Over the past six months, clean energy equities have undergone a massive rally, greatly outperforming the overall market. A combination of the market anticipating a Democratic presidential win, along with challenges faced by traditional energy companies due to the pandemic, has led to an exponential growth in the interest for sustainable infrastructure assets. Several companies in the solar, wind, and other renewable sources have more than doubled over this period, as wholly illustrated by their respective ETFs’ performance, such as Invesco Solar Portfolio ETF (TAN) and Shares S&P Global Clean Energy Index ETF (ICLN).
While many of the companies in the industry are enjoying excellent growth prospects, there are few options in the market that offer exposure to sustainable infrastructure assets while paying a juicy enough yield to increase investors’ margin of safety.
Several months ago, a possible candidate would be Hannon Armstrong Sustainable Infrastructure’s (HASI) stock. However, from yielding 6-8% near its March lows, shares have also massively rallied, currently offering a much tinier yield of around 2.74%, the lowest in its publicly-traded history.
In this article, we want to take a look at a related company, Atlantica Sustainable Infrastructure (AY), whose operations involve investing in namesake assets, currently offering an attractive ~5% yield.
Asset portfolio, Offtakers, and Contracts
Atalantica’s asset portfolio consists of 27 assets. These include renewable energy sources like solar and wind farms (69%), transmission and transport (15%), efficient natural gas (13%), and water (3%), creating a well-diversified source of cash flows. Additionally, the company has achieved geographical diversification with 45% of its revenues sourced from North America, 35% from Europe, 12% from South America, and 8% from the rest of the world.
Source: Q3 presentation
What we believe is the highest quality characteristic of Atlantica’s business is its creditworthy offtakers and long-term life of contracts. As you can see in the above table, Atlantica’s clients include:
- The Kingdom of Spain,
- UTE (Uruguay’s National Administration of Power Plants and Electrical Transmissions),
- The Government of Peru,
- Sonatrach & ADE (Algeria’s state-owned oil company),
- and CNE (National Energy Commission of Chile).
Because Atlantica’s customers are governmental entities, the company has mitigated much of the risk that comes with receiving payments, especially when considering that its assets are essential. Its other customers, like Enel Generacion Chile (OTCPK:EOCCY) and Eskom (JSE: BIESKM), are publicly traded companies with transparent financials, forming a quite trustworthy customer base.
In terms of its contracts, they have a weighted average life of around 18 years remaining, with predefined rates and options to renew further in many cases. As a result, Atlantica is set to enjoy secure, decade-long cash flows, which is a case in point for those looking for such features, able to lead to reliable distributions.
During the quarter, the company signed a purchase agreement to acquire “Calgary District Heating,” an essential infrastructure with high barriers to entry to increase its exposure in North America. Again, Atlantica has ensured AAA conditions such as:
- A 20-year weighted average contract life
- 80% contracted revenues with inflation indexation
- A diversified mix of 22 high credit quality clients (~41% A+ rating or higher, the rest unrated)
- No commodity risk
Therefore, it looks like Atlantica is adding another stable source of revenues, expectedly to grow its Cash Available For Distribution (CAFD). Speaking of which…
CAFD, Dividends, Future returns
Taking advantage of the global surge in demand for renewables, the company enjoys a strong pipeline of potential acquisitions. Atlantica has been able to consistently grow its CAFD over the past several quarters, adequately covering its underlying distributions. By taking its LTM (last-twelve-month) figures, AY’s payout ratio is standing at around 83%, which means that the company is also retaining a decent amount of cash to strengthen its balance sheet.
Source: Company Filings, Author
Since 2017, AY has been growing its DPS on a quarterly or semi-annual basis, in line with its CAFD. However, these increases are minor, usually by around a cent or two.
Source: Seeking Alpha
Based on the current growth rate of its CAFD and ROCE (Return On Capital Employed), of around 3%, we believe that a fair estimate for AY’s CAFD/share and DPS growth is around 5% in the short to medium term, in line with its current dividend growth.
Source: Seeking Alpha
Management believes that CAFD can expand in the future, expecting to achieve cheaper refinancing opportunities, reducing its current interest expenses (current cost of debt of around 6.1%). However, we choose to remain prudent with our estimates to ensure a wider margin of safety. Based on its most recent CAFD, AY features a CAFD/share run-rate of around $2.04. Consequently, at its current price of around $33.76, AY is trading at a P/CAFD of around 16.54.
Based on AY’s current price, our estimated growth rates, and various valuation multiples, investors could be potentially looking at the following return scenarios. Around its current valuation levels (red dots), we can see AY delivering returns in the high single-digit to low teens range. Source: Author
Keep in mind that there catalysts that could increase these returns in the long run. As AY expands its asset portfolio and acquires more tangible assets, it’s quite likely that, as management expects, its current high cost of debt will slide lower, expanding CAFD. Additionally, as investors capture the surplus of its (often governmentally-)secured cash flows, the stock could undergo a valuation expansion, similar to that of $HASI, further benefiting current investors.
Additional useful metrics
Some useful metrics to fill some potential issues raised in this article are the following:
- The company has an average debt maturity of 5.3 years, with no meaningful maturities appearing until 2025, hence a clear runway to grow its business.
- While its customers are international, often utilizing volatile currencies, more than 90% of AY’s contracts are denominated in USD.
- Similarly, around 90% of its long-term interest rates in projects are fixed or hedged.
- Despite its steep borrowing rates, AY has a decent interest coverage ratio of around 1.25.
Combining AY’s decent operational metrics, trustworthy customer base, secured cash flows amid multi-decade contracts, and a well-covered ~5% yield, we believe that shares present a compelling investment case for those looking to get exposure to the sector while receiving tangible returns.
The company’s CAFD growth may not be exponential, though investors should expect more reliable, predictable, and overall less volatile returns than investing in most of the clean energy companies in the market. While companies like First Solar (NASDAQ:FSLR) and Vestas (OTCPK:VWDRY)(OTCPK:VWSYF) are growing rapidly amid the boom in demand for renewable energy assets, infrastructure operators are able to deliver way more stable and foreseen returns.
Our estimates point towards annualized returns in the high-single to low-teens, which have the opportunity to expand further as the company scales. Simultaneously, around 5% of these annualized returns should be delivered by tangible distributions, ensuring a wider margin of safety and presenting an attractive pick for income-oriented investors.
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Disclosure: I am/we are long AY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.