Gordon Pape: This energy stock offers an attractive yield – but with risks

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Yieldcos that specialize in renewable energy are popular with investors these days. They provide stable cash flow and usually offer an above-average yield. Here's one I came across recently, and which I personally own. Prices are as of the morning of Aug. 30.

Name: Pattern Energy Group Inc.

Trading symbols: PEG-TSX; PEGI-Nasdaq

Current price: $31.35; $23.97 (U.S.)

Annual payout: $1.56 (U.S.)

Yield: 6.5 per cent

Risk rating: Higher risk

• The business: Pattern Energy is a San Francisco-based renewable energy company, with a portfolio of 17 wind power facilities in Canada, the United States and Chile with an owned interest of 2,554 megawatts (MW). It is a classic yieldco, along the lines of TransAlta Renewables and Enbridge Income Partners. Its parent company is Pattern Development. Pattern Energy has a right of first offer on several projects now owned by the parent.
• Why we like it: The yield is obviously very attractive at 6.5 per cent. But what makes this company unique is the fact it has increased its dividend for 10 consecutive quarters (that’s right, quarters, not years). The latest increase of 2.6 per cent was announced in August. Since March, 2013, the dividend has increased by 27.8 per cent.
• Financial highlights: The company announced second-quarter results in early August. Revenue was up by slightly over 10 per cent to $93.4-million (U.S.). Net cash from operating activities was $54.3-million (up 68 per cent from last year). However, the company posted a loss of $15.6-million for the period. Management said that new projects acquired since May 2015 were the main contributors to the loss, along with increased interest charges and net losses on derivatives.
• Risks: As mentioned, yieldcos are popular right now but when interest rates start to rise their prices will come under pressure. However, if Pattern can continue to increase its dividend on a regular basis, that should negate the impact of any rate hike. Of course, that’s a big “if.” No one expects a company to continue to raise its dividend on a quarterly basis forever.

I'm concerned about the loss posted by the company this year ($44.7-million in the first six months). Granted, a lot of this relates to the company's heavy long-term debt, which was used to acquire its assets from the parent. But I'm always uncomfortable to see yieldcos in a deficit position.

The situation may be improved by a recent new issue of 10 million shares that raised $239-million for the company. The funds are earmarked for new acquisitions and repayment of its revolving credit facility. The new issue came out at $23.90.

• Distribution policy: Dividends are paid quarterly, with the next one due on Oct. 31.
• Tax implications: This is a little complicated. The company organizes its affairs in such a way that the distributions are treated as return of capital for tax purposes. That should mean no tax is payable in the year the payments are received and your cost base is adjusted accordingly.

However, it may not work out that way in practice. Some brokerage firms, RBC Dominion Securities among them, withhold 15 per cent of any payments made to non-retirement accounts and remit the money to the U.S. Internal Revenue Service (IRS). The rationale is that these are dividends from a U.S. company and therefore are subject to withholding tax. If they are eventually confirmed to be return of capital (which has been the case in every year to date) it is possible to file a claim with the IRS but that is a long and complicated process.

The bottom line is that unless the shares are held in a registered retirement savings plan (RRSP), registered retirement income fund (RRIF), or life income fund (LIF), expect to be hit with a 15 per cent withholding tax on the dividend income.

• Who it’s for: This stock is appropriate for investors seeking above-average yield who are comfortable with the enhanced risk involved.
• How to buy: The shares trade on both Nasdaq and the TSX but the volume in Toronto is usually very light, often less than 5,000 shares a day. You have a better chance of being filled promptly and at a more competitive price by placing your order on Nasdaq.
• Summing up: Pattern Energy is another yieldco that offers an attractive return but comes with a degree of risk. Ask your broker whether it is suitable for your account.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.