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As new year approaches, bullishness returns to yieldco market

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A horse grazes near a wind turbine in the Noble Ellenburg Windpark in Ellenburg, N.Y.
Source: Associated Press

The yieldco market appears to be settling back into the good graces of investors amid a shuffle in majority sponsors and a more disciplined approach to capital allocation.

In what originated as a vehicle offering investors steady dividends via holdings of contracted, cash-generating renewable assets, shortly after its formation the sector's ability to tap capital markets for growth was tested by cooling sentiment and concern that the firms were over extended. But as 2017 draws to a close, the yieldco sector broadly has several strategic sale processes to thank for the wider replacement of some of its largest equity sponsors, signaling better alignment between the asset-class itself and its sponsors' cost of capital.

Moreover, the yieldco market has demonstrated of late its ability to be selective buyers of new assets, even looking beyond sponsors to third-parties, without necessarily leaning on capital markets for additional liquidity.

Revival of sentiment

Brookfield Asset Management Inc. recently closed on its acquisition of a 51% interest in TerraForm Power Inc, while Algonquin Power & Utilities Corp. has agreed to purchase a 25% stake in Atlantica Yield plc. Sale processes for large equity interests elsewhere in the market are underway and could draw to a close by year-end.

NRG Energy Inc. management signaled its intention to divest the entirety of its equity in NRG Yield Inc. by year-end, with previous reports indicating potential buyers could include Blackstone Group LP and NextEra Energy Inc., among others. Meanwhile, a sale of First Solar Inc. joint interest in 8point3 Energy Partners LP could also close in the coming weeks, with Bloomberg New reporting on Nov. 20 the short-list included Capital Dynamics and Pattern Energy Group Inc., itself the recent recipient of a $1 billion capital injection.

The culmination of such transfers of ownership appear to be helping to ease overhang on the sector.

"Given these issues have largely been resolved, investors will be able to refocus on the underlying fundamentals of these businesses,and the clean energy sector overall. Interestingly, most yieldcos continue to reflect limited growth and offer attractive cash flow yields protected by long-term contracts," Morgan Stanley Research analyst Stephen Byrd said on Dec. 6. "We remain constructive on the group as we move into 2018."

"Confidence in the yieldco model has strengthened in investors' minds due to the change in sponsors since mid-year," RBC Capital Markets analysts said in a Nov. 20 report, pointing to master limited partnership investment funds' renewed interested in the yieldco space.

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Throughout the yieldco market's broader transition, NextEra Energy Partners has weathered weaker sentiment by positioning itself among analysts as the leading yieldco, partly on the strength of its parent sponsor, NextEra Energy Inc. The NextEra yieldco was also able to raise third-party equity from both BlackRock Inc. and KKR & Co. LP, earning the title of "golden child of the yieldco space" from CreditSights analysts, and recently closed on a 691-MW drop down.

Leading the pack

That "golden" imprimatur may be warranted heading into 2018, with Credit Suisse analysts on Dec. 7 initiating coverage of the NextEra Energy Partners at a $44 per share price target, compared to its closing price of $39.05 on the same day.

"The largest risk to yieldcos stems from rising interest rates and changes to US energy/tax policy," Credit Suisse said. "[NextEra Energy Partners] is better placed than peers, as it has a sector-leading dividend growth (12-15%) and the lowest cost of capital (4% current dividend yield), doesn't expect to pay taxes for the next 15 years, and sponsors more than 13.5 GW of dropdown eligible contracted assets are safe-harbored from future changes to renewable tax credits."

The yieldco even earned the distinction from Gabelli & Company analysts on Dec. 6 as the "best idea" in the utility sector in 2018, calling the company, "the premier distribution-oriented renewable operating [limited partnership], or yieldco, primarily due to [NextEra Energy Partners'] sponsor and general partner, NextEra Energy."

Despite headwinds to the renewable tax equity market borne out of provisions in proposed tax reform bills, Morgan Stanley believes that NextEra Energy Partners is best positioned to benefit from the ensuing development of renewables on an economic basis.

"The U.S. power sector recently reached an inflection point where renewables have become the cheapest form of new generation across much of the country," Morgan Stanley said. "Yieldcos with access to sponsors with development capabilities are positioned to benefit from this trend, supporting sustainable growth."