Tag Archives: alternative

The Long Case For NextEra Energy Partners

Summary NEP is a first-in-class YieldCo with robust fundamentals and a strong sponsor. The upside is driven by long term contracts from diversified energy projects, with double digit distribution growth. NEP trades at a discount to intrinsic value with upside of 55%. By Cillian Huang and Ryan Ren Rating: Buy Market Cap: $732.9M Price Target: $ 37 . 01 Shares Outstanding: 29.67M Price(10/23/2015): $2 3 . 9 5 52 – week High/Low: $48.23/$19.34 Potential Upside: 55 % Dividend Yield: 3.8% Investment Thesis Nextera Energy Partners, LP (NYSE: NEP ) is a growth-oriented Yield Co that acquires and manages clean energy assets with contracted long term cash flows. Affected both by macro market volatility and by sector factors, NEP is currently trading at a discount to its intrinsic value, presenting an attractive buying opportunity with an upside of 55% . We see NEP as a premier Yield Co with strong fundamentals bolstered by a portfolio of existing assets operated by topnotch operators; and by a slate of upcoming assets supported by the development capabilities of North America’s largest clean energy developer NextEra Energy, Inc. (NYSE: NEE ). Why Does The Opportunity Exist? Solid renewable s pipeline : Supported by its sponsor NEE, NEP has been provided with Right-of-First-Offer (ROFO) on a portfolio of clean energy assets that are currently being developed by NEE. NEE is the leader in the clean energy space. It has developed over 12GW of renewables and is the largest clean energy developer with 17% of the current market share. NEE continues to grow its renewable development pipelines, creating a visible stream of projects to propel NEP toward its growth target of 12-15% until 2020. Extended growth runway : NEP recently acquired NET Midstream, which owns and develops seven gas pipelines that are strategically located in the Eagle Ford play. The transaction is immediately accretive to shareholders and contributes approximately $150M adjusted EBITDA and $115M CAFD in 2016. Adding gas pipelines to NEP’s existing renewable portfolio offsets its exposure to resource variability caused by wind and solar. The transaction furthermore provides the platform for NEP’s future expansion into the gas pipeline space, considering NEE is building its presence in the business by developing three pipeline projects that would be dropped down to NEP. Robust renewable s growth prospects : The renewables have presented a robust growth path during the past decade. The momentum will continue with the improving renewable economics, the increasing Renewable Portfolio Standards, the enactment of the Clean Power Plan, and bipartisan support for extension of the production tax credit and investment tax credit. Viable Yield Co model : Yield Co’s growth is dependent on their regular access to the debt and equity market to fund projects acquisitions. Present market conditions have been adverse to the entire Yield Co space, making it challenging for Yield Cos to raise funds by issuing equity that should fairly reflect fundamental values. However, we are confident in the validity of the Yield Co structure, as this model has worked successfully in the MLP space. With effectively managed cost of capital and solid project pipelines, we believe Yield Cos like NEP will continue to deliver stable cash flow in the long run despite a difficult short term trading environment. Proven management track record: The parent company NEE has provided NEP with a high quality management team with extensive experience in developing and financing clean energy projects. With prudent capital market discipline, the management team led by CEO James Robo has demonstrated a track record of success in delivering value to shareholders. Valuation NEP’s unit price has tumbled as a result of market concern over the Yield Co sector and negative market response to the NET acquisition. However, we still see NEP as a premier Yield Co with strong fundamentals. Ultimately, a Yield Co with high distribution growth, strong and stable cash flow, and efficient capital structure deserves high valuation. We reached the one year price target of $37.01 by blending two methodologies – distribution discount method and EV/EBITDA multiple method . Due to the recent financing need for the acquisition of NET Midstream and Jericho Wind Energy, the dilutive effect incurred by potential NEP’s equity issuance has been baked into our valuation models, increasing the total LP units from 93M to 96M. The DDM – Gordon Growth method reflects NEP’s robust distribution profile to satisfy investors’ appetite for income growth. Our view on NEP’s sustainable capacity to deliver growth is reinforced by NEP’s near-term execution on planned drop-down wind energy assets acquisitions and its long-term strategy to expand into the natural gas pipeline space. Supported by a deep assets pipeline developed by its sponsor NEE, NEP is on track to achieve 12.0% to 15.0% distribution per unit growth rate through 2020. In the DDM – Target Yield method, we applied the 2016 target yield to our 2016 estimated distributions per unit. We assumed NEP will maintain a 3.80% yield, which is in line with the pure play peers’ 2016 estimated average yield. Our EV/EBITDA Multiple starts with 2015 estimated adjusted EBITDA of $459.75 million that is driven by 2072MW renewables generation capacity with 19 years average PPA; and by the recently acquired 7 gas pipelines with aggregated capacity of 3 BCF/day binded to 16 years ship or pay contracts. Due to NEP’s stable long term cash flow and better growth prospects, we applied the median EV/EBITDA multiple of 15x derived from trading comps, reflecting a reasonable premium to NEP’s current trading multiple of 12x. Caveats Rising Interest Rates : Interest rates hike presents a downside risk by diverting yield-hungry investors to U.S treasury notes that offer competitive yield with lower risk. High interest rates further undermine NEP’s ability to maintain an efficient cost of capital due to the increasing financing costs. Unfavorable financial markets : The Yield Cos are vulnerable to volatile financial markets. Depressed share prices hinder the Yield Cos’s ability to accretively fund new acquisitions by issuing new shares. Conversely, a healthy financial market is advantageous to the Yield Co, making it easier to raise equity at a proper valuation. Unpredictable resource variability: Although all of NEP’s wind and solar assets are contracted with Power Purchase Agreements, the wind does not always blow and the sun does not always shine. Weak wind together with dimming sun diminishes cash flow estimates. Corporate governance : The sponsor NEE controls the major voting rights of NEP. Besides third party acquisitions, NEP’s growth is largely contingent on its ROFO rights to projects developed by NEE. This could present a risk to NEP’s shareholders when NEP is unable to negotiate favorable terms by catering to NEE’s interest. Conclusion We are confident NEP is the first-in-class Yield Co with robust fundamentals supported by its strong sponsor NEE. The upside is bolstered by contracted cash flow, double digit distribution growth, and experienced management. The downside is indicated by potential interest risk hike, unfavorable financial markets, and possible conflict of interests between NEE and NEP.

RSX Bear Thesis: What Worked And What Did Not Work

Summary RSX is down 10% since by initial bear thesis article was published in June. I can’t call it a success and I surely expected more downside. I discuss the reasons for this underperformance and the outlook for RSX. Back at the end of June, I published an article titled RSX: The Bear Thesis , where I outlined my thoughts about the direction of the Market Vectors Russia ETF (NYSE: RSX ). My main points were the weakness of the ruble, the poor state of the economy and bearishness on oil prices. I mentioned cheap valuations of Russian companies as the main factor for the bullish thesis, but stated that these valuations were chronic and that I did not expect them to provide significant support for RSX. How the thesis played out so far On June 26, when the initial article was published, RSX closed at $18.28. On October 27, RSX closed at $16.47, declining 10% from the day when the initial thesis was published. During this period, RSX was volatile: it touched lows of $14.00 and then rebounded to $17.81 before sliding to current levels. At the same time, USD/RUB, which closed at 54.78 on June 26, increased to 64.90 on October 27. Brent oil declined from $63.05 to $47.03. Thus, oil declined 25.5%, the ruble declined 18.5% and RSX declined only 10%. I can’t call it a bad idea but I’m a little bit disappointed because I expected more downside. I think it is time to revisit the thesis and see why it did not play out as well as I expected and whether there is still more downside possible. Why RSX gained more support than I expected I strongly believe that the lack of interest rate adjustment in the U.S. together with the monetary policy in the EU provided support for RSX. Tired of ultra-low (and sometimes negative) interest rates, investors decided to shop elsewhere. Also, Russia finally had its first capital inflow in 5 years, as money was most likely repatriated in fear of further sanctions. I’ve seen different opinions on why exactly Russia suddenly had a capital inflow despite no positive changes in economy, investment climate, etc., and I stick to my own view of repatriation of the capital. I must admit that you won’t get a firm data on this topic, so any conclusions imply some sort of speculation. The next thing is that the Russian government was willing to accept a lower ruble-denominated oil price. The ruble-denominated price is critical for the Russian budget, which is seriously dependent on oil income. However, the USD/RUB quote is followed by the majority of population during spikes. An increasing ruble is perceived as a sign of strength of the country, and the declining ruble is a sign of weakness. Therefore, everyone gets nervous when ruble devalues further. So, there is a kind of political “stop” to the rate of ruble’s devaluation even if it hurts the budget and the economy to some extent. When I was writing my initial article on RSX, the ruble-denominated price of oil was 3453 per barrel. Now, it is just 3052 per barrel. This is an 11% decline and I expect that the ruble-denominated price of oil will normalize closer to at least 3200 level. Ultimately, it is a bet on oil price direction Here are RSX top 15 holdings . Stock Weight Sector Surgutneftegaz ( OTCPK:SGTPY ) 8.69% Oil & Gas Sberbank ( OTCPK:SBRCY ) 8.22% Financial Gazprom ( OTCQX:GZPFY ) 8.04% Oil & Gas Magnit 7.97% Services LUKOIL ( OTC:LUKFY ) 7.89% Oil & Gas Novatek 5.83% Oil & Gas Tatneft ( OTCPK:OAOFY ) 5.47% Oil & Gas VTB Bank 4.93% Financial Rosneft ( OTC:RNFTF ) 4.83% Oil & Gas Transneft 4.00% Oil & Gas Mobile Tele Systems 3.94% Technology Uralkali 2.25% Basic Materials Yandex (NASDAQ: YNDX ) 2.21% Technology Polyus Gold ( OTCPK:OPYGY ) 2.20% Basic Materials Polymetal ( OTCPK:AUCOY ) 2.19% Basic Materials As you can see, most companies directly depend on oil and gas prices. The devaluation of the ruble gave them cost advantage, but at the same time they remain vulnerable to additional oil price downside. Financial and services companies will continue to feel pressure from the slowing economy. In my view, the more oil stays around $50, the worse the Russian economy will get. The head of VTB Mr. Kostin even made a remark ( Google translate link ) during the forum “Russia calling” that it made no sense to lend to small and medium businesses in the country. Of course he got bad media for this call, but truth is truth no matter how ugly it is – new businesses need growth prospects in order to survive, and these prospects are muted in the current environment. I believe that pressure on all non-energy and materials sectors will mount if oil prices stay where they are. RSX is mostly a bet on the energy sector, but the performance of other companies does matter as well. GDP continues to shrink along with domestic demand. Reserves has been stable in recent months, but the budget deficit will start eating the country’s reserves unless there is an increase in the price of oil. At the end, it looks like everything will mostly depend on the price of oil. If you believe in the oil price upside, you should buy RSX. If you, like me, think that there will be additional downside in the price of oil, then RSX is a short candidate. I think that currently neither investors nor economy is ready for Brent prices of about $40 per barrel. If we see this, RSX will likely retest its last-year lows.

MOAT: Have You Considered Using An ETF To Find Companies With Moats?

Summary The sector allocations were a bit surprising to me. Industrials were heavily weighted while utilities and health care were not. The fund has a 15% turnover ratio, which seems within reason for the strategy. The idea of holding attractively priced companies with solid economic moats makes sense, but applying that strategy as an ETF is problematic. The sheer size of the ETF would be a huge problem for acquiring shares in smaller companies with the equal weighting philosophy. Larger companies will receive significantly more coverage and the market should be more efficient. Investors should be seeking to improve their risk adjusted returns. I’m a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. One of the funds that I’m researching is the Market Vectors Wide Moat ETF (NYSEARCA: MOAT ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The net expense ratio for MOAT is .49%. I tend to be very frugal with my expense ratios, so I like to see those low levels. When I’m looking at a simple market cap weighted broad market or total market ETF I would expect to see single digit expense ratios. On the other hand, this portfolio would require analysis on the individual companies so higher expenses would be expected. Sector The following chart breaks down the sector allocations: I don’t love huge allocations to consumer discretionary, but I can believe that they would make sense for a portfolio based on having economic moats since there should be some material differentiation in the products provided by the companies. On the other hand, seeing industrials at almost 25% is quite a surprise to me. Perhaps their concept of a moat is different from mine, but they clearly don’t weight utilities high despite the utilities having regulated monopolies. I would think a monopoly that was protected through regulation would have a fairly solid economic moat. In a similar manner I would have expected stronger allocations to health care because the patent system provides long lasting economic moats. Largest Holdings The following chart shows the largest holdings for the fund from the end of the third quarter: I pulled up the daily list of holdings to verify that they were not materially changed. Since the goal here is to buy companies with durable economic moats, I would expect the allocations to remain similar with some small variations as shares go up and down in value causing them to trade places on the list. (click to enlarge) I had to pull the fund up on Schwab to find the turnover ratio, which was listed at 15%. All in all that suggests the portfolio would be turned over about once every 6 to 7 years. That isn’t too bad. The reason for the turnover seems to be that the portfolio is designed to be allocated as an equal weight portfolio across the “most attractively priced” companies that have been classified as having large moats. If the case is based on most attractively priced, then it starts to seem strange that the companies are not moving up in price enough to force the positions to be turned over the next time the index is updated. Conclusion There is nothing wrong with the concept of selecting stocks based on finding reasonably priced companies that have economic moats to prevent competition from eroding their profits. The strategy makes a great deal of sense and investors selecting individual companies would be wise to consider the influence of future competition on the success of their investment. A challenge for an ETF attempting to follow the same strategy is that it could require some fairly significant capital flows if the ETF becomes larger. The need to completely remove companies and buy up a 5% allocation in another company would risk moving market prices if the ETF were large and their strategy included fairly small companies. While moats may be much more common for established companies that rule their space, that doesn’t mean there won’t be very attractively priced smaller companies that are flying under the radar. The nature of needing to be able to suddenly buy up around $30 million to $40 million would be a difficulty for companies with a market capitalization lower than $1 billion since it could require purchasing at least 3% of the company. This will probably force the ETF to only consider larger companies. The concept makes sense, but execution of the strategy seems like a logistical nightmare unless the investment universe is significantly restricted to limit the list of potential investments to medium and larger companies. Once those restrictions are in place, it seems much more difficult to find and select the best securities because larger capitalization companies attract substantially more analyst attention and should generally be priced be more efficiently.