Brookfield Asset Management Inc. and its spin-offs have been veritable powerhouses of earnings growth, delivering solid value for shareholders. Over the last five years, Brookfield has delivered an average annual return of almost 20%, while one of the largest listed pure-play infrastructure stocks, Brookfield Infrastructure Partners L.P., has yielded just over 15% annually.
However, one of the most promising Brookfield spin-offs, Brookfield Renewable Partners L.P. (TSX:BEP.UN)(NYSE:BEP) has failed to unlock value for investors, delivering a return of just under 2% annually. This poor performance has led to claims that it is a value trap because it appears inexpensive and possesses considerable potential, yet it has failed to perform. There is also concern over whether or not Brookfield Renewable’s distribution is sustainable, despite management hiking it by 5% at the end of 2016.
Let’s pop the hood on one of Brookfield’s more controversial spin-offs to find out what it offers investors.
Now what?
Brookfield Renewable owns and operates one of the largest renewable energy businesses globally with 10,700 megawatts of installed capacity. Its portfolio of electricity-generating assets is focused on hydro with 88% of that installed capacity coming from hydro facilities located in South and North America.
While power generation across its portfolio for 2016 increased by an impressive 46% compared to 2015, it was still 15% below the long-term average generation. This can be attributed to lower hydrology in the northeastern U.S. and lower than expected wind power-generation in Canada and Europe.
This aspect of its business highlights a key risk for these types of renewable energy: their dependence on favourable environmental conditions.
Nonetheless, despite lower than expected power generation, 2016 revenues and EBITDA surged by 51% and 26%, respectively, when compared to 2015; disappointingly, funds flow from operations fell by 10%.
The decline in funds flow can be attributed to a sharp increase in 2016 operating costs, which almost doubled compared to a year earlier. The reason for this was the costs associated with acquiring and bedding down Isagen S.A., Colombia’s third-largest electricity generator. This acquisition boosted Brookfield Renewable’s installed capacity by 3,000 megawatts and gives it considerable exposure to one of South America’s fastest-growing economies.
Once integration into the partnership’s operations is completed, the company’s earnings will get a considerable lift.
Brookfield Renewable also has 153 megawatts of assets under construction, and as these are completed and come online, they will help to boost overall output, giving earnings a further bump.
For these reasons, I expect to see a healthy increase in Brookfield Renewable’s earnings in coming months, especially if there are more favourable environmental conditions.
This earnings growth will help to ensure the sustainability of that very tasty 6% dividend yield, even with 2016 distributions having a payout ratio of 123% of funds flow. Then there is the fact that operating expenses are expected to fall during 2017 and 90% of cash flows are contractually locked in, which will also help to ensure the sustainability of that impressive yield.
So what?
Brookfield Renewable’s performance has been disappointing, but there are signs that its performance will continue to improve, particularly because the secular trend to renewable energy is a powerful long-term tailwind. Investors should not forget that in 2016, after including distributions, the company delivered a very impressive total return of 20% for investors. This trend should continue as operating expenses fall, earnings grow, and Brookfield Renewable expands its asset base.
