The Return of the YieldCo

Investor interest in Yieldcos is picking up once again, but does that mean we're in the next leg of a yield based valuation methodology? The answer isn't yet definitive but we note average one month YLCO index return of ~6% led by TERP (40%) and NYLD (20%) suggests investors are starting to give the sector the benefit of the doubt again. We maintain our overall constructive bias on the sector amidst the backdrop of an exceptional low interest rate environment; the sector has underperformed peer sector moves in the UTY and AMZ, with a willingness from a wider array of investors in pursuit of yield.

What's Priced In? TERP Is Quite Expensive vs Peers

Street fails to appreciate higher risk and shorter duration of TERP shares vs. peers

Investor sentiment already embeds life beyond a dormant SUNE sponsor entity. In fact, we estimate TERP valuation now embeds valuations at the top end of the YieldCo sector, on par with CAFD. Given both the lack of any clear sponsor or at least strategy tied to any bidder for SUNE, as well as discrete uncertainties tied to the process we see this newfound confidence as unwarranted despite the broader bid for YieldCos of late.

Using our NPV estimates shown below, implied discount rates on current market prices of our yieldco's under coverage suggests investors are pricing in growth beyond the current portfolios, higher than expected cashflows, or a mix of each. We believe growth expectations are more likely given recent announcements from NYLD and NEP to pursue debt-funded drops, while CAFD's shelf offering suggests appetite for equity raises is slowly returning.

But can it keep going? All depends on the drop-down thesis

With investors focused on strictly assets (ex- drop down growth) typically valuing assets at a levered low end of the range of ~5-6% of late, we see the DCF discount rates implied by shares as clearly reflecting some degree of this growth. While we perceive a commitment and ability to grow from sponsors tied to peer YieldCo structures, TERP appears the least evident. Rather, we see confidence in TERP appears tied to simply the fact that SUNE's ongoing reorg and corresponding sale of the two subsidiary structures at the core of its value could lead to either a new GP sponsor or outright acquisition of all remaining shares (as Brookfield appears to have indicated already in buying ~25% of publically floated shares alongside its parallel efforts to buy private shares from SUNE).

So what is Brookfield doing?

Given Brookfield's substantial existing portfolio of assets with 7.4GW, substantially located across the Northeast US and Ontario in addition to global markets, the recently disclosed Brookfield investment in public TERP shares remains unclear. We note BEP management has recently established a date for an Analyst Day on September 29^th as a potential update on its new strategy. Seeing BEP as among the structures off which the original YieldCo's were modelled, the question remains whether the entity is simply being pursued to merged into its BEP structure, held outside of this public entity, or ultimately leveraged as the YieldCo subsidiary of the parent BEP structure. BEP is itself a Yield oriented vehicle listed in Canada, making any drop down thesis between these entities unusual. Rather, with other Canadian utilities having recent purchased publically traded US utilities we think there could also be an angle towards a US listing if BEP were to acquire the balance of TERP shares. The public 13D filing made by Brookfield indicates it has approached SUNE already for its remaining shares held (see the filing here).

Finally, is there appetite for a block equity raise? We think some.

Short answer is we believe some yieldcos could be waiting for their counterparts to test the waters. While Brookfield Renewable Energy recently issued C$150M of preferred units (with 5.75% starting rate), we have yet to see one of the mainstream US-based yieldco's undertake a significant equity raise for the purposes of a dropdown. The trend of late has remained holding company leverage and employing existing utility prior to tapping capital markets for more equity. So far this leverage story has been successful, yet transparent, and limited latitude remains.