- Recession, pandemic, and disruption-resistant business model
- Global diversification
- Strong BBB+ balance sheet and A-rated backing from its parent Brookfield Asset Management (BAM)
- Safe and growing distribution
While shares are not cheap (I rate the stock as a hold), it remains an attractive pick for conservative dividend growth investors that want an attractive balance of current income and inflation-beating income growth.
1. Political, Recession, Pandemic, and Disruption-Resistant Business Model
Perhaps the biggest reason that BEP is a retiree’s dream stock is its political, recession, pandemic, and disruption-resistant business model.
Its model consists of acquiring and/or developing high-quality renewable power assets at bargain prices, using conservatively structured leverage to enhance returns in a manner that minimizes the risk to the portfolio as a whole, optimize cash flows by implementing a value-add business plan using Brookfield’s in-house operational expertise, and then eventually selling the asset opportunistically and recycling the capital into a new opportunity to create value for investors.
The strength of its model is that it is largely like a utility in that people and businesses need electricity regardless of whether or not the economy is booming or not. Granted, electricity prices generally tend to go up when the economy is strong, but the long-term nature of BEP’s contracts and its hedging strategy insulates it to a large degree from economic volatility. Given that it is focused on “green” renewable energies, BEP also benefits from a degree of insulation from political risk as environmental activists are less likely to target them and the emerging far-left in the U.S. is trying to push legislative reform that would use the power of the government to force greater use of renewable energies. Furthermore, the idea that man’s economic activity contributes to climate change is widely accepted in society today (author’s note: this is not a personal endorsement of this theory, it is simply a statement of fact for the sake of the investment analysis), thereby making it increasingly likely that businesses and more moderate political groups will continue to push greater use of green energy technologies as well. As a result, the company is also, to a large degree, insulated from technological disruption as its circle of competence is in the area where much of the innovative energy research is focused. This will enable its assets to remain in demand for the foreseeable future instead of having to worry about them losing demand.
While the private market has slowed considerably due to the uncertainties created from COVID-19, thereby potentially slowing some of BEP’s capital recycling efforts, management has shifted more of their focus towards the publicly-traded markets, where volatility has proven to be more significant, and liquidity remains high. As a result, we expect growth to slow somewhat, but still see a growth runway for the business.
The business’s performance in the wake of COVID-19 shows that their existing holdings are doing quite well. Normalized FFO grew by 5% year over year due to BEP’s commercial and re-contracting initiatives as well as higher margins driven by cost-cutting efforts.
2. Global diversification
Another reason why BEP remains a very attractive holding for retirees is its global diversification. They own assets in North and South America as well as Europe and Asia. This helps insulate them from geopolitical as well as currency risk. Furthermore, it gives them numerous avenues for growth. Finally, with 66% of their long-term power generation coming from North America and Europe, most of their revenue generation is concentrated in developed economies with a greater degree of geopolitical and economic stability.
3. Strong Investment-Grade Balance Sheet
If the past few months have taught us anything, it is that tomorrow is not promised. Literally, anything can happen. As a result, having the balance sheet necessary to weather periods of extreme volatility and uncertainty is essential for any retiree holding. Fortunately, for BEP investors, this stock fits the bill. With a sector-leading BBB+ balance sheet, support from an A-rated parent in Brookfield Asset Management, which is also a major unitholder in BEP, no material maturities over the next half-decade, an average overall debt term to maturity of 10 years, 80% of total debt being asset level non-recourse, and over $3 billion in liquidity, the business faces little risk of financial distress anytime soon, enabling investors to sleep well at night.
4. Safe and Attractive Distribution
In a world where interest rates are approaching zero, if not negative territory, a 4.4% safe and growing yield is very challenging to come by. However, that is exactly what you get from buying BEP units at today’s prices.
Not only is the distribution attractive at a 4.4% yield and a 5%-9% annualized growth target (which we expect to remain closer to 5% annually for the foreseeable future due to reduced growth prospects via acquisitions in the private market), but it is also quite safe. The cash flows are relatively stable as they largely come from recession and pandemic-resistant assets that are also contracted over lengthy terms and fixed rates with currency hedge in place. Furthermore, there is a meaningful buffer between current cash flows and the distribution with a 79% FFO payout ratio and a 93% Cash Available for Distribution (or CAFD) payout ratio. As already mentioned, however, slower acquisition growth and management’s desire to reduce the payout ratio back towards its long-term target of 70% of FFO will likely cause management to sustain their current 5% annualized distribution growth rate instead of pushing it towards the upper bound of the long-term growth range. Despite this, a 4.4% current yield with mid-single-digit annualized growth is excellent for funding a retirement as it enables investors to live according to the “4% Rule”, keep up with inflation, and keep a little extra in reserve.
With the latest breaking news of Dominion Energy’s (D) and Energy Transfer’s (ET) woes on their respective pipeline projects (the Atlantic Coast Pipeline and the Dakota Access Pipeline), as well as the shift towards the Democrats in U.S. 2020 election polls, investing in conventional fossil fuel energy is becoming increasingly politically risky, and, by default, making renewable energy assets look more and more attractive.
That said, BEP is not without risks. Despite its strong balance sheet, BEP still does carry considerable leverage, exposing it to the risk of rapidly rising interest rates outpacing increases in electricity rates. Furthermore, the very low price of natural gas also places a cap on the rates that BEP can earn on its own clean energy. Furthermore, though its diversification is overall viewed as a strength, being all over the world exposes BEP to the risk of significant write-offs in the event of a major geopolitical crisis in one or more of its host countries.
Overall, we view BEP as a hold for investors focused on long-term total returns as we see the total return potential being in the high single-digit range. That said, for retirees, we like the stock at current prices, as the yield and growth are sufficient to provide for living expenses under the 4% Rule, while also keeping up with inflation over the long term. Additionally, the extra 0.4% in the current yield and the annualized growth rate being a few hundred basis points above the current rate of inflation will provide investors with a little bit of extra savings to be able to compensate for any future hits to income from any of the risks facing the business coming into play.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.