Equity Research Model
Brookfield Renewable Partners L.P. (Q3/19)
A long term perspective with short term operational headwinds - Target Price: C$60.15; Recommendation: Buy; Risk: Low
Contact Modelyze Investments for an overview of the model.
(all currencies are in CAD$ unless otherwise noted)
Event: Brookfield Renewable (“BEP.UN” or “BEP”) reported Q3/19 results on Nov 11, 2019. Q3/19 Adjusted EBITDA of C$429 million was below Modelyze Investments forecast of $771 million. Actual generation on a proportionate basis was 7% below long-term average (LTA) with lower than expected hydro and wind generation. FFO per LP unit of C$0.43 was below our forecast of C$0.79. This represents a QoQ decrease of 42% and YoY growth of 27%. Q3/19 was a moderate quarter from an earnings and cash flow perspective and weak from an operational efficiency perspective. BEP.UN also announced its intention of future unit split and creation of an exchange corporation to expand its investor base.
Highlight: Though Q3/19 was a slightly weak quarter from an operation perspective as hydro and wind generation were hampered with below average hydrology in the U.S. Northeast, Canada, Colombia, Europe and Brazil, BEP.UN benefited from cost reduction strategies and re-contracting initiatives at favorable realized market prices in Canadian and Columbian markets. BEP.UN continued expanding its footprint in the renewable markets through C$100 MM equity investment in TerraForm Power and the acquisition of a 200 MW wind farm in China while selling low return assets such as Northern Ireland and Portougal wind farms to private investors, realizing 18% returns and disposing South African solar portfolios at high valuations. Through issuance of the largest Canadian corporate green bond, BEP.UN extended its corporate debt maturity to 10 years, maintaining an investment grade balance sheet (BBB+).
BEP.UN is expanding its investor base through the creation of a structure allowing investors additional flexibility to invest either through the current Partnership (BEP LP) or a newly created, publicly listed Canadian corporation (BEPC). The transaction will be analogous to a unit split with no change to aggregate cash flows or net asset value and a one-time distribution payment in the first half of 2020. BEP.UN remained on track to close the acquisition of a 50% interest in X-Eilo alongside institutional partners to enhance solar development capabilities. With 151 MW of assets under construction with commission dates ranging from 2020 to 2021 and through further developments in New York, California and Hawaii, including 960 MW of advanced stage projects through final permitting, acquisitions in China and India and asset disposals in South Africa, Brookfield Renewable continued expanding its global renewable pipeline. Modelyze Investments valuation includes the realization of these investment opportunities. In spite of weak hydrology in primarily North America and Latin America which has been the seasonal trend, the continued capital recycling efforts alongside favorable pricing in Colombia and Canada contributed to lower than expected generation and revenue numbers this quarter and the company benefited from 18% lower variable costs with respect to our forecast in wind portfolios. With negative earnings (C$0.17 per LP units), earning quality represented by lower operating cash flow over net earnings, and cash flow quality measured by lower flow ratios with respect to Q2/19 results are moderate; the operational efficiency with respect to Q2/19 deteriorated due to lower profit, EBIT and EBITDA margins. Balance sheet strength was moderate with C$2.5 billion liquidity due to availability of C$2.1 billion credit facility and issuance of corporate green bonds. BEP.UN continued to lengthen its power contracts in emerging markets, contracting 2,287 GWh/year with 10 year durations in Colombia and 139 GWh/year with 7 year durations in Brazil.
Valuation: BEP.UN is valued using both intrinsic and relative valuation. BEP.UN is an acquisitive company, with long term assets, high depreciation, capex and leverage, operating in the infrastructure space. Since Brookfield Renewable Partners is considered a long-term investment, Modelyze Investments relied on intrinsic approach accounting for its risk, growth and cash flow characteristics. Given the market conditions, geographical diversity and debt characteristics of BEP.UN, and considering all developments of the quarter, a 4.32% WACC and 2.28% term growth rate close to treasury yields, Modelyze Investments arrived at a target price of C$60.15/share. From the perspective of relative valuation, the best multiple used to value this highly levered, capital intensive firm is EV/EBITDA. Modelyze Investments used comprehensive analysis of North American power and utility companies with respect to their size, leverage and fundamental drivers such as profit margins to arrive at the most suitable Comp group. The Comp group includes TransAlta Renewables, Capital Power Corp., Algonquin Power, Northland Power, Fortis Inc., Hydro One, Canadian Utilities, Emera Inc., Atco and AltaGas. BEP.UN clearly trades at a premium to the mean multiple (including the target firm) as its revenue model not only includes contracted and merchant sales, but also capital recycling strategies making it superior to the peers; hence Modelyze Investments applied a premium over the average (EV – LTI)/EBITDA (LTI: long term investment) multiple to correct for this discrepancy. This premium is determined at 31% for EV/FY2019 EBITDA. Under the above assumptions and an implied (EV – LTI)/FY2019 EBITDA multiple of 10.24x, the forecasted target price is C$60.15. Modelyze Investments maintains its Buy recommendation despite short-term operational headwinds.
Risk to Target Price: Key risks to target price include variable generation and extreme weather events, commodity price risk, contracting risk, interest rate risk, counterparty credit risk, exchange rate risk, regulatory and political risk, equipment failure, inability to refinance at favorable terms, and ownership and control by BAM (60% ownership).
Conclusion: Modelyze Investments believes BEP.UN has maintained its focus on sustainable distribution growth of 5% – 9%, it has exceeded its target distribution payout ratios of 70% this quarter, and it has met the long term (over three years) total return objective of 12% – 15%. Despite short-term headwinds, given the continued domestic and global expansion and successful capital recycling strategies, Modelyze Investments maintains a BUY recommendation at a target price of C$60.15/share and assigns a LOW Risk Rating.
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