In recent years a new investment vehicle gained in popularity among income-seeking investors as the “yieldco” became renewable energy’s answer to the master limited partnership. Today I want to provide an update on the recent performance of this segment.
Internal Revenue Code Section 7704 states that at least 90% of MLP income must come from qualified sources, such as natural resources or real estate. Section 613 of the tax code requires qualifying energy sources to be depletable resources such as crude oil, petroleum products, natural gas and coal, or their derivatives. Various proposals to extend MLP eligibility to renewables like wind and solar have thus far failed to clear Congress.
As an aside, one notable exception to the denial of MLP tax benefits for renewable energy ventures is wood pellet producer Enviva Partners (NYSE: EVA), which we recommended to subscribers back in March. It has returned more than 30% since our Buy recommendation and is currently the best performing MLP over the past 12 months.
A yieldco, like an MLP, owns assets that produce cash flow for investors. For example, a solar power company may form a yieldco to solicit investments in utility-scale solar farms supplying energy under long-term power purchase agreements.
Yieldcos are not exempted from the corporate income tax like MLPs and other pass-through partnerships. But the accelerated depreciation provisions of the tax code and other tax breaks offered to renewable power producers allow them to report net losses for five years or more, while paying out positive cash flow to investors via dividends classified as a return of capital.
Yieldco distributions are treated as dividends under US tax law to the extent they are paid out of current or accumulated earnings. If payouts exceed current and accumulated earnings, the excess is treated as a return of capital for US federal income tax purposes, just as with an MLP. This reduces the adjusted tax basis of the shares, and once the adjusted basis reaches zero, subsequent payouts are taxed as long-term capital gains.
A number of yieldcos debuted over the past three years, many to very high investor demand. But as the market became saturated with these vehicles, skeptics began to question the sustainability of the business model. Adding to the uncertainty around the space was the recent implosion and subsequent bankruptcy of SunEdison (OTC: SUNEQ). As a result the yield chase hit a wall, and after peaking in the spring of 2015 many yieldcos saw their share price fall by 50% or more by the end of the year.
But after bottoming out in February of this year along with much of the energy sector, yieldcos have staged a comeback. Here is how the current roster of renewable energy income plays stacks up, sorted in descending order by enterprise value:
- EV – Enterprise Value in billions of U.S. dollars as of Sept. 28
- EBITDA – Earnings before interest, tax, depreciation and amortization for the trailing 12 months (TTM), in billions
- FCF – Levered free cash flow for the TTM, in millions
- FQ – Fiscal quarter
- Debt – Net debt at the end of the most recent fiscal quarter
- Yld – Annualized yield based on the most recent quarterly distribution
- YTD Ret – Total shareholder return, including dividends, thus far in 2016
Financial metrics for the group span a wide range, but the average year-to-date performance lags that of the Energy Select Sector SPDR ETF (NYSE: XLE), which is up 15.7% YTD. Seven of the nine companies listed managed to generate positive free cash flow (FCF) in the most recent quarter, and six of the nine have a positive total shareholder return for the year. Yields are comparable to midstream MLPs, with the exception of Terraform Global’s (NASDAQ: GLBL).
Note that GLBL and its sister yieldco TerraForm Power (NASDAQ: TERP) show stats that are likely out of date, as a result of filing delays tied to the bankruptcy of sponsor SunEdison. TERP and GLBL are currently up for sale.
Brookfield Renewable Energy Partners (NYSE: BEP) is the bellwether of this group, larger in size than the next four biggest rivals. BEP is a publicly traded partnership investing primarily in hydropower, along with some wind power. BEP has 260 distinct renewable assets totaling over 6 GW of power in North America, Latin America and Europe. Unlike the rest of the group, BEP issues K-1 tax forms as do most MLPs. This tax treatment may make BEP more attractive to income-seeking investors, but less suitable for tax-deferred retirement accounts.
While we have covered the yieldcos in previous articles, we have generally avoided recommending this particular class of investments. The risks are higher than in the leading midstream MLPs and the tax treatment ultimately less generous.
We believe there is one exception, so we do in fact have one of these yieldcos in the portfolios of MLP Profits and The Energy Strategist. In fact, since being added to our Energy Strategist portfolio in February, this one is up more than 70% — and we still think it has room to move higher. To receive in-depth analysis and our current portfolio recommendations, please consider subscribing.