Brookfield Renewable Partners: high base effect limits future growth
Brookfield Renewable Partners (TSX:BEP.UN:CA) (NYSE:BEP) is a utility with approximately 32.1 GW of geographically diversified generation assets, with renewables representing around 97% of the total. The company’s business model relies on stable cash flows, as 90% of the revenues are contracted under Power Purchase Agreements with a weighted average remaining life of 13 years. The recent increase in inflation, which remains relatively high, had a limited impact on the company’s revenues, as approximately 70% of the contracted revenues are inflation-adjusted.
The company’s strategy is based on the growth of its international asset base and a significant increase in operating revenues. Over the last decade the company has achieved a 10% CAGR of its Funds From Operations (FFO).
According to the company’s presentation, the expectations of the FFO growth for the next 5 years are based on the combination of the following: 2-3% increase in inflation, 2-4% improvement in margins, 3-5% contribution from new development projects, and over 9% resulting from M&A activities.
The company’s management feels confident in the investment case and consistently allocates capital to repurchase shares
"In light of public market conditions and our strong conviction in the intrinsic value of our business and growth trajectory, we continued to allocate capital to repurchase shares. In 2023, we repurchased 2 million units under our normal course issuer bid. Looking forward, we will continue to allocate capital based on where we are seeing the best risk-adjusted returns and remain confident we will continue to create meaningful value for our investors."
Q1 results
In its Q1 results, the company reported a solid quarterly increase year over year in Revenues, Adjusted EBITDA, FFO, and distributions per unit. However, it reported a quarterly net loss of US $0.23 per unit.
(All numbers are in CAD unless otherwise stated. The numbers presented in the table above are in USD).
However, the management reiterated its confidence in the company’s business model and believes the market undervalues its units. It announced that over the last nine months, the company bought back over 4 million units and has allocated capital for future purchases.
Based on the BEP’s high-growth business model and the disciplined approach towards capitalization on new opportunities, the management remains confident in the company’s long-term ability to deliver 12-15% return to investors.
Massive development pipeline supports the business case
As the company’s business model is growth-based, the management pays special attention to the size of the development pipeline and its geographic and technological diversification. The development plan for this year is based on bringing in around 7GW of new capacity, representing approximately 22% of the current asset base. At the same time, the near-term development pipeline also increased, reaching 23.8GW with expected future contributions to FFO of around US $300 million per year.
These plans seem ambitious, as in 2023, the company brought 5GW of new projects to commercial operations globally, increasing its FFO by approximately US $65 million annually. However, BEP's long-term plans largely rely on the recently signed renewable energy framework agreement with Microsoft.
In 2025, the company is set to deliver 1GW of capacity to this off-taker. The new agreement anticipates BEP providing over 10.5GW of new renewable capacity between 2026 and 2030. The company also expects to implement more potential partnership opportunities with Microsoft internationally.
Balance sheet
The company is BBB+ rated, and its balance sheet shows available liquidity of 4.5 billion. 98% of the debt is long-term and fixed-rate.
“Our approach to financing is to raise the majority of our debt in the form of asset-specific, non-recourse borrowings at our subsidiaries on an investment grade basis with no financial maintenance covenants.”
This business model relies on FFO growth and is very capital-intensive. According to the 2023 Annual Report, the company's overall debt reached US $29.7 billion. Adjusted EBITDA for the year of US $2.2 billion results in a 13.5x Total Debt to Adjusted EBITDA ratio.
However, this number includes US $ 11.5 billion in non-recourse project-level debt. Without it, the Debt to Adjusted EBITDA ratio goes down to 8.3x. This still indicates high leverage. However, 98% of the debt is fixed rate and long-term, and most of the revenues are based on long-term power purchase agreements with credible off-takers at predetermined rates and adjusted to inflation, significantly lowering the risks associated with the high debt levels.
According to the Annual Report, the average interest rate for the portfolio in 2023 was 5.4%,0.5% higher than in the previous year. The weighted average term of debt was 12 years, the same as in 2022.
To improve its balance sheet, the company is divesting its non-core assets. According to the Q1 report, it expects to continue asset recycling, which should generate approximately US $1.3 billion.
Brookfield Renewable Partners has solid coverage of the preferred and LP units' dividends. With an FFO in 2023 of US $1.1 billion, the preferred dividend coverage is approximately 11x. The FFO per share to dividend per share coverage ratio for LP units amounts to 1.2x.
BEP has a strong track record of dividend payments on its LP units. The company raised the dividend for 2024 to $1.88 per share, which represents a 5% increase year over year. This is the 13th consecutive annual dividend increase by at least 5% since 2011 - the year of the company’s listing.
Valuation indicates that the company’s units are trading close to fair value
Brookfield Renewable Partners has a strong track record of paying distributions to the unit holders with an average growth rate of around 5% per year. In addition to the dividend payments, it returns value to shareholders through unit buybacks. My Dividend Discount Model (DDM) is based on the assumed total distributions represented by the sum of dividends and the value of buybacks per unit. The required return calculation is based on the 10-year GOC yield of 3.29%, 12% risk premium for Canadian utilities and Beta of 0.87. For this analysis, I assume that future dividends will continue to grow at the historical rate of 5%.
These calculations result in a target price of $35.91, which provides only a 4.8% upside to the current market price of the units of $34.28 in CAD.
Investment case for preferred shares
The company has nine preferred shares, which vary based on the dividend calculation methodology, redemption, and currency. Based on prices as of June 18, 2024, the yield for these preferreds ranges between 4.7% and 11.1%. The most interesting preferreds for investing currently are Canadian Dollars Series 2 (BRF.PR.B:CA), Series 3 (BRF.PR.C:CA), and USD Series 17 (BEP.PR.A).
Series 2 ((BRF.PR.B:CA)) are floating preferreds converted from the fixed dividend BRF.PR.A at the beginning of 2020. The current yield is based on the sum of the spread of 2.62% and the quarterly recalculated yield for 3-month GOC bonds. With the inverted yield curve resulting in historically high yields for short-term bonds, these preferreds pay an annual dividend of approximately $1.88, which results in an 11.1% yield.
As I wrote in my previous article, “TC Energy Floating Preferred Shares: Double-Digit Yield With Relatively Low Risk,” with the US outlook for higher for longer interest rates and the Bank of Canada's (BOC) increased dependence on the FED's monetary policy decisions, it is likely that over the next two years, Canadian floating dividend preferred shares will outperform preferreds that pay fixed dividends.
Series 3 (TSX:BRF.PR.C:CA) are the shares that will have their 5-year fixed dividend reset on July 31, 2024. According to the prospectus, the recalculation will be based on the 5-year GOC bond yield 30 days prior to that, on July 1, 2024. We expect the new fixed yield to be around 7.8%, based on the price of $20.03. Assuming the new yield will be recalculated as a sum of the 2.94% spread and the 5-year GOC yield (currently 3.303%), the new fixed annual dividend will be around $1.56.
This is a 43% premium to the annual dividend of $1.09 paid over the last 5 years. I do not expect a meaningful share price appreciation between the recalculation and reset dates in the current macroeconomic environment.
There is a chance that the company will redeem these preferred shares as it has done recently. As stated in the Q1 financial report, the company
“issued US $150 million of fixed rate perpetual notes, with proceeds being used to refinance outstanding preferred shares that were scheduled to reset in April. The newly issued notes are 70 bps cheaper than the reset rate of the outstanding preferred shares we redeemed, saving us almost US $5 million over the next five years.”
Series 17 (BEP PR A) preferred units are US dollars denominated and trading on NYSE. The fixed dividend payment for these units is calculated based on the constant yield of 5.25% and the issue price of US $25 per share. This results in the US $1.3125 annual dividend payment equivalent to the 7% yield based on the unit price of US $18.65 as of June 18, 2024.
These preferred units are redeemable after March 21, 2025, at US $25. It is doubtful that they will be redeemed over the next year as a sharp decrease in the interest rates remains unlikely. At the same time, the downward interest rate trajectory will result in a potential upside for the market price of the shares over the next 12 months.
Preferred shares of Brookfield Renewable Partners are PFD-3H rated by DBRS and BBB- by Fitch. According to the Canadian Preferred Shares, these ratings (though not investment grade) indicate “Medium credit quality while protection of dividends and principal is still considered. Comes with moderate credit risk.”
Risks to the units and preferred shares
Brookfield Renewable Partners has a massive development pipeline. The timely and on budget implementation of new projects is a critical factor for the company’s valuations.
The high level of total debt, including non-recourse project finance, increases the overall risk to the BEP’s profitability and makes it vulnerable to changes in interest rates.
M&A is an important part of the company’s growth strategy. However, it can also involve risks of overpaying and unplanned increases in additional capital requirements and operating expenses.
BEP owns and operates an internationally diversified portfolio of power generation projects. Utilities depend heavily on regulatory environments in the geographies of their operations. In addition, developing and acquiring assets internationally may also result in higher regulatory risks.
A significant part of the company’s operations relies on market power prices, which are driven by regional supply and demand. Lower-than-expected power prices could undermine the company’s financial performance.
The majority of the company’s assets are renewable generation. Climate changes and cyclical fluctuations in the availability of renewable resources represent both upside and downside risks for the company’s operating results.
Conclusion
My analysis of the company’s units and preferred shares indicates that the units are fairly priced and not likely to provide investors with a meaningful upside over the next 12 months. The high base effect limits the company’s growth and market valuations.
At the same time, Series 2 ((BRF.PR.B:CA)) preferreds offer an 11.1% yield and will likely outperform the company's units and fixed dividend preferred shares over the next 2 years. However, Series 17 (BEP PR A) USD-denominated and Series 3 (BRF.PR.C:CA) look like a good longer-term investment. (BRF.PR.C:CA) is likely to provide a fixed yield of around 8% over the next five years. The shares are due for a rest on July 31, 2024, with the recalculation date coming on July 1, 2024. Assuming the interest rate dynamics do not change, it makes more sense to buy the company’s preferred shares closer to the date of the dividend recalculation.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Dmytro Konovalov
I am a seasoned investor and financial journalist with over twenty years of experience in sell-side equity research, corporate and project finance, M&A and valuations, focusing on Canadian electric utilities, and infrastructure sectors. For ten years I worked as an equity research analyst at global banks including UniCredit Securities and HSBC Global Markets. As an analyst, I was top-rated by the Institutional Investor and Extel surveys. I was also responsible for strategic and economic analysis of capital markets. Before my investment banking career, I spent ten years in a Canadian corporate environment working on the development and finance of power projects and mergers and acquisitions. As an active investor, I believe in actionable ideas and the power of a good story and clear arguments. I am interested in sharing those stories and arguments with others, aiming to contribute towards a smarter and richer world.
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