Brookfield Renewable Energy Partners Earnings Show 3 Reasons Dividend Investors Should Stay Away

Source: Brookfield Renewable Energy Partners

Defensive dividend stocks such as utilities have held up relatively well over the past year, as income investors flee to safety. One exception is Brookfield Renewable Energy Partners (NYSE: BEP) which just reported concerning earnings that illustrate why Wall Street is correct to offer a relatively high 6.5% yield for the yieldco.

BEP Total Return Price data by YCharts

Let's look at three troubling trends that explain why I believe this high-yield yieldco is unlikely to make a good long-term income investment over the next five to ten years.

Growth not translating to AFFO growth

Source: Q4 earnings supplemental information

Initially Brookfield Renewable Energy Partners' business model seems foolproof. With the help of its sponsor and general partner, Brookfield Asset Management (NYSE: BAM) -- one of the largest and most experienced energy and infrastructure managers in the world -- it continually acquires hydroelectric and wind power capacity. Cash flow stability is provided by extremely long-term power purchase agreements or PPAs, with large utilities.

With such stable, and theoretically growing, Adjusted funds from operations (which is what funds the payout) management believes it can achieve 5% to 9% annual distribution growth resulting in long-term total returns of 12% to 15% CAGR.

However, as you can see 2015's sales, Adjusted EBITDA, and most importantly, AFFO per unit, declined, despite an 8.4% increase in power generating capacity. Most alarmingly, its DCR, the best metric for measuring long-term payout sustainability -- declined substantially.

Unfortunately, when you look at the long-term financials of Brookfield Renewable Energy Partners you see a pattern that calls into question whether or not management is truly following a strategy that is in the best interest of long-term investors.

Payout profile degeneration is a long-term trend

Source: Q4 earnings supplemental presentation

Thanks to the backing of Brookfield Asset Management the yieldco has been able to achieve impressive 8% CAGR in terms of power generation capacity over the last four years. However, due to falling energy prices it's been able to obtain for its PPAs, as well as worsening drought conditions in recent years negatively affecting its hydroelectric dams, the cash available to cover its fast growing payout has actually been falling.

In addition, over the last two years Brookfield Renewable Energy Partners has been increasing its reliance on equity funding via selling new units. While the 2.3% annual growth rate in its unit count is actually low for a yieldco (which funds growth via debt and equity markets as part of its business model) when combined with falling cash flow and a payout that has no business growing this quickly, the long-term sustainability of the distribution comes into doubt.

Management's long-term assumptions may prove overly optimistic

Source: Q4 earnings supplemental presentation

As you can see 29% of Brookfield Energy Partners' contracts will end within the next five years. While management is confident that the long-term price of energy it generates will rise there are none the less two key risks to its plans to grow its way back to distribution sustainability.

First, in order to diversify its cash flow the yieldco has been diversifying its power generation capacity away from hydroelectric dams and towards wind energy. In fact from 2011 (when it IPOed) through 2015 its energy capacity mix has increased from 9% to 17%, courtesy of numerous European wind investments its made with the help of Brookfield Asset Management.

However, wind energy can also be highly variable and in 2015 Brookfield Renewable Energy's actual wind power generation came in 9% below its long-term average. That was compared to 2014's 8.4% below long-term average generation.

When combined with the yieldco's shortfall from hydroelectric production (2015 say generation fall 8.6% below the expected long-term average compared to 2014's 1.4%) Brookfield Renewable Energy's 2015 electric production came in 7.9% below expectations, more than double 2014's shortfall. This shows that the yieldco's electric generation is at the mercy of the weather, which is why I believe management's aggressive payout growth policy is inappropriate.

Finally, an increased focus on wind power means that Brookfield Renewable is potentially exposing itself to lower long-term electricity prices because the cost of wind has continued to fall aggressively. Thus its possible that the yieldco's ability to command higher future PPA prices for its generation could be far below expectations.

Bottom line
Given the variability in its hydro and wind power generation, in addition to the long-term trend in falling contracting power prices (a trend that could continue in the future due to continuing falling costs of wind power) I have grave doubts about management's ability to continuing rewarding investors with 5%-9% annual payout growth.

Perhaps more troubling is that Brookfield Renewable Energy Partners, in a likely attempt to boost its unit price, continues to pursue an aggressive distribution growth policy despite a coverage ratio that continues to deteriorate at a disturbing rate. This short-term thinking could very well prove harmful to the yieldco's long-term growth prospects and is why I recommend dividend lovers look elsewhere for high-yield income.