Equity Research Model
Brookfield Renewable Partners L.P. (Q2/19)
A long term perspective with short term operational headwinds - Target Price: C$50.59; Recommendation: Buy; Risk: Low
Contact Modelyze for an overview of the model.
(all currencies are in CAD$ unless otherwise noted)
Event: Q2/19 Adjusted EBITDA of C$552 million was below Modelyze forecast of $641 million. Actual generation on a proportionate basis was 14% above long term average (LTA) with hydro and solar generation above forecast. FFO per LP unit of C$0.74 was above Modelyze forecast of C$0.45. This represents a QoQ increase of 1% and YoY growth of 31%. 2019Q2 was a strong quarter from an earnings and cash flow perspective but moderate from an operational efficiency perspective.
Highlight: Q2/19 was a slightly busy quarter for Brookfield as the company continued expanding its footprint in the renewable markets while recycling low return assets. BEP added meaningful growth levers to its operations via C$653 million investment in European solar giant X-Eilo through a joint partnership with KKR in June, closing the phase one (C$35 million) of acquisition of operating wind assets in India for a total of C$70 million in June, closing the first C$350 million tranche of the original C$750 million investment into TransAlta renewables portfolio in May while increasing its ownership in TranAlta over the next two years from 5% to 9%, disposing its interest in solar and wind facilities in South Africa, and further scheduled disposal of solar assets in Thailand, Malaysia and South Africa in the second half of 2019. Modelyze’s valuation includes the realization of these investment opportunities. Strong hydrology in primarily North America and Latin America, the acquired solar assets in Europe along with favorable pricing in Colombia contributed to generation and revenue numbers this quarter. The company benefited from 15% lower costs with respect to forecast due to cost reduction strategies. Though earning quality indicated by higher operating cash flow over net earnings, and cash flow quality measured by higher flow ratios with respect to Q1/19 results are strong, the operational efficiency with respect to Q1/19 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 undrawn credit facility. BEP continued to lengthen its power contracts in Colombia and Brazil for a total 1,239 gigawatt-hours (GWh) per year leading to 30% of contracts having greater than 5 years terms while benefiting from a 17 year average contract term with no material maturities until 2029 in North America. BEP.UN has 131 megawatts (MW) of capacity in North/Latin America, Europe and China under construction with expected commission dates between 2019 and 2021, 629 MW construction-ready projects through final stages, and a further 220 MW of repowering projects in regions with significant renewable energy policies such as California, New York and Hawaii under assessment.
Valuation: BEP.UN is valued using both intrinsic (DCF) and relative (Comp) valuation. The purpose of a valuation dictates the best method of valuation for this company. BEP is a value stock and an acquisitive company, operating in the infrastructure space with long term assets, high depreciation, capex and leverage. Since Brookfield Renewable Partners is considered a long term investment in the portfolio, the method that dictates the value of this company is the intrinsic approach accounting for its risk, growth and cash flow characteristics. Given the market conditions, geographical diversity and debt characteristics of BEP.UN, a 4.33% WACC and 2.4% term growth of the general utility sector, Modelyze arrived at a target price of C$50.59/share. From the perspective of relative valuation, the best multiple used to value this highly levered, capital intensive, infrastructure firm is EV/EBITDA. It is advised to consider the impact of long term investments (LTI) and equity accounted investment in the value component of the multiple in the numerator by choosing (EV less LTI) to correct for this discrepancy across comparable firms. Modelyze used comprehensive analysis of North American power and utility companies with respect to their size, leverage and industry 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. Looking at the multiples across these firms, BEP.UN is clearly trading at a premium to the mean multiple (including the target firm). The distribution of multiples are relatively normal across these firms with mean and median close to each other. Brookfield Renewable Partners is an acquisitive company and BEP.UN revenue model not only includes contracted and merchant sales, but also its capital recycling strategy in which the firm buys cheap assets and sells assets with high valuations. None of the companies in the comp group pursue such strategy to this extent; hence Modelyze applied a premium over the average (EV – LTI)/EBITDA multiple to correct for this discrepancy. In order to pick the right premium, the Implied EV arrived from intrinsic valuation less LTI is chosen as the numerator, and the premium is calculated over the mean of the comparable company multiples which includes the target company. This premium is determined at 39% for EV/FY2019 EBITDA. Under the above assumptions and an implied (EV – LTI)/FY2019 EBITDA multiple of 13.68x, the forecasted target price is C$50.59 using the intrinsic and relative valuation. Modelyze recommends a Buy for this stock as a long term investment opportunity in spite of short term operational headwinds.
Conclusion: Modelyze believes BEP.UN has maintained its focus on sustainable distribution growth of 5% – 9%, it is moving closer to distribution payout ratios of 70%, and it has met the long term (over three years) total return objective of 12% – 15%. In spite of short term headwinds, given the continued domestic and global expansion and successful capital recycling strategies, Modelyze maintains a Buy recommendation at a target price of C$50.59/share.
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