Why Wall Street is Wrong About This Fasting Growing, High-Yielding Renewable Energy Stock

Source: NRG Yield

One of the best way for dividend investors to profit from the long-term growth of renewable energy such as solar and wind is through yieldCos, such as NRG Yield (NYSE: NYLD), NextEra Energy Partners (NYSE: NEP), 8Point3 Energy Partners, (NASDAQ: CAFD), TerraForm Power (NASDAQ: TERP), and TerraForm Global, (NASDAQ: GLBL). 

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Over the past year this specialized utility sector has been crushed as SunEdison, one of the largest players in the space, has gone bankrupt and caused Wall Street to doubt the business model its TerraForm yieldCos. However, as is often the case, Wall Street is throwing out the baby with the bathwater by now undervaluing all yieldCos, including those of superb quality. 

Let's look at three reasons why NRG Yield represents just such an excellent long-term income opportunity that might prove to be a worthy addition to your diversified dividend portfolio. 

Massive sponsor means strong continued growth

Source: Q1 earnings presentation, note NRG Yield IPOed in Q2 of 2015 which is why YoY comparison with this quarter is unavailable

NRG Yield's business model consists of buying long-term contracted energy generation assets from its sponsor and general partner, NRG Energy (NYSE: NRG), the largest wholesale energy provider in the US. 

It then sells the power to utilities under incredibly long-term (between seven and 25 years remaining under contract), fixed-fee power purchase agreements, or PPAs. This provides the stable cash available for distributions or CAFD, which funds the quarterly dividends. 

• Wind Power: 2,000 GW capacity (33.3% of power capacity)
• Natural Gas: 1.945 GW (32.4%)
• Thermal Power: 1.573 GW (26.2%)
• Solar Power: 491 MW (8.2%)

Because NRG Energy has nearly 50 GW of diverse capacity, including some of America's largest solar and wind production assets, it's able to drop these down to its yieldCo to provide extremely fast growth in both CAFD and sustainable dividends. 

For example, NRG Energy intends to sell its remaining 51% stake in the 250 MW California Valley Solar Ranch to NRG Yield in Q2 of 2016. This is part of management's planned 15% payout growth plan through 2018, which when combined with the already generous yield, has the potential to generate substantial investor returns. 

Dividend profile shows excellent long-term opportunity

Sources: Yahoo Finance, earnings releases, management guidance

You can see from TerraForm Power's and TerraForm Global's sky-high yield that Wall Street has little confidence in the sustainability of their dividends. Meanwhile, NRG Yield, NextEra Energy Partners, and 8Point3 Energy Partners, offer mouth watering yields but also strong payout growth potential, at least according to management's current growth plans. 

For dividend investors the long-term sustainability of the current dividend should be the primary concern, since a dividend cut is likely to send the share price cratering. From that perspective NRG Yield's first quarter coverage ratio should give investors confidence in its security, but more importantly, management expects 2016 CAFD to come in around $265 million which should provide for full year 2016 payout coverage of 2.73. 

Not only does that mean rock solid dividend security in the long-term, but it also indicates that NRG Yield should be retaining around $168 million in annual cash flow by the end of 2016. Which brings me to another major reason to like NRG Yield; management's conservative approach to one of the biggest risks to long-term growth. 

Management's smart debt focus

Source: NRG Yield investor presentation.

The yieldCo business model allows a high proportion of CAFD to be paid as dividends because new growth is partially funded by external debt and equity capital. However, this means that investors need to be careful that management avoids becoming too debt happy because an over leveraged balance sheet can not just hinder a yieldCo's growth plans, but also put at risk the security of the current dividend. That's what's occurring with TerraForm Power and TerraForm Global, whose unsustainable debt levels put them in violation of debt covenants that might result in heavy dividend cuts or even complete suspensions. 

NRG Yield investors should take heart that management is focusing on a more conservative, "slow but steady" payout growth strategy with a great deal of its excess cash flow going to paying down debt which will allow for increased financial flexibility and better long-term growth prospects in the years to come. 

Risks to keep in mind

The renewable energy yieldCo business model is still too new to determine whether or not fast growing dividends will remain sustainable once those decades long PPAs expire and are forced to compete with future wind and solar power prices, which are quickly declining. 

In addition, there is a risk that NRG Energy wholesale energy business model, which is less stable than the regulated utility businesses of other utility yieldCo sponsors such as NextEra Energy Inc's. This could force NRG Energy to attempt to take advantage of NRG Yield by selling it assets at inflated valuations, which is what SunEdison did with its TerraForm yieldCos after its unsustainable debt load made it desperate for capital. 

Bottom line

The renewable energy yieldCo business model has yet to be proven over the very long-term. However, over the next five to 15 years the predictable cash flows provided by NRG Yield's quality, diversified assets should result in both generous income today, and potentially superb dividend growth in the coming years.