One of my long–term favorite stocks, Pembina Pipeline ( PPL PPL +0.43%, PBA), is underwater this year. A big chunk of underperformance is because of the -8 percent decline in the Canadian dollar, which cuts the US dollar value of Pembina’s share price and dividends by an equal amount. But it’s also the result of the market’s persistent under appreciation of the strengths of Canada’s third largest energy midstream.
Since going public more than 20 years ago, Pembina has raised its distribution every year with no cuts. That includes years of sub-$10 per barrel oil and $1 per thousand cubic foot gas, price differentials between Canadian and US oil of $50 a barrel, the financial crisis and recession of 2007-09 and the Canadian government’s death sentence for income trusts, of which the company was one.
That’s an extraordinary record matched only by the very strongest U.S. MLPs like Enterprise Products Partners (EPD), and Pembina has accomplished it while growing its asset base by 20-fold since the end of 2002.
Last year’s acquisition of the former Veresen added numerous choices gathering systems for gas and NGLs as well as stakes in the Alliance and Ruby pipeline systems. The deal boosted the long-term, secure contracted portion of Pembina’s revenue streams, while opening up new opportunities to spur Canada’s moribund energy exports.
With a less than $17 billion market cap versus $63 billion for EPD, there’s plenty of room for Pembina to find projects that will significantly move the profit meter. Cash from operating activities per share surged 47.9 percent in the first six months of 2018. It continues at a robust pace in the second half of the year as management brings new projects on stream, many ahead of schedule and under budget.
Ironically, Pembina shares turned lower following its strong results. Aside from the lower Canadian dollar, likely blame goes to lower oil prices amid trade concerns and a Canadian court ruling delaying the Trans Mountain pipeline expansion, which Ottawa owns.
Pembina, however, has little exposure to pipeline delays, thanks to capacity-based contracts with oil sands producers in it for the long haul. The upshot is nothing has changed. Now is a great time to buy Pembina up to our buy target of USD35.
Looking at a more aggressive recommendation, one should take notice of NRG Yield (NYLD). I have always maintained that behind every successful yieldco is a deep-pocketed and motivated sponsor, and now NRG Yield has one in privately held Global Infrastructure Partners (GIP).
On August 31, GIP closed its acquisition of NRG Energy NRG +1.12% (NRG) ownership interest in the yieldco, changing its name to Clearway Energy Inc. Beginning September 17, 2018, the NYSE symbol for the shares will automatically switch to CWEN. NYLD “A” shares will trade as CWEN.A.
While NRG Energy sold out to appease activist investors’ demands to cut debt, GIP bought to build a vehicle to profitably recycle capital invested in rapidly growing renewable energy, just as NextEra Energy NEE +1.22% (NEE) has done successfully with NextEra Energy Partners (NEP).
Under the new structure, GIP is placing all current and future renewable energy assets into a new entity it will own and run, Clearway Energy Group (CEG). That includes the 6.4 gigawatt renewable energy development pipeline it also purchased from NRG Energy. And CEG will hold the 4.7 gigawatts of utility scale solar development projects acquired from cash-strapped SunPower (SPWR) in a deal announced August 31.
As it buys and builds, GIP/CEG will recycle capital by dropping down contracted assets to the yieldco, Clearway Energy Inc. Doing so, it’s agreed to forgo any incentive distribution rights and has set up an Independent Conflicts Committee to review terms of all drop downs.
That clearly aligns GIP/CEG’s interests with those of the yieldco’s ordinary shareholders. And it ensures maximum leverage to management’s expertise in power, which will drive the growth of the yieldco’s ROFO (right of first offer) pipeline of drop downs. These now include energy storage: This spring, the yieldco bought a 2.8 MW fuel cell project from FuelCell Energy (FCEL) that sells output under a multi-year power sales agreement.
The key to success for the former NRG Yield now Clearway Energy Inc will be performance at the existing portfolio and maintaining a low enough cost of capital to fund a profitable stream of drop downs. The bump in share price since spring and a generally low cost of debt capital augurs well for future success.
Regards dividend growth, I expect GIP/CEG to do more self-funding and therefore to roll back to a more sustainable 8 to 10 percent rate, from the recent 15 percent, but that’s still a compelling value proposition for a stock yielding upwards of 6.5 percent. Buy Clearway Energy up to $20.
Date: Sep 14, 2018