contrast, Wall Street is pricing NextEra Energy Partners as if its payout is about as secure as that of a typical utility. Yet all three are primarily renewable-energy utilities that pay investors from cash flow generated from assets bought from their respective sponsors and general partners, NextEra Energy (NYSE: NEE) and SunEdison. One slight difference is that NextEra Partner's also owns natural gas pipelines and gets about 25% of its revenue from this source.

The cash flow is secured by extremely long-term, fixed-fee power purchase agreements, or PPAs, with major electric utilities. Thus one might expect all three yields to be roughly the same.

An obvious reason for this enormous yield discrepancy is that NextEra Energy Partners' DCR -- the best single metric of long-term distribution security -- is so much larger than those of its TerraForm peers. This means not only that the yieldco is much less likely to have to cut its payout in the future, but also that it has plenty of room to achieve management's targeted distribution growth rate of 12% to 15% a year through 2020.

Here's why Wall Street hates TerraForm yieldcos
TerraForm's problems stem from the fact that SunEdison is now likely to declare bankruptcy, courtesy of its monstrous and untenable debt load.

Given the utility nature of TerraForm's assets, this shouldn't necessarily spell doom for the yieldCos' payouts except that SunEdison forced them to massively overpay for assets. This resulted in their likewise taking on way too much debt. For example, TerraForm Power now hold $6 in debt for each dollar of cash on its balance sheet.

Excessive debt can light your money on fire

Company/yieldCo Total Debt Interest Coverage Ratio Weighted Average Cost of Capital (WACC) Return on Invested Capital (ROIC)
NextEra Energy Partners $3.5 Billion 1.83 7.8% 8.2%
TerraForm Power $2.4 Billion 0.89 NA 0.6%
TerraForm Global $525 Million NA NA (2%)
NextEra Energy $29.7 Billion 3.82 4% 6.4%

Sources: Morningstar, Gurufocus, Yahoo Finance, 10-Qs

SunEdison and its yieldCos' balance sheets are, simply put, horrific. The utility business isn't cheap, and large amounts of debt are to be expected. By contrast. NextEra Energy's management has been careful to make sure that its interest costs are always well covered by cash flows, as well as maintaining its debt covenants with creditors. SunEdison cared more about growing as fast as possible at any cost and forced its yieldCos to load up on debt to buy overpriced assets. The faster its yieldcos grew their payouts, the more IDRs it would collect. Now, as a result, all three may be forced into bankruptcy protection.

After all, TerraForm Power is so burdened by high interest costs that it's barely making any returns on its invested capital. Similarly TerraForm Global is actually losing money on every shareholder dollar it spends on new renewable energy projects.

Meanwhile SunEdison has delayed filing its annual 2015 financial report because of "material weakness" and both TerraForm Power and TerraForm Global have similarly failed to file these legally required documents. In fact, TerraForm Power has delayed its 10-K not once, but twice. Nasdaq has notified both yieldcos that they're in violation of its listing requirements and at risk of being delisted.

Bottom line
Yieldcos are owned for one reason -- income. Thus, it's essential that investors consider several factors before investing in these high-yield equities. Chief among these are the financial strength of its sponsor, the yieldco's balance sheet, and the long-term security of its payout.

Thanks to SunEdison's short-term-focused, debt-fueled growth binge, both TerraForm Power and TerraForm Global are probably doomed to either follow it into bankruptcy or, at the very least, will probably have to slash their distributions. Contrast this with NextEra Energy Partners, which, thanks to more conservative, long-term-focused management, is well positioned to prosper from the accelerating renewable-energy bonanza.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

NextEra Energy Partners Stock Quote
NextEra Energy Partners
$75.73 (1.22%) $0.91
TerraForm Power Stock Quote
TerraForm Power
NextEra Energy, Inc. Stock Quote
NextEra Energy, Inc.
$78.02 (1.06%) $0.82

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/25/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.