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What is your take on renewable power producers after their big gains recently?

Renewable power companies have had a huge run, propelled by low interest rates, solid growth prospects and surging demand from “ESG” investors who evaluate companies based on environmental, social and governance factors. The presumed victory of Democratic presidential candidate Joe Biden, who has proposed investing US$400-billion in clean energy and climate research, has given these stocks another lift.

Some of the gains have been extraordinary. Boralex Inc. (BLX) and Northland Power Inc. (NPI), for example, are both up more than 60 per cent year to date, Innergex Renewable Energy Inc. (INE) has risen close to 50 per cent and Brookfield Renewable Corp. (BEPC) has soared about 65 per cent since its shares began trading in July.

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But some analysts are warning that valuations have become stretched.

“We continue to see the sector as poised for significant growth,” Justin Strong and Robert Hope, analysts with Bank of Nova Scotia, said in a recent note. “However, given the sector’s strong recent performance we believe the market may be viewing the sector as currently overvalued, and thus has more downside risk versus other sectors.”

Indeed, many pure-play renewable stocks are already at or near analysts' one-year target prices, which suggests future returns may be more modest. Waiting for a better entry point might be a prudent strategy, although given the current momentum – and Mr. Biden’s apparent victory – the rally could still have legs.

That said, some analysts suggest that investors can find better values in stocks that aren’t strictly pure-play renewable power producers but will still benefit from the shift to green energy.

“We do see a handful of instances where stocks with a rising proportion of renewable generation and/or attractive sustainability attributes have not yet enjoyed a corresponding valuation lift,” David Quezada, an analyst with Raymond James, said in a recent note.

For example, one of Mr. Quezada’s top picks is Algonquin Power & Utilities Corp. (AQN), which operates regulated electricity, gas and water utilities in the United States and also owns a growing portfolio of contracted wind, solar, hydroelectric and natural gas generating facilities in North America.

He cited Algonquin’s “robust” capital expenditures plan, reasonable valuation and sector-leading earnings growth. "Moreover, we do not believe the market has ascribed AQN full credit for the [approximately] 30 per cent of the business that is renewable power or the fact that the company is building significant amounts of renewable power in its regulated rate base.”

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Algonquin yields about 3.9 per cent – higher than most pure-play renewable stocks – and has a history of increasing its dividend.

Another of Mr. Quezada’s top picks is Capital Power Corp. (CPX), which is benefiting from improving power prices in Alberta, a “substantial runway” of carbon reduction initiatives and a growing North American portfolio of wind and solar projects.

Capital Power’s stock price jumped this week after the company’s third-quarter results topped expectations. But the shares are still attractively valued, Mr. Quezada said, and offer an above-average yield of about 6.6 per cent.

Not comfortable picking individual stocks? A good alternative is the BMO Equal Weight Utilities Index ETF (ZUT), which provides diversified exposure to the major Canadian utilities, power and renewable power companies. I wrote about ZUT a few weeks ago (online at tgam.ca/heinzl-zut).

I have owned Brookfield Renewable Partners LP (BEP.UN) for more than 10 years. When BEP.UN has distributed return of capital (ROC) in the past, I have deducted the ROC from my adjusted cost base, as required. If I now deduct the fair market value of the recently issued Brookfield Renewable Corp. (BEPC) shares from the cost base of my BEP.UN units, as one of your previous columns advised [tgam.ca/heinzl-bepc], my cost base will be negative. How do I handle this for tax purposes?

In general, once the adjusted cost base (ACB) of an investment reaches zero, any further return of capital distributions are reported as capital gains in the current year. The ACB of the investment is therefore deemed to be zero for the purposes of calculating the capital gain when the investment is eventually sold.

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This is consistent with the explanation provided in the prospectus for BEP.UN’s special distribution of BEPC units. If the ACB of a Canadian resident investor’s interest in BEP.UN is negative, “the absolute value of such amount is generally deemed to be a capital gain realized by the resident holder and the … adjusted cost base of the resident holder’s interest in [BEP.UN] will be reset to nil,” the prospectus states. Get professional tax advice if you are unsure of how to proceed.

I own Algonquin Power & Utilities Corp. (AQN) and I gather its dividends are paid in U.S. dollars, which are converted to Canadian dollars in my account. However, I never see U.S. taxes being deducted from the dividends. Why is that?

Algonquin is a Canadian company and its dividend is therefore not subject to U.S. withholding tax. The dividend also qualifies for the Canadian dividend tax credit. In 2014, Algonquin switched to declaring dividends in U.S. dollars to reflect the growing contribution of its U.S. utility operations. However, the change in currency had no bearing on how its dividends are taxed.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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