In the first article of this survey of yield cos, I noted that many of the recent yield co IPOs have risen so far as to "lend the very term "yield co" a hint of irony" because rising stock prices are accompanied by falling annual dividend yields.
Yield Co Worries
Because yield cos invest in clean energy infrastructure such as wind farms and solar facilities, conservative income investors may worry about the durability of the technology. Will solar panels still be producing power twenty years from now? Others have brought up the credit quality of utility counter parties, and the untested nature of residential solar leases.
All of these concerns are real. Some solar panels will fail sooner than expected, and possibly many at a single solar farm. Utilities in Europe are already struggling financially, in part due to regulatory policies which were designed to promote renewable power. The residential solar lease model is only a few years old. Many solar leases contain inflation escalators which cause the price of solar power to rise by a few percent a year.
If electricity prices fall with the cost of power generated from wind and solar, what will homeowners do if they find they are suddenly paying more for electricity from their solar panels than they would for grid electricity? Might populist politicians pass laws declaring solar leases invalid because the lessees feel like they've gotten a raw deal?
While all of these risks are real, most can be dealt with by diversification. Falling prices of solar panels will make it cheaper to replace ones that fail prematurely. Both electricity prices and politics are local, meaning that geographic diversification can do much to manage these risks. Technological risks can be dealt with by diversifying between technologies. See the second article in this series for details on the types of power generation owned by each yield co.
The Biggest Risk
While all these risks are real, they are fairly standard investment risks, and can be dealt with through portfolio diversification: Don't own just one yield co (especially the smaller ones that own only a few facilities), and don't focus all your holdings on wind or solar.
The biggest risk, and the one that can't be diversified away is the risk of paying too much. For yield cos, which are designed to pay healthy dividends, not paying too much means getting a decent yield, now or in the near future. For me, "decent" means at least 2% more than long term government bonds. Even 2% is a fairly thin margin to compensate for the risks discussed above. The ten year US Treasury note currently pays 2.5%, and the 30-year bond pays 3.3%, so anything below a 4-5% dividend yield is too little to be taken seriously, unless we are very confident that dividend growth can continue at a rapid pace for many years to come.
High Expectations For Growth
Most US-listed yield cos have outlined aggressive plans for dividend growth. NRG Yield (NYLD) is the most ambitious, and expects to grow its dividend by 15% to 18% for five years. In order of decreasing ambition, Terraform Power (TERP) aims for 15% growth for 3 years, NextEra Energy Partners (NEP) expects 12% to 15% growth for three years, Hannon Armstrong Sustainable Infrastructure (HASI) expects 13% to 15% growth for two years, Pattern Energy Group (PEGI) aims for 10% to 12% for three years, and Abengoa Yield is aiming for relatively modest 6.5% growth over the next 12 months. Canadian yield cos, like TransAlta Renewables (TRSWF or RNW.TO) and Brookfield Renewable Energy Partners (BEP, BEP-UN.TO) have not laid out specific dividend growth targets, but do have reasonably aggressive growth plans which are likely to boost distributable cash flow and dividends over time.
The three London-listed yield cos, The Renewables Infrastructure Group (TRIG.L), Greencoat Wind (UKW.L), and Bluefield Solar Income Fund (BSIF.L) are less aggressive, and aim simply to increase distributions in line with inflation.
Sources Of Growth
Investing Cash Flow
Since yield cos return most of their investable cash to shareholders, most expected future dividend growth cannot come from re-investing earnings, as we would expect from traditional growth companies. Hence, dividend growth will have to come either from issuing debt and using that to buy assets, or from buying assets (with debt or new equity) at low prices which make those assets significantly accretive to cash flow per share.