Pattern Energy Group: ‘Speed Bumps’ Create Modest Buying Opportunity

The renewable energy sector has not historically been a source of satisfactory investment returns. Case-in-point: 112 major E.U. and U.S. renewable energy companies went bankrupt between 2009 and 2014, according to The Daily Caller. Unfortunately, many alternative energy companies tend to go bankrupt after their government subsidies are cut off. The markets tend to value these companies accordingly. Many renewable energy companies trade at attractive valuations based on earnings or assets, as well as above-average dividend yields. Pattern Energy (PEGI) is one example of this. The company is currently trading at a dividend yield of 7.2%, making it a member of the elite group of stocks with 5%+ dividend yields. 

You can see the full list of all 416 companies with 5%+ dividend yields here.

Pattern Energy’s dividend yield is very attractive, but there are certainly risks associated with investing in the renewable energy sector. Further, Pattern Energy is experiencing company-specific issues that are contributing to its low valuation and high dividend yield. This article will analyze the investment prospects of Pattern Energy in detail.

Business Overview

Pattern Energy is a renewable energy power company that owns and operates a portfolio of assets that generate power via wind and solar. The company typically finances its assets with long-term debt and generates revenue through long-term contracts (called Power Purchase Agreements, or PPAs) with creditworthy counterparties. Pattern Energy’s debt is often non-recourse or occasionally limited recourse, and the company sometimes has a partial ownership in its power-generating assets (rather than complete ownership).

Pattern Energy currently owns 2.6 gigawatts of generation capacity. More details about the company’s business model can be seen below.

Source: Pattern Energy Group March 2017 Investor Presentation, slide 3

Note that the company’s main yardstick by which it measures its performance is cash available for distribution (CAFD), which the company defined as follows in its most recent 10-K:

“We define cash available for distribution as net cash provided by operating activities as adjusted for certain other cash flow items that we associate with our operations. It is a non-U.S. GAAP measure of our ability to generate cash to service our dividends.”

Source: Pattern Energy 2016 10-K, page 59

Cash available for distribution is useful for evaluating the viability of Pattern Energy’s dividend. Pattern Energy benefits considerably from its relationship with Pattern Development, a separate entity that operates as a developer (not operator) of renewable energy assets. Pattern Development has substantial industry expertise and a strong track record of completing projects on-time and on-budget. Pattern Development has installed 4.8 gigawatts of renewable energy capacity since it was founded in 2009. It is a privately-held company. Importantly, Pattern Development owns approximately 19% of Pattern Energy’s outstanding common stock, incentivizing it to act in the best interests of Pattern Energy. More information about the track record of Pattern Development can be seen below.

Source: Pattern Energy Group March 2017 Investor Presentation, slide 11

Pattern Development’s completed projects are often sold to Pattern Energy in what are known as ‘drop-down deals’. The relationship between the two companies is very shareholder-friendly and is a key component of this stock’s investment thesis. In addition to this stock’s unique relationship with Pattern Development, Pattern Energy’s portfolio benefits from considerable geographic diversification. The company owns and operates assets across the world, including the United States, Canada, Chile, Puerto Rico, and Japan.

Source: Pattern Energy Group March 2017 Investor Presentation, slide 21

Moving on, the next section will discuss Pattern Energy’s pertinent recent events in detail.

Current Events

Shareholders of Pattern Energy will recall that in the company’s November 7th earnings release, the company announced some weaknesses in internal financial controls that did not materially affect the company’s financial reporting. Here’s an update from the company’s 10-K filed earlier this year.

“Based on our assessment as of December 31, 2016, our management believes that our internal control over financial reporting was not effective due to the aggregation of internal control deficiencies related to the implementation, design, maintenance and operating effectiveness of various transaction, process level, and monitoring controls. These deficiencies largely have arisen during fiscal 2016 because of growth of the Company, increases in employee headcount to support growth, and frequent changes in organizational structure that were not adequately supported by elements of our internal control over financial reporting.”

Source: Pattern Energy 2016 10-K, page 77