Deutsche Bank Initiates 8point3 Energy & TerraForm Power As Buys - YieldCos Explained

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A YieldCo is a publicly traded company that is formed to own operating assets that produce a predictable cash flow, primarily through long term contracts. On July 14, Deutsche Bank analyst Vishal Shah published a report initiating both 8point3 Energy Partners LP
CAFD
and TerraForm Power, Inc.
TERP
with a Buy rating. Not all income investors are aware of this asset class, but according to Shah "…the YieldCo phenomenon is global, growth rates are likely to be much faster than MLPs and size of the market is likely to be much larger than the oil & gas sector." YieldCo Sponsors/Structure Investor Trivia: 8.3 seconds is how long it takes light from the sun to reach the earth; and the equally clever 8point3 Energy ticker symbol CAFD, is also the acronym for (cash available for distribution). Based upon that, it should come as little surprise that First Solar Corp.
FSLR
and SunPower Corp.
SPWR
selected 8point3 Energy as the name of their 50/50 managed YieldCo for completed projects.
Source: Raymond James - "8point3 Partners" IPO S-1 graphic TerraForm Power is sponsored by SunEdison
SUNE
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utilizing a similar structure, and was formerly known as SunEdison Yieldco. Solar/Wind Powered Cash Flow CAFD = Quarterly Earnings – (Interest and Tax paid; Maintenance and Capex; Principal Payments; & Reserves) Shah noted, "TERP and CAFD are both dividend-paying growth-oriented companies focused on renewable energy with long-term contracted cash flows and stated growth plans in the double-digit range." How Does The Parent Benefit? Assuming a typical YieldCo vehicle is structured as a parent-subsidiary relationship, Deutsche Bank believes that "… a cost of capital arbitrage exists as long as the yield company's cost of capital is lower than the parent company's." The parent companies which are deemed "riskier" because they are in the project development business. Having a permanent home, or "take-out" lender for the projects enables them to arrange more favorable project financing with construction lenders. There are numerous other benefits as well, including IDC (incentive distribution rights), or a formula giving the general partner of the limited partnership an increasing share of the partnership cash flow over time. Huge Growth Potential According to Deutsche Bank, "The MLP sector currently supports ~10% financing of the $1.1 trillion US oil and gas sector; has a cumulative market cap of approximately ~$700+ billion and generated a 27% CAGR in market cap over 24 years. YieldCos currently account for less than 1% of financing of the global renewables market and have a market cap of ~$30 billion." What If Interest Rates Rise? Deutsche Bank "remain[s] constructive on YieldCos, even in a rising interest rate environment."
The chart above illustrates Deutsche Bank's view how "…every 100 bps increase in interest rates would require a ~600 bps increase in annual [dividend] growth expectations to offset a relative yield impact and keep the stock price unchanged, all else equal." Solar Development Economics Many experts forecast that the cost of power paid to electric utilities by ratepayers will continue to increase, not decrease over time.
However, there is also a consensus that the installed unit cost of both distributed and utility scale solar power projects is trending downward at a significant rate, as shown above. Deutche Bank - 8point3 Energy: Initiated Buy, $25 PT The DB $25 target price represents a potential ~38 percent upside in share price based upon the CAFD previous close of $18.07 per share.
Shah noted that 8point3 "…has strong growth visibility for more than 3 years and a business model that is not dependent on acquisitions." All of the designated 8point3 ROFO (right of first offer) "drop-down" projects are solar, developed by either First Solar or SunPower. Deutsche Bank - TerraForm Power: Initiated at Buy, $50 PT The DB $50 target price represents a potential ~26 percent upside in share price based upon the TERP previous close of $39.61 per share.
In addition to a strong solar project development pipeline, SunEdison has its First Wind platform and subsequent acquisitions of Atlantic Power as well as Invenergy wind assets. Additionally, TerraForm has an innovative project "warehouse" which contains "…assets for future drop down (a facility which is effectively a private yieldco in multiple tranches)," which can be used to augment the dividend growth in a rising interest rate environment, or replace a delayed pipeline project.
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Posted In: Analyst ColorLong IdeasNewsEducationDividendsPrice TargetInitiationIPOsAnalyst RatingsTechPersonal FinanceTrading IdeasGeneralReal EstateDeutche BankVishal Shah
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