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Abengoa Yield PLC: Diversified Global YieldCo With Attractive Dividend And Upside Potential

Summary Attractive sustainable current dividend yield of over 8 percent; expected to increase by 31 percent next year. YieldCo sponsored by global engineering giant with a substantial pipeline of attractive acquisition opportunities. Solid diversified asset portfolio with stable cash flow and global exposure. Last week we brought readers an interesting opportunity with a renewable energy focused YieldCo in NextEra Energy Partners (NYSE: NEP ). With this article, we’re focusing on another YieldCo with substantial upside potential, along with a strong sustainable high yield dividend. This time, however, the company is more nuanced and has, in our view, a different risk profile than NextEra Energy Partners. However, we believe the potential upside with this company is significant and offers a great source of low cost diversification to an income focused portfolio. Abengoa Yield PLC (NASDAQ: ABY ) is a United Kingdom registered company that trades primarily on the NASDAQ. Abengoa Yield follows the typical YieldCo model for project developers: its sponsor, Abengoa SA (NASDAQ: ABGB ), wins contracts, develops projects and then the Yieldco has the opportunity to be the first bidder on these projects as they’re sold. The sponsor benefits by freeing up capital to pursue more development opportunities and investors in the Yieldco benefit by holding onto long-term stable cash flow generating assets that can be levered to produce a high dividend yield. The sponsor, Abengoa SA, is a global engineering company based in Spain whose expertise is primarily in the development of power projects. Its market capitalization is approximately $1 billion, with 2014 revenues of over €7 billion. As of the second quarter of 2015, the sponsor held a 51.1 percent interest in Abengoa Yield, though the company is targeting this to be reduced over time to a 40 percent interest. Unfortunately for Abengoa Yield, there are conflicting views on the financial health of the sponsor, with a recent upgrade by Standard & Poor’s in July offset by the news that Moody’s has put the company on credit watch in early August. Abengoa Yield PLC does enjoy a higher credit rating from Moody’s than the sponsor, indicating limited concern about the impact of a default or bankruptcy of Abengoa SA on the YieldCo’s immediate financial situation. However, there is no doubt that a default of the sponsor would have a considerable impact on the future project pipeline that the YieldCo has access to, and we believe that this risk is captured in Abengoa Yield’s lower valuation and higher yield. With the YieldCo business model, questions around governance are common. In the case of Abengoa Yield, we believe there are adequate governance controls in place to protect the interests of its shareholders. First, a majority of its Board of Directors are independent directors, independent of both management and of the sponsor company. The board must vote on any acquisition of assets from the sponsor and determine that the terms are set “no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances.” These terms would be determined based on a market analysis of what similar projects would be priced at in the market. While the risk remains that the board could be swayed by influence of the sponsor, it would be at great legal risk to the independent directors and so we believe that this level of control is adequate. Further, there is an inherent control in the business model as the sustained ability for the YieldCo to raise equity in the market is based upon its ability to generate attractive cash flow returns. A poorly priced deal could hamper the YieldCo’s ability to attract equity financing in the future, harming the very purpose of the fund for the sponsor. Finally, in the case of Abengoa Yield, the sponsor does plan to dilute its interest over time to only 40 percent of the outstanding shares, handing majority shareholder ownership over to the public. In terms of its asset portfolio, Abengoa Yield is a highly diversified YieldCo, with assets ranging beyond just renewable energy on long-term contracts. In addition to solar and wind generation assets, the company also owns a conventional 300 megawatt gas plant, 1,100 miles of electric transmission lines and two water treatment facilities, along with a financial interest in a Brazilian electricity transmission project. The diversified nature of its assets is attractive, with many other YieldCo type models more focused on generation specific projects. All of these assets are backed by long-term contracts, most with investment grade counterparties, allowing Abengoa Yield to apply a significant degree of leverage through project financing. The average remaining contract life for the assets is 23 years. (click to enlarge) Source: Abengoa Yield PLC’s June 2015 Investor Presentation Along with the long-term, stable cash flow contracts, Abengoa Yield has also locked down O&M costs for all of its assets. This has generally been done through long-term inflation linked O&M agreements, primarily with Abengoa SA as the contractor. This provides cost certainty not only on the revenue side but also on the cost side, offloading operating and maintenance risks to the O&M services provider. This is a common practice in the YieldCo space, and Abengoa SA certainly has the skills and global reputation to be a strong operator of these assets. Abengoa Yield is still exposed to capital maintenance expenditures for its assets, however, and increasing capital maintenance costs could pose a risk down the line. In the medium term, however, we review this risk as small as most of the assets are fairly new in vintage and won’t be facing substantial overhauls for decades. In many cases, much of the return on and return of capital for a project is captured in its initial contract term, making maintenance and renewal of future contracts an option that the company can decide, or not, to exploit down the road depending on market conditions. Beyond the diversification in the types of assets of the company, the firm is also significantly geographically diversified. Its solar projects are split between the United States, Spain and South Africa, while its wind generation is located in Uruguay, its gas generation is in Mexico and its transmission assets are in Peru and Chile. Finally, the firm’s water treatment projects are in Algeria. Some of these jurisdictions certainly add risk to the company’s profile, but we also find the diversification to be encouraging in an industry where political and regulatory risk threaten companies with over-concentrated positions. We would expect further diversification of the company’s assets geographically due to the nature of potential push down projects from the parent, which truly operates in every corner of the globe. The firm’s assets are generally supported by long-term contracted cash flow arrangements. This enables the company to pay both a high dividend and maintain a significant amount of leverage. The firm’s cash flows are based 61 percent on availability, rather than production, and 93 percent of the cash flows are in US dollars, or hedged to US dollars through a swap arrangement with the sponsor. Further, less than 4 percent of contracted cash flow is from counterparties that have less than an investment grade rating. The combination of these factors provides a very stable cash flow base from which the company can support its high payout ratio dividend. In terms of future projections, the company has published some attractive but well supported numbers, with a projected 2016 exit dividend of $2.10-2.15 per share annualized. This would be a significant increase from the $1.60 per share paid today. The company then projects ongoing growth at 12-15 percent per year based primarily upon further acquisitions of Abengoa SA projects, potential third-party acquisitions and efficiencies. We think the long-term trend might be on the aggressive side of attainable and we reflect that in our valuation analysis further on this report. Source: Abengoa Yield PLC’s June 2015 Investor Presentation The YieldCo’s primary source of expansion projects is completed projects with contracted cash flows purchased from the sponsor. The firm has a Right of First Offer on all projects that Abengoa SA offers for sale, giving it the opportunity to participate in any potential acquisition from Abengoa’s substantial project list. The sponsor had a backlog of €8.8 billion, according to its first half 2015 presentation, with significant power and infrastructure projects under development that would be ideal assets for inclusion in Abengoa Yield PLC’s portfolio down the road. Previous asset sales occurred at a 15 percent IRR, which is a significant discount to Abengoa Yield PLC’s current return on equity as calculated in our valuation, offering the potential for accretive acquisitions at its current price. Positives Diversified Geographical Exposure: The variety of geographical locations represented in Abengoa Yield’s holdings is an attractive feature for a company of this nature. Having a variety of jurisdictional exposure limits the impact of any one country’s political or regulatory changes, which can have a significant impact on these types of assets. Despite the geographic diversification, the contracted cash flows for the company are primarily in US dollars or are hedged to US dollars and therefore the firm has limited foreign exchange exposure risk. Diversified Portfolio of Asset Types: The variety of assets held by Abengoa Yield is attractive for investors. We believe that the lower risk conventional gas generation and electric transmission assets act to reduce required equity returns for the firm overall and underpin the company’s stable cash flow profile. The renewable assets are well diversified themselves with a split between solar and wind projects of varying sizes. ROFO Agreement with Abengoa SA: The firm’s Right of First Offer arrangement with Abengoa SA is highly attractive on the basis that the sponsor has a significant pipeline of developed and in development projects that could be sold down to the YieldCo at an attractive price. We expect that Abengoa SA will overcome its liquidity crunch in the medium term and this project pipeline will be realized at its full value for the YieldCo. Conservative Leverage at Hold Co Level: The firm currently reports a net debt to cash flow available for distribution of 1.8x versus its target level of 3x. This offers some ability for the company to finance future acquisitions through additional debt, rather than the dilutive equity offerings which are too common in the YieldCo space. Risks Many Assets in Higher Risk Jurisdictions: Many of Abengoa Yield PLC’s assets are located in jurisdictions that pose higher business risks than assets in North America or Western Europe. While a concentration of assets in any one high-risk jurisdiction may pose a concern for us, having small exposures to numerous jurisdictions seems to offer a higher potential return, with minimal incremental risk on a portfolio basis. That said, if future acquisitions continue to build exposure in an existing asset location, or if the risk profile of future asset locations was significantly higher, this would materially impact our required equity return and valuation. Financial Health of the Sponsor: The conflicting views on the financial health of the sponsor, Abengoa SA, are certainly weighing on this stock. We believe that Abengoa SA has taken steps to address its financial situation but the outcome of this is uncertain. Further deterioration in the financial health of the sponsor may have a material impact on the availability of projects for Abengoa Yield to acquire through the ROFO agreement. Valuation One attractive aspect of a company that is primarily driven by its dividend and distributes nearly all available cash to shareholders is the ease in analyzing and comparing its relative value along with assessing its implied cost of equity capital. In the case of Abengoa Yield, our baseline assumptions are the lower end of 2016 dividend guidance of $2.10 per share, a 90 percent payout ratio and an 11 percent annual growth rate. Why do we reduce the expected growth rate below the guidance provided by the company? Our concerns about the sponsor’s financial health are not insignificant and any major liquidity crunches at the sponsor could impact the available project pipeline for future acquisitions by the YieldCo. We do believe that the higher growth rate could be obtainable, as demonstrated by the company’s ability to beat that growth rate in 2016, if the sponsor company can maintain an adequate pipeline of projects at a reasonable cost. Into the details of the valuation, based on the September 18 share price of $19.34, these dividend, payout ratio and growth assumptions produce an implied cost of equity of 23 percent on a free cash flow to equity basis, nearly on par with the equity cost of capital determined in our analysis of NextEra Energy Partners, but still significantly higher than Brookfield Renewable’s (NYSE: BEP ) 16 percent cost of equity. Importantly, this is also a significant discount to the typical sale price of these types of assets, with the recent purchases from the sponsor occurring at a 15 percent IRR. This is reflected in Abengoa Yield PLC’s current price to book of 0.88. Arguably, the lower risk transmission assets held by this YieldCo should reduce its cost of equity compared to a firm like NextEra Energy Partners, who has a more concentrated asset exposure. Over the longer term, we believe that these YieldCos will trend towards a more reasonable 15-18 percent return on equity. This is the basis of our base case scenario for Abengoa Yield PLC of $30.00 per share (at an 18 percent return on equity). This would represent an even 7 percent dividend yield in 2016, which is much more generous than the yield on the firm’s stock earlier in 2015, illustrating significant upside potential beyond our projection. Summary Overall, we believe that Abengoa Yield offers an attractive valuation and potential upside for a set of high quality power and infrastructure assets located in geographically diverse locations. Current drag from the financial situation of its sponsor has weighed on this price but we do believe that this simply offers an attractive entry point for long-term investors. We view Abengoa Yield as having a unique risk and return profile and offsetting highly attractive qualities that together make for a bargain priced addition to a diversified portfolio. Disclosure: I am/we are long ABY, NEP. (More…) 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.

Fed-Free Week Still Full Of Obstacles For ETFs

Summary A 2015 rate hike is off the table. In the near term, USDU might be the preferred option of the pair simply because it is short several emerging markets currencies, which have the potential to continue falling. As is often the case with weekly ETF previews, some familiar ETFs frequently re-emerge, and that is the case this week. By Todd Shriber, ETF Professor After a week spent worshiping at the altar of the Federal Reserve, financial markets will be spared the specter of a Fed meeting in the week ahead. However, that does not mean a 2015 rate hike is off the table. San Francisco Fed President John Williams told reporters last week that a rate hike this year could be appropriate. Richmond Federal Reserve President Jeffrey Lacker on Saturday said he dissented at a Fed policy meeting because he thought the economy was now strong enough to warrant higher interest rates, Reuters reported . Federal Reserve Bank of St. Louis President James Bullard said he argued against the continuation of the Fed’s zero interest rate policy. The ETF Situation The PowerShares DB USD Bull ETF (NYSEARCA: UUP ) and the actively managed WisdomTree Bloomberg U.S. Dollar Bullish ETF (NYSEARCA: USDU ) are the two primary exchange traded funds tracking greenback fluctuations, so suffice to say these ETFs would like 2015 rate hike momentum to reemerge and do so soon. In the near term, USDU might be the preferred option of the pair simply because it is short several emerging markets currencies, which have the potential to continue falling. UUP tracks the dollar against major developed market currencies, some of which could and should rally the longer the Fed puts off higher interest rates. There is some evidence to suggest some market participants were not reassured by the Fed’s no-hike call last week. For example, the Consumer Staples Select Sector SPDR ETF (NYSEARCA: XLP ) and the Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) , each among the most rate-sensitive sector ETFs, lost a combined $382.3 million in assets last week. XLP posted a modest gain, while XLU climbed 1.6 percent – which could mean the latter is worth monitoring in the week ahead. Watch List As is often the case with weekly ETF previews, some familiar ETFs frequently re-emerge, and that is the case this week. It should be noted the Global X FTSE Greece 20 ETF (NYSEARCA: GREK ) merits a place on traders’ watch lists in the week ahead. In what feels like a monthly occurrence, Greece holds national elections again this weekend. Even with potential for increased volatility due to the election and news of a major index provider lowering Greece’s market classification , the Global X FTSE Greece 20 ETF climbed 3.8 percent last week and is up 6.3 percent over the past month. It could be a sign of a renewed risk appetite, though only time will tell, but the PowerShares QQQ Trust ETF (NASDAQ: QQQ ) , the NASDAQ-100 tracking ETF, hauled in over $1.2 billion in new assets last week despite suffering a modest drop. Remember what investors are doing by being long QQQ. They are making an ETF proxy bet on the likes of Apple, Microsoft and Amazon, as those stocks combine for over a quarter of QQQ’s weight. Disclaimer: Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

We Have Heard This Message For A Long Time: Solomon, The Talmud, Diversification And Cash

Summary The investment community is divided on the importance of cash. This piece shows that it was very important for some ancient people. While there are references in the Bible regarding investing, there is scant advice on how to invest. The Talmud does offer investing advice, and this piece will show you how to use it, and how it performs. Biblical Diversification One of my passions has always been faith based investing, and using ancient texts to guide one’s money decisions. Jesus talked about money more than anything, except the kingdom of God. There are 101 verses in Proverbs about money, and there are many more in the Old Testamant. I have written about these topics before, but sometimes one should take another look at things to see if they still hold true. There is one, I specifically on which I want to focus. It is found in Ecclesiastes (11:1-6), and it comes from Solomon: “Ship your grain across the sea; after many days you may receive a return. Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land. If clouds are full of water, they pour rain on the earth. Whether a tree falls to the south or to the north, in the place where it falls, there it will lie. Whoever watches the wind will not plant; whoever looks at the clouds will not reap. As you do not know the path of the wind, or how the body is formed in a mother’s womb, so you cannot understand the work of God, the Maker of all things. Sow your seed in the morning, and at evening let your hands not be idle, for you do not know which will succeed, whether this or that, or whether both will do equally well.” Simply it means: Be involved in commercial enterprise. Invest in many things (seven is a special number). You simply cannot predict what will happen. Why should one diversify? As the English proverb says, “Don’t venture all your eggs in one basket.” If one concentrates all of their investments in one asset class, it is possible the entire investment could head straight to zero. Simply, diversification helps one to avoid unsystematic risks, those that are specific to particular investment or investment class. It goes beyond that, however. Brinson, Hood and Beebower conducted a landmark study, “Determinants of Portfolio Performance,” and presented in Financial Analysts Journal (May – June, 1992) there was an update in 1996. They showed that asset allocation decisions, far more than any other factor, affected the long-term performance of an investment portfolio. In fact, Brinson and his colleagues show that asset allocation effects over 90% of a portfolio’s performance. The results are illustrated in the chart below. (click to enlarge) Asset allocation is 15 times more influential than security selection and timing. Interestingly, the financial media spends the bulk of their market news in the latter. Of course, it is doubtful one would be able to sell much ad space if the media outlet spent the bulk of its time talking about asset allocation. When I see sites like the American Association of Individual Investors recommend seven asset classes for specific portfolios, I usually have a wry smile, and wonder if that was by accident or by design. Who knows? What is interesting is that Solomon did not specifically state how to invest. In fact there is no specific advice on how to invest in the bible. Talmudic Investing Now we look at the Talmud ; “…the body of Jewish civil and ceremonial law and legend comprising the Mishnah and the Gemara.” The Talmud evolved after the destruction of the second temple, and was the recordings of discussions and debates regarding the Torah. It was an attempt by Rabbinic Jews to write the oral law; an explanation of how to live under Biblical law. It was a guidebook on how to live. As for this piece, the focus is on the Tractate Baba Mezi’a folio 42a: R. Isaac also said: One’s money should always be ready to hand, for it is written, and thou shalt bind up the money in thy hand. R. Isaac also said: One should always divide his wealth into three parts: [investing] a third in land, a third in merchandise, and [keeping] a third ready to hand. Two parts of this investing strategy are pretty obvious. First, to invest in land simply means real estate. That is understood, and there are plenty of real estate investments one can make, some are in the form of real estate investment trusts (REITs) and are traded in the stock markets. Second, investing in merchandise means to invest in business; equity investing. It is the third part to this formula where there seems to be some disagreement. Where I see some debate is defining, “…and [keeping] a third ready to hand.” There are some who feel that means to invest in short-term securities which are safe. U.S. Government bonds would fit this quite well. Taken in context, though, the previous part of the discussion is pretty clear where it says, “One’s money should always be ready to hand…and thou shalt bind up the money in the hand.” The footnote to this passage states, “And not in another man’s keeping, so that advantage can immediately be taken of a trading bargain that is available.” To some, including me, this is a pretty clear conclusion that the Rabbi was talking about cash. The approach this is pretty simple. I used the following investments to track the value of a $1 investment since 1978: Wilshire US REIT Index Wilshire 5000 Total Market Index BlackRock Ready Assets Prime Money (MUTF: MRAXX ) The investments were divided in thirds, and rebalanced every calendar year. The chart shows the results: (click to enlarge) Someone who followed this strategy since 1978 would have realized an annual return of 10.25% (±10.44%). Compared to S&P 500 annual return of 11.58%, this is a strategy that holds up nicely, especially considering that 33% is invested in a Money Market Fund. What is more relevant is that it is less volatile than the S&P (±17.32%) for the same period. Why Should One Care? Let’s think about this. Solomon warns us of that we, “…do not know the path of the wind.” Rabbi Isaac says we should keep our money close in hand, which is similar to Deuteronomy 14:25, albeit that passage was referring to tithing. The key is that rabbinical texts suggest that one keep a certain amount in cash, and it is quite a bit of money. Why? The Bible is replete with verses about not knowing what tomorrow will bring. The Old Testament brings us: ” Do not congratulate yourself about tomorrow, since you do not know what today will bring forth. ” ~Proverbs 27:1 And let’s not forget that Solomon warns, “for you do not know which will succeed, whether this or that, or whether both will do equally well.” Was this a warning that we really do not know what will happen with our investments? I say, “Yes.” While the New Testament (albeit not part of the rabbinical text) tells us” ” You never know what will happen tomorrow: you are no more than a mist that appears for a little while and then disappears. ” ~James 14:4 This is just a theory, but I am willing to say that the Rabbi knew one should keep cash because of an uncertain future, and uncertain results. While the financial community is fairly split down in the middle when it comes to cash, it is important to keep a reserve so one can take advantage of opportunities. If one is fully invested, there is no way to buy new securities on the cheap without selling something; thus incurring a commissionable event. Remember the footnote, “so that advantage can immediately be taken of a trading bargain that is available.” One has to have cash on hand to take advantage of opportunities. During this downturn, one is unable to buy the stocks that just went on sale if all of their assets are otherwise invested already. Some proponents of modern asset allocation go as far as to suggest holding up to 15% in cash and its equivalents in a conservative portfolio. If 15% is considered conservative, then 33% would considered ultra conservative. Does this approach work? It depends on what one wants. If one wants to be fully invested in the stock market, that portfolio would yield a full 190% better result than the cash heavy Talmud portfolio over a 20 year period. One should remember, though, that same approach would have suffered a 37% loss in 2008 with no opportunity to respond. Meanwhile the Talmud portfolio would have only lost 24% in 2008, but still leave one with the ability to buy beaten down securities. It is really up to one’s personal psychology to decide. Conclusion I have often said that one should give up beating market averages . Investing is more about psychology, than one realizes. If sudden downturns force one to abandon a plan, then it is not a very good plan. If downside deviation keeps one awake at night, then one should consider a different approach; this is one that does work. It beats the two benchmarks that matter for most investors; zero and inflation. If one is looking for index funds for the Wilshire 5000 and REIT investments, consider BlackRock’s Total Stock Market Index (MUTF: BKTSX ) and BlackRock Real Estate Securities (MUTF: BCREX ) funds. Matching those with the previously mentioned money market fund, and one will have a nice three pack of mutual funds that will deliver over time. Happy Investing! Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.