Pacific Gas & Electric notified the authorities and employees Monday that it plans to file for bankruptcy protection. Not only will investors in PG&E Corp. be affected by the bankruptcy, but the California utility will also be allowed to break or renegotiate any or all of its contracts, putting YieldCos and other power producers at risk.
Entities that sell power to PG&E Corp. (PCG) will continue to sell that power to the utility. But if that power is currently being sold at above-market prices, those contracts may be renegotiated. The rapid decline in the price of solar power means that YieldCos with older power-purchase agreements (PPAs) signed with PCG are the most vulnerable. This is not to say that any or all PPAs will be broken or renegotiated, but the PG&E bankruptcy means that this is a real possibility that YieldCo investors should be prepared for.
Among YieldCos, Clearway (CWEN, CWEN-A) has by far the most exposure to PG&E’s bankruptcy. Other YieldCos with exposure are Atlantica Yield (AY), NextEra Energy Partners (NEP), and Pattern Energy Group (PEGI). TerraForm Power (TERP) and Brookfield Renewable Energy Partners (BEP) have minimal exposure to PG&E.
To get an estimate of how great each YieldCo's exposure is, we need to look at several factors:
1. How many PPAs are with PG&E?
2. Are these solar or wind PPAs? (Solar PPAs are likely to be at prices that are further above market.)
3. How old are the PPAs? (Older PPAs are likely to have higher prices because of the falling price for new installations, but older PPAs may also be nearer to expiry. A YieldCo with a soon-to-expire PPA will have a lot less to lose than one that still has 15 more years to run.)
Precedent shows there is a good chance that renewable energy contracts won’t be negatively impacted by a PG&E bankruptcy. But the risk isn’t zero.
In the following sections I estimate how each of the exposed YieldCos could be affected in what I consider to be a worst-case scenario. The impact on these firms will most likely be less (if PPAs end up being renegotiated at all). The impact could also be worse than my estimates if my guesses as to how these old PPA prices relate to current market prices are too conservative.
According to Clearway's most recent annual report, 23 percent of the YieldCo's electric power is sold to PG&E. By revenue, 12 percent of this is from conventional generation, which is less likely to be at inflated prices, and 11 percent is from renewables (see page 98). Because CWEN is highly leveraged, any reduction in these revenues will have an outsized effect on Clearway's cash available for distribution (CAFD).
Clearway's total 2017 revenue was $1,009 million, of which $121 million was from conventional power sold to PCG and $111 million from renewable power sold to PCG. In a worst-case scenario, investors might see conventional revenue reduced by 10 percent ($12 million) and renewable revenues reduced by 50 percent ($55 million). Again, these are estimates based on my understanding of the decline in PPA prices over time.
This would impact CAFD and potential dividends on a direct one-to-one basis, because there’s no reason for expenses to decline with this change.
Clearway’s 2017 annual CAFD was $267 million, guidance for 2018 CAFD was $285 million and guidance for 2019 CAFD was $295 million. I assume that 2019 guidance does not include any revenue reduction due to a PG&E bankruptcy.
Hence, in a worst-case scenario, we might see CWEN's 2019 CAFD reduced from an expected $295 million to $228 million (that’s a reduction of the $12 million plus $55 million referenced above), or 23 percent. The current annual dividend is $1.32 per share. If it were also cut by 23 percent, it would be reduced to $1.02 per share annually.
Assuming a yield of 7 percent for a YieldCo with no further downside exposure to PG&E, that puts the fair value of Clearway stock (CWEN and CWEN-A) at about $14.60.
There is a good chance that this worst-case scenario will not come to pass, however, and Clearway's PPAs will either be maintained or reduced less drastically. So $14.60 should be considered a point at which the YieldCo's stock is an attractive buy, despite the PG&E bankruptcy risk. Short-term market fluctuations have already driven the stock lower.
Pattern (PEGI) has one 101-megawatt wind farm selling power to PG&E. The farm began commercial operation in 2010, and the PPA ends in 2025. This accounts for 3.6 percent of PEGI's owned capacity.
Since this is a wind farm, the PPA is less likely to be as far above market price for a new wind farm than it might be for solar, so in a worst-case scenario, I would expect revenue from this farm might be reduced by 30 percent, lowering PEGI's revenues and CAFD by approximately $4.7 million, or 1 percent of annual revenue and 2 to 3 percent of expected 2019 CAFD. This is a small enough percentage of CAFD that I would expect PEGI to continue to maintain its dividend, although future dividend increases would likely be delayed.
At PEGI's current annual dividend of $1.69, and a dividend yield of 85 (because PEGI has few prospects for dividend growth in the next few years), I reach a worst-case valuation of $21.12. PEGI is trading at $19.38 as I write.
Atlantica Yield (AY) has a 280-megawatt wind farm that sells power to PG&E under a 25-year PPA that began in 2014. This is a much newer wind farm than Pattern's and so is even less likely to be priced above market. It accounts for 19.4 percent of AY's renewable generation, which produced $767 million in revenue in 2017.
A worst-case 15 percent PPA price cut (because the wind farm is so new) would likely reduce Atlantica's revenue and CAFD by $22.3 million, or about 12 percent of expected 2019 CAFD.
Atlantica might be able to absorb a 12 percent CAFD hit without reducing its dividend, but it would not be easy. So I will assume this would lead to a 12 percent dividend reduction to $1.27 per year.
At the 7 percent yield that I would expect a YieldCo without any further exposure to a PG&E bankruptcy to trade at, I reach a worst-case valuation of $18.10 for AY. As I write, the stock is trading at $18.83.
NextEra Energy Partners
NextEra Energy Partners' (NEP) disclosure of assets is relatively opaque compared to other YieldCos, but investor presentations show the company has the 87-megawatt Golden Hills wind farm and 545 megawatts of solar in California.
The wind project has a different offtaker, so it’s unaffected by the impending PCG bankruptcy. However, PG&E is an offtaker for 300 megawatts of the 550-megawatt Desert Sunlight Farm, commissioned in 2015, in which NEP has a 275-megawatt stake. Let’s assume PG&E has 150 megawatts of NEP’s portion, dividing the 300-megawatt offtake in half. PG&E is also the offtaker on NEP’s 250-megawatt Genesis concentrating solar thermal plant built in 2007.
This means that PG&E is the offtaker for 400 megawatts of NEP's solar production, or about 8.5 percent of NEP's renewable capacity. The YieldCo also owns 542 miles of natural-gas pipelines.
NEP's annual revenue was $812 million, most of which comes from renewables, although I could not find an exact figure. I will assume that 80 percent of revenue comes from renewable energy and 20 percent from other divisions, and also that NEP's solar revenue from PG&E is reduced by 40 percent in a worst-case scenario. In that case, revenue and CAFD would be reduced by $34 million, amounting to a 7.5 percent reduction in annual CAFD.
NEP would likely absorb this CAFD reduction without reducing its dividend, but near-term dividend growth would likely be reduced. NextEra Energy Partners trades at a premium to other YieldCos based on a high 12-15 percent annual growth target. The current annual dividend is $1.80, and at a 5 percent dividend yield, the company would trade at $36. It is currently trading at $41.30 and a 4 percent yield.
Worst-case scenario will likely be manageable
Based on my assumptions, the worst-case for scenario these YieldCos (with the exception of Clearway) in the event of a PG&E bankruptcy is manageable. In almost all cases, the market prices are already reflecting these worst-case scenarios as if they were near-certainties.
NextEra Energy Partners remains overvalued, in my opinion, for reasons unrelated to the PG&E bankruptcy. Investors looking for bargains should look at other YieldCos.
Clearway, Pattern and Atlantica are currently trading near or below my worst-case valuations in the event of a severe reduction in revenue due to the PG&E bankruptcy. If you have cash available, this is a good time to initiate or add to your positions. If PPAs are reduced in accordance with my worst-case estimates, you still keep your investment. If the PPAs are upheld (which is a real possibility), you should see significant gains compared to the current stock price.
Tom Konrad, Ph.D., CFA, is an analyst, portfolio manager and freelance writer specializing in income-oriented green stocks. He is editor for AltEnergyStocks.com.
Disclosure: Long CWEN-A, AY, PEGI. Short NEP.
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