Once upon a time, renewable energy investing was the domain of growth-oriented investors. Only those who could handle the industry’s stomach-churning ups and downs took part.
Today, that’s no longer the case.
Conservative investors can now get a piece of the industry (and its growth) through a relatively new class of income-producing securities called 'yieldcos'.
The very first yieldco, NRG Yield (NYSE:NYLD), came into being in July 2013. Just two years later, there are more than 20 yieldcos to choose from – and there’s even a yieldco ETF yielding close to 3%.
What Are Yieldcos?
According to the National Renewable Energy Laboratory, a yieldco is a dividend growth-oriented public company, created by a parent company, that bundles renewable and/or conventional long-term contracted operating assets in order to generate predictable cash flows.
Typically, the assets are already producing and providing electricity to customers under long-term contracts. Because of their length – contracts can last as long as 30 years – they offer predictable income. Plus, power projects still under development remain in the parent company, not in the yieldco.
There’s also a growth component to yieldcos. As they acquire more assets, they’ll be able to increase payouts. The acquisition of more power-generating assets is funded with monies not distributed to shareholders.
Finally, yieldcos are subject to corporate taxes – but keep in mind that most renewable energy projects don’t generate taxable income for many years. Thus, distributions can effectively be considered nontaxable returns of capital to shareholders.
How to Choose a Yieldco
If you wish to purchase an individual yieldco, you should first look to see if there’s a strong pipeline of renewable power projects at the parent company. These projects will be the driver of future payout growth.
Next, see if the yieldco has the right of first refusal on projects from the parent. And, perhaps most importantly, determine at what price the yieldco is buying assets from the parent. This is key, since the more money a yieldco pays for assets, the less it has available to distribute to shareholders.
Finally, it’s worth seeing whether the yieldco is branching out geographically or technologically. Here are two examples of what I mean:
Sunedison (NYSE:SUNE) has already spun out a very successful yieldco, TerraForm Power (NASDAQ:TERP). The stock is up 28% year to date, thanks largely to its growth strategy. Now, SunEdison says it will spin off a second yieldco with its emerging market assets.
Another successful yieldco, Abengoa Yield (NASDAQ:ABY), came from Spain’s Abengoa (NASDAQ:ABGB) and is up over 18% year to date. It already has assets in North America, South America, and Europe, and in February announced the purchase of two desalination plants in Algeria.
Another Option: Yieldcos Exchange-Traded Fund (ETF)
If you don’t want to do all the homework necessary to choose an individual yieldco, there’s a great alternative: Global X YieldCo Index ETF (YLCO), a new ETF that came to market in May. Its portfolio consists of 20 securities, with TerraForm Power the top holding at 12.4%.
Why only 20 stocks? Because there are still a very limited number of yieldcos listed here in the United States, with another few in London. But this ETF’s universe will expand soon with yieldco IPOs coming from First Solar (NASDAQ:FSLR), SunPower Corporation (NASDAQ:SPWR) and others.
The Future Looks Sunny
There’s a lot to like about yieldcos, but investors should be aware of a few potential pitfalls.
First, higher interest rates could negatively affect yieldcos, as they will most income instruments. Secondly, yieldcos have built-in assumptions about steadily-rising electricity prices. If renewable energy is so successful that electricity prices actually drop, that would obviously have a negative impact.
However, that’s a very long-range concern, and the future looks bright for yieldcos right now.
According to the International Energy Agency (IEA), clean energy will account for 25% of global production in 2018. In 2011, that figure was just 20%.
Meanwhile, yieldcos have quickly become a godsend for the industry itself, which had trouble raising funds in the past but now has access to newer and cheaper capital. With renewable energy continuing to ramp up globally, yieldcos should remain the hottest trend in energy finance.
Good investing,
by Tim Maverick