I have watched the renewable power sector drop like a stone in the past year and I’m wondering if this is a good time to take the plunge. What are your thoughts?
Generally, buying good companies whose shares have dropped in price is a sound strategy. But in this case, there are some caveats to keep in mind.
After enjoying big gains in the months before and after Joe Biden’s U.S. presidential election victory, renewable power stocks have stumbled badly. Among Canadian-listed companies, Innergex Renewable Energy Inc. INE-T has plunged 40 per cent in the past 12 months; Boralex Inc. BLX-T, 36 per cent; Brookfield Renewable Partners LP BEP.UN-T, 31 per cent; and Northland Power Inc. NPI-T, 28 per cent.
Initially, the declines were likely triggered by momentum investors who had jumped onto the renewables bandwagon only to jump off after driving valuations to unsustainable levels. More recently, the sector has been facing several headwinds that likely won’t be going away any time soon. These include inflation, tight labour markets and rising interest rates, all of which increase costs for solar, wind and other projects that require large amounts of capital.
What’s more, higher interest rates also reduce stock market valuations of renewable power companies on a discounted cash-flow basis – a method of determining a stock’s current value based on its estimated future cash flows. Delays in Mr. Biden’s “Build Back Better” bill – which includes about US$500-billion in climate spending – haven’t helped, either.
So should investors steer clear of renewable power stocks altogether? I don’t think so. The sector still has many years, if not decades, of solid growth ahead of it as governments and corporations reduce their carbon footprints. Moreover, with share prices already down sharply, the short-term negatives may already be at least partially baked into stock prices.
Another consideration is that, because of the drop in prices, dividend yields are higher now than they were a year ago. That means investors get “paid to wait” for stock prices to recover.
One of the highest yields in the sector belongs to TransAlta Renewables Inc. RNW-T, at about 5.5 per cent. This reflects the stock’s recent decline after the company said it will need to replace all 50 turbine foundations at its Kent Hills 1 and 2 sites in New Brunswick – at a total cost of $75-million to $100-million, plus lost revenue – following the collapse of a tower in October.
In a recent note, analyst Nelson Ng of RBC Dominion Securities said TransAlta Renewables offers investors good value after its tumble. “We believe shares negatively overreacted to the Kent Hills turbine foundation replacement,” Mr. Ng said. He rates TransAlta Renewables at “outperform” with a price target of $21.
He also rates Algonquin Power & Utilities Corp. AQN-T at “outperform.” (Keep in mind that Algonquin is primarily a regulated utility company; its renewable-energy division accounted for just 16 per cent of revenue in 2020 – the latest full year for which figures are available.)
Among other pure-play renewable stocks, Mr. Ng said investors should consider Brookfield Renewable for its attractive hydroelectric generating assets and because about 70 per cent of its power sales contracts are linked to inflation. He also likes Northland Power “for offshore wind exposure” and Boralex “for its highly contracted portfolio.” He rates these stocks “sector perform.”
Can’t decide which stock to buy? Consider an exchange-traded fund that provides diversified exposure to the sector. One ETF worth considering is the BMO Equal Weight Utilities Index ETF ZUT-T.
I like ZUT because, in addition to allocating about 30 per cent of its assets to pure-play renewable power producers, the ETF holds all the big Canadian utilities, such as Fortis Inc. FTS-T, Emera Inc. EMA-T and Hydro One Ltd. H-T. This improves the ETF’s diversification and also enhances its yield, which is currently about 3.5 per cent. Utilities also stand to benefit from the transition to green energy as they convert fossil-fuel generation to renewable sources and build out transmission lines to bring new wind and solar power to market.
If you invest in renewable energy stocks now, you might not be rewarded immediately with big gains. But over the long run, these companies stand to generate solid returns for investors. Remember to do your own due diligence before investing in any security.
Disclosure: The author owns shares of AQN, BEP.UN, FTS and EMA.
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