Tag Archives: energy

TerraForm Power: Is It Time To Buy This YieldCo?

Considering the recent downfall in TerraForm Power stock levels we look at if it is worth investing in this security. We review various risk factors and our assessment on required yield based on the risk factors. Currently we view the valuation range of $17.50 to $20 subject to downward revision if Vivint Acquisition goes through. Over the last year, we have been consistently negative on YieldCo valuations and did not see a reason to invest in any of the YieldCos in the market. We were of the opinion that the market was mispricing risk in the long term assets held by these YieldCos. However, the yield bubble that we were in for much of the last year has caused many of the YieldCos to be priced at incredibly high valuations and consequently drove project developers like SunEdison (NYSE: SUNE ) go on an unsustainable growth path. One of the risks of this yield mispricing is that project developers counting on low yields tend to develop projects at unacceptably low margins. When yields rise, as they did recently, these developers find themselves cash strapped and with limited options on exiting from the projects under development. That is the quagmire that SunEdison finds itself in today. Companies affected by this same malady but to a much lesser extent, in an approximate order of declining risk, include SolarCity (NASDAQ: SCTY ), Vivint Solar (NYSE: VSLR ), SunRun (NASDAQ: RUN ) in the residential sector and Canadian Solar (NASDAQ: CSIQ ), SunPower (NASDAQ: SPWR ), Fist Solar (NASDAQ: FSLR ), Trina Solar (NYSE: TSL ) and JinkoSolar (NYSE: JKS ) in the large scale project sector. Of the above group, we are skeptical about the survival chances of the residential solar installers as their risks are far in excess of what the markets currently comprehend. Of the latter group, we believe the risk factors are more manageable given the manufacturing component of the companies, the much smaller project component, cost/margin advantage due to the use of in-house panels, and the location and returns of the assets under development. Of the solar asset holding companies, only SunEdison, First Solar and SunPower have their own YieldCos. When it comes to these companies many investors have tended to tie the performance of these sponsor companies with their YieldCos. As misguided as that line of thinking was, the markets and the Wall Street analyst community played a role in reinforcing that sentiment. However, we believe the time has now come to decisively cut the cord between sponsors and YieldCos and look at these companies separately and objectively. With this mindset, we now review the prospects for TerraForm Power (NASDAQ: TERP ). It should be noted that TerraForm Power has fallen from a peak of about $42 in April of this year to about $22 today – almost a 50% correction for a so called stable yield vehicle. At the current price, TerraForm Power yields about 6% on a TTM dividend basis and about 8% on forecasted 2016 dividend basis. Is the current stock price a reasonable approximation of the Company value? Or, conversely, is the yield level appropriate for this class of assets? To evaluate this, we believe one has to consider the risk factors of the asset base of the YieldCo and assess an appropriate risk/yield level. Our view of the required yields and risk factors are as follows: – To begin with, when it comes to energy assets, investors should note that not all solar asset classes have the same risk. We are of the opinion that, all else being equal, US utility assets deserve a discount rate of about 8%, US high grade commercial assets about 10%, and US residential assets about 12%+. – While TerraForm Power management prides in saying the YieldCo consists mainly of OECD assets and thus low risk, we believe investors should keep close tabs on the source of the assets. Not all OECD countries have similar currency and country risk profiles and some countries have a vastly higher set of risks than others. Several of the currencies have depreciated significantly vis-à-vis dollar and there is not much of a compelling story on why the trends should reverse. In general, assets from any country with likely future depreciation against dollar should cause the yield to increase. – Remaining life of the PPA is also a significant risk factor. With the rapidity of the changes in the solar industry, it is likely that some of the solar PPAs will not even be renewed. To the extant they are renewed, it is likely that they will be renewed at prices far lower than the existing PPA levels. – It is also likely that many of the assets would require significant upgrades for them to be renewed. For example, the utility or commercial customer may demand certain amount of dispatchability or a shaping of the energy. The capital costs required at renewal for any such changes and upgrades should be rolled into the IRR and yield calculations. – The rate of the PPA compared to the current market should also be a consideration. The larger the disparity between market and PPA rates, the higher the motivation for the customer to renegotiate and a chance that the asset may become distressed. – The potential for curtailment for each of the assets should be evaluated and discounted. – Wind resources, on the other hand, have a different risk profile than solar. Wind has an energy profile that complements the solar production and may end up holding up better in terms of PPA prices in the future. Wind resources may also likely need smaller battery support to make the power plant resources “pseudo dispatchable”. In other words, the wind assets may have a lower risk factor at renewal time than solar assets. – Investors should note that this is only a partial list of risks and any other risks specific to an asset or asset class should also be considered and impact evaluated While having a checklist can be useful, there are multiple challenges in evaluating the risks and costs we present above starting with disclosures. Even if the risks and costs can be reasonably identified, weighing of the factors is, at best, an informed estimate. When dealing with such unknowns, a reasonable safety margin is mandatory. Without using much scientific rigor in analysis, our estimate is that the current portfolio of assets in TerraForm Power need to yield at least 10% to provide a satisfactory risk adjusted return to investors. This, in turn, would imply that the valuation of TERP is likely around $17.50 a share based on forward guidance. Note that this valuation does not give any premium for growth. One question to ponder in this context is how much growth is possible at the new and increased cost of equity. To understand the Company’s growth potential, one has to estimate the future cost of capital for TerraForm Power. Firstly, while it is true that the cost of equity has gone up substantially for TERP, we believe that there is a reasonable chance that TerraForm Power can obtain debt capital at attractive rates. Secondly, markets have consistently demonstrated that unsophisticated investors are likely to buy debt and equity at surprisingly high valuations. If TerraForm Power can attain a WACC in the 8 to 10% range, we believe that growth, though hard to come by, is possible. Discounting for possible growth, and assuming a fairly benign yield environment, we can see TerraForm Power’s intrinsic value reaching about $20 by the end of 2016. This, of course, assumes that asset quality remains reasonable. As we wrap up this discussion, investors should consider another key factor when acquiring a YieldCo stock. While the current yield bubble has burst, it is neither the first one not will it be the last one. With Wall Street’s penchant for newfangled metrics, and with no shortage of investors subscribing to yet another non-standard valuation methodology, managements will always be faced with bubbles in the stock price and yields and will be issuing new equity or debt to take advantage of it. When the prices of these instruments correct from bubble levels, the preexisting stockholders who acquired the equity at a lower level will be beneficiaries of the largesse of the new stockholders. To benefit from this effect, it is very important for yield oriented investors to accumulate the YieldCo stock when the asset class is out of favor and shun purchases when the asset class is trading at rich valuation levels. All things considered, for yield oriented investors, we see TerraForm Power as a buy in the $17.50 to $20 range. While the stock has not gotten to this trading range, alert investors may be able to enter the position when there is a market weakness. Alternately, given the limited downside from the stated levels, the position can also be entered through selling puts at the $17.50 or $20 levels. The key risk factor at this point for this YieldCo is the acquisition of Vivint Solar . While this deal makes increasingly less sense, management has continued to stick with it to date. Vivint asset purchase and the aggressive addition of residential assets ahead of ITC step down could push up the risk adjusted yield requirements of the portfolio to north of 11%. In such an event, the entry point to TerraForm Power should be adjusted accordingly. Given the emerging nature of the energy landscape, we believe there may be several unanticipated risk factors for this equity and from that view, TerraForm Power can be considered overvalued. Summary Of Our View: Enter through selling put contracts in the $17.50 to $20 range. Disclosure: I am/we are long FSLR, SUNE, JKS, TSL, CSIQ. (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.

Is It A Temporary Recovery For Oil?

Famous American industrialist, Jean Paul Getty once said: “Formula for success: rise early, work hard, strike oil.” Though the major oil suppliers followed Getty’s formula seriously, they forgot to consider the demand side. Since the middle of last year, the market is witnessing a free fall in crude prices. In fact, the price of West Texas Intermediate (NYSE: WTI ) fell nearly 60% as compared to mid-2014, when oil was trading above $100 each barrel. Though the price of WTI surged nearly 6% on Friday after jumping 10% a day before, there are still speculations that the momentum is hardly sustainable. The slump in oil prices took a toll on energy shares over the past few months. The biggest energy fund – the Energy Select Sector SPDR ETF (NYSEARCA: XLE ) – lost 8% and 17% in the past one-month and three-month periods, respectively. The slowdown in Chinese economy, an increase in the U.S. rig count, a stronger dollar and oversupply concerns emerged as the key reasons behind the slump. Will It Sustain? The recovery in crude prices at the latter half of last week comes as a surprise, since the fundamentals driving oil price are not so strong. A better-than-expected second-quarter U.S. GDP report, the rebound in Chinese stock markets and the decline in oil inventory emerged as the main reasons behind the surge. However, it is anticipated that these factors had a temporary effect on crude price, and will fail to offset the weak global economic picture and oversupply concerns in the long term. In China, which is the world’s second largest consumer of oil, manufacturing activity for the month of August touched the lowest level in the last six and a half years, basically underlining a frail economy. This also highlights that if China wants to reach its 7% GDP growth target in 2015 – the lowest in years – the country will have to come up with measures to stimulate its economy. In fact, without a step-up, some analysts apprehend that China’s economic activity may fall below 7% in the third quarter. Moreover, news that oil producers increased their rig count for five straight weeks shocked an already oversupplied market. Separately, the nuclear deal between Iran and the U.S. raised concerns about increased oil supply. Moreover, buoyed by higher output from Iraq and Saudi Arabia, the Organization of Petroleum Exporting Countries (OPEC) is currently producing oil higher than their target. Also, foreign oil companies are finding it more profitable to sell crude in an environment of stronger dollar, which in turn, is putting pressure on oil supply. Who are Making the Most? Recently released auto sales data indicates the benefits from the low oil price environment. U.S. auto sales came in ahead of expectations in July, fueled by demand for light trucks and sports-utility vehicles rather than fuel-efficient cars. The seasonally adjusted annual sales rate (SAAR) climbed 3.2%, from June to 17.6 million in July, its second highest tally in a decade. Meanwhile, the airline industry is one of the major gainers from this situation. In the second quarter, the aviation industry is said to have amassed a record quarterly profit of more than $5 billion. The plunge in fuel prices, along with strategic investments to bring in more passengers on board has buoyed profit margins. In this situation, the Auto fund – the First Trust NASDAQ Global Auto Index ETF (NASDAQ: CARZ ) – and airlines fund – the U.S. Global Jets ETF (NYSEARCA: JETS ) – will remain on investors’ radar in the coming days. Separately, along with strong labor market conditions, the decline in oil prices has played an important role in boosting consumer spending. According to the “advance estimate” released by the U.S. Department of Commerce, Real Personal Consumption Expenditure rose 2.9% during the second quarter, higher than the first quarter’s growth rate of 1.8%. Moreover, the Commerce Department reported that retail sales increased 0.6% in July from the previous month, in which sales had remained flat. Core retail sales increased 0.3%, following revised gains of 0.2% in June. In this favorable environment, investors will closely watch the performances of top two retail funds, the SPDR S&P Retail ETF (NYSEARCA: XRT ) and the Market Vectors Retail ETF (NYSEARCA: RTH ), in order to analyze the sector trend in coming days. Bottom Line With less and less possibility of a sustainable oil price recovery in the upcoming months, investors will do well to focus on the sectors discussed above in this volatile environment. Original Post

A Closer Look At Suburban Propane Partners’ Results And Cash Flows As Of 6/30/15

SPH benefited from lower oil prices; it did not pass on to its customers all the benefits of lower propane costs thus increasing gross margin to 57% in 3QFY15 . Distributions coverage at 1.09x in the TTM ended 6/30/15; sustainable DCF shows a marked improvement over the prior TTM period. SPH has demonstrated less volatility and has performed better than the Alerian MLP Index over the past 12 months. SPH may not provide substantial distribution growth and may underperform the index if we see sustained increases in MLP price levels. But the ~10% yield appears secure, the valuation multiple is lower, and it is less leveraged. This article focuses on some of the key facts and trends revealed by results recently reported by Suburban Propane Partners LP (NYSE: SPH ). The quarters are noted with an FY designation because SPH’s fiscal year ends in September. Its third quarter of fiscal 2015 ended on 6/30/15 and is designated as 3QFY15. The article evaluates the sustainability of the partnership’s Distributable Cash Flow (“DCF”) and assesses whether SPH is financing its distributions via issuance of new units or debt. SPH is organized into 3 principal business segments. The propane segment, which generates the bulk of SPH’s revenues and cash flows, is primarily engaged in the retail distribution of propane to residential, commercial, industrial and agricultural customers and, to a lesser extent, wholesale distribution to large industrial end users. The fuel oil and refined fuels segment is primarily engaged in the retail distribution of fuel oil, diesel, kerosene and gasoline to residential and commercial customers for use primarily as a source of heat in homes and buildings. The natural gas and electricity segment is engaged in the marketing of natural gas and electricity to residential and commercial customers in the deregulated energy markets of New York and Pennsylvania. SPH is also engaged in other activities, primarily the sale, installation and servicing of a wide variety of home comfort equipment, particularly in the areas of heating and ventilation. SPH’s business is highly seasonal. It typically sells ~ 2/3 of its retail propane volume and ~ 3/4 of its retail fuel oil volume during the peak heating season of October through March. Consequently, the bulk of sales and operating profits are concentrated in the quarters ending December and March (the first and second quarters of the fiscal year). In the quarters ended June and September SPH typically reports losses. Cash flows and DCF coverage ratios are typically highest during the quarters ending March and June; this is when customers pay for product purchased during the winter heating season. SPH’s profitability is largely dependent on volumes generated by its retail propane operations and on the gross margin it achieves on propane sales – the difference between retail sales price and product cost. Table 1 shows volumes and gross margins for the 8 most recent quarters: (click to enlarge) Table 1: Figures in $ Millions, except gallons and percentages. Source: company 10-Q, 10-K, 8-K filings and author estimates. Volumes and earnings for 3QFY15 were adversely affected by unseasonably warm weather during much of 3QFY15 (16% warmer than normal and 6% warmer than 3QFY14 in areas served by SPH). In addition, the timing of the much colder than normal temperatures in March 2015 led to additional deliveries during 2QFY15, obviating the need for further deliveries in 3QFY15 to many customers. Propane prices in 3QFY15 fluctuated between $0.32-$0.57 per gallon and, on average, declined by 55.9% vs. 2QFY15, in line with the dramatic declines in crude oil and natural gas prices as prices. Lower propane prices benefit SPH’s customers and affect SPH by decreasing both its revenues and cost of goods sold. The impact on gross margin may vary; in 3QFY15 gross margin increased to 57% of revenues compared to 46% in 3QFY14 because SPH did not pass on to its customers all the benefits of lower propane costs. However, gross margin declined in absolute dollar terms ($126 million vs. $136 million) due to lower volumes. DCF and adjusted earnings before interest, depreciation & amortization and income tax expenses (“Adjusted EBITDA”) are the primary measures typically used master limited partnerships (“MLPs”) to evaluate their operating results. Making comparisons between MLPs is difficult because of lack of standard definitions these terms (a recent article discusses some examples). It is even more so in the case of SPH because it does not measure its results in terms of DCF and does not provide DCF data. However, SPH does provide Adjusted EBITDA figures: (click to enlarge) Table 2: Figures in $ Millions except per unit amounts, percent change and gallons sold. Source: company 10-Q, 10-K, 8-K filings and author estimates. Net income included expenses of $1.1 million and $4.3 million in 3QFY15 and 3QFY14, respectively, related to integration of the retail propane business acquired from Inergy L.P for ~$1.9 billion in August 2012. For 3QFY14, net income also included an $11.6 million loss on debt extinguishment. Adjusted EBITDA excludes the effects of these charges, as well as the unrealized (non-cash) mark-to-market adjustments on derivative instruments. SPH was able to decrease its investment in working capital in the trailing twelve months (“TTM”) ended 6/30/15, with lower commodity prices significantly reducing both inventories and accounts receivable. This resulted in a sharp increase in net cash from operations, as shown in Table 3: Table 3: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates. To enable comparison of DCF, investors must generate their own estimates because, as previously noted, SPH does not utilize this metric. Table 4 below provides my estimate of sustainable DCF generated by SPH in the periods under review, as well as my estimate of what SPH’s reported DCF would have been had it adopted a methodology similar to that used by some other MLPs (see article titled ” Distributable Cash Flow” ). Most of the MLPs I follow exclude working capital changes, whether positive or negative, when deriving their reported DCF numbers. This is one of the differences between DCF as is typically reported by MLPs and sustainable DCF. The relevant numbers for SPH are as follows: Table 4: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates. The two corresponding coverage ratios are as follows: Table 5: Figures in $ Millions except coverage ratio. Source: company 10-Q, 10-K, 8-K filings and author estimates. For the TTM ended 6/30/15 there were no material differences between DCF (excluding the impact of working capital changes and risk management activities, as it is generally reported by MLPs) and what I call sustainable DCF. Coverage of distributions ratio was positive (above 1x). Sustainable DCF shows a marked improvement over the TTM ended 6/30/14, primarily due to $82 million that was required for working capital in that earlier period. Table 6 presents a simplified cash flow statement that nets certain items (e.g., acquisitions against dispositions, debt incurred vs. repaid) and separates cash generation from cash consumption in order to get a clear picture of how distributions have been funded. It provides further insights on changes in coverage ratios. (click to enlarge) Table 6: Figures in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates. Table 6 indicates that net cash from operations, less maintenance capital expenditures, exceeded distributions by $104 million in the TTM ended 6/30/15, but fell short of covering distributions by $63 million in the TTM ended 6/30/14. Cash reserves were used to fund the shortfall. Table 7 provides selected metrics comparing the MLPs I follow based on the latest available TTM results. Of course, investment decisions should be take into consideration other parameters as well as qualitative factors. Though not structured as an MLP, I include KMI as its business and operations make it comparable to midstream energy MLPs. As of 08/26/15: Price Current Yield TTM Adjusted EBITDA EV / TTM Adj. EBITDA IDR- Adjusted EV/Adj. EBITDA Long-term debt (net of cash) to TTM Adj. EBITDA Buckeye Partners (NYSE: BPL ) $69.00 6.74% 844 14.7 14.7 4.2 Boardwalk Pipeline Partners (NYSE: BWP ) $12.89 3.10% 672 10.0 10.1 5.2 Enterprise Products Partners (NYSE: EPD ) $27.29 5.57% 5,239 14.6 14.6 4.1 Energy Transfer Partners (NYSE: ETP ) $46.86 8.83% 5,308 9.0 10.4 5.2 Kinder Morgan Inc. (NYSE: KMI ) $30.80 6.36% 7,373 15.2 15.2 6.0 Magellan Midstream Partners (NYSE: MMP ) $68.29 4.33% 1,102 17.1 17.1 3.0 Targa Resources Partners (NYSE: NGLS ) $27.38 12.05% 1,065 9.5 10.7 4.8 Plains All American Pipeline (NYSE: PAA ) $33.23 8.37% 2,229 10.3 12.8 4.3 Suburban Propane Partners $35.74 9.93% 332 9.8 9.8 3.3 Williams Partners (NYSE: WPZ ) $37.52 9.06% 3,681 10.6 12.3 4.6 Table 7: Enterprise Value (“EV”) and TTM EBITDA figures are in $ Millions. Source: company 10-Q, 10-K, 8-K filings and author estimates. Note that BPL, EPD, KMI, MMP and SPH are not burdened by general partner incentive IDRs that siphon off a significant portion of cash available for distribution to limited partners (typically 48%). Hence multiples of MLPs without IDRs can be expected to be much higher (see Table 4, column 5). In order to make the multiples somewhat more comparable, I added column 6, a second EV/EBITDA column. I derived this column by subtracting IDR payments from EBITDA for the TTM period. Other approaches can also be used to adjust for the IDRs of the relevant MLPs. In prior articles I expressed concerns regarding the susceptibility of SPH to weather conditions, volatile commodity costs, customer migration to natural gas or electricity, difficulties encountered by SPH in passing on higher propane costs to its customers, flat distributions since February 2013 and lack of a clear path to achieving distribution growth. These concerns are still valid, although some are mitigated by lower oil prices. But while the midstream MLP universe has been violently shaken by the decline in the price of oil, SPH has demonstrated less volatility and has performed better than the Alerian MLP Index over the past 12 months (19.5% decrease in unit price vs. a 35.5% decline in the index). Furthermore, the outperformance has been consistent whether measured on a 12-months, year-to-date, 6-months, 3-months or 1-month basis. Although SPH may not offer distribution growth and will probably underperform the index if we see sustained increases in MLP price levels, its ~10% yield appears secure, its valuation multiple is lower and it is less leveraged (3.3x long terms debt, net of cash, over TTM EBITDA). Investors brave enough to broaden their exposure to midstream energy MLPs should consider initiating, or adding to, positions in SPH. Disclosure: I am/we are long EPD, ETP, MMP, NGLS, PAA. (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.