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Morgan Stanley clean energy sector analyst Stephen Byrd has raised his stock price targets across the board after the passage of climate-friendly U.S. legislation that creates profit growth prospects that are a major step higher for many of the companies he covers.

The recently passed Inflation Reduction Act (IRA) contains numerous tax incentives that make clean energy stocks more attractive for investors. The bill includes tax credits for wind and solar power, fuel cells, energy storage, carbon capture, sustainable fuel producers, green hydrogen and nuclear power. Subsidies are now available for U.S. producers of solar and wind power and for battery makers (including miners of raw materials such as lithium for batteries).

Mr. Byrd sees the biggest upside for Sunrun Inc. (RUN-Q), Plug Power Inc. (PLUG-Q) and the AES Corp. (AES-N). In the first case, the analyst raised the price target from US$70 to US$79, implying a 133-per-cent upside from current levels. Plug Power’s target was increased from US$42 to US$53 (86-per-cent potential upside), and the AES target was increased to US$32 from US$29.50 (31-per-cent potential upside).

For disclosure, I’ll point out that I own a small position in green hydrogen producer Plug Power, bought at roughly US$16, in part because of Mr. Byrd’s previous research. The analyst lists green hydrogen companies – specifically Plug Power and Bloom Energy Corp. – as “the most direct, concentrated beneficiaries” of the IRA bill.

He expects the new legislation to result in higher profit margins, thanks to the tax breaks and increased scale, but also because of increased demand for each company’s fuel cells and hydrogen-creating equipment.

Mr. Byrd lists rooftop solar panel provider Sunrun Inc. as his top pick in the clean energy sector. He expects new installations to grow at a 25-per-cent annual pace to 2025 (up from 20 per cent) as a result of the tax breaks. The analyst has also increased his estimate for installation growth between 2025 and 2030 from 15 per cent to 20 per cent a year.

Electric utility company AES Corp. is undervalued because of legacy coal and natural gas operations, according to Morgan Stanley. The current stock price does not fully reflect the 42 per cent of power now generated sustainably. Mr. Byrd expects AES’s solar and battery storage businesses to grow more quickly thanks to the new tax incentives.

The decarbonization process remains in its early stages, leaving ample runway for clean energy companies to expand their operations and increase profits. Stocks such as Sunrun, Plug Power and AES are ideally positioned to reap the benefits of the new legislation, which will accelerate the move away from fossil fuels.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

TFI International Inc. (TFII-T) Score one for the real world over the digital economy. On the list of best-performing Canadian stocks over the past five years, TFI now ranks above Shopify Inc. As Tim Shufelt tells us, the Montreal-based trucking and logistics company has quietly put together a remarkable run, boosted by a shift in consumer spending from services to goods during the COVID-19 pandemic, as well as an enviable track record of lucrative deals.

The Rundown

What this $4-billion dividend-stock buying money manager is buying and selling

While some investors are fretting about the market drop in recent months, money manager Donny Moss considers it an opportunity for long-term investors like him to buy high-quality stocks at sale prices. His performance numbers suggest he’s on the right track: His $3.3-billion iA Clarington Dividend Growth Class fund saw a return of 7.4 per cent over the past year as of July 31, compared with a loss of 0.1 per cent for the S&P/TSX Composite Index over the same period. Brenda Bouw found out about his latest portfolio moves and market outlook.

Conservative investors lost more than aggressive ones in the past 12 months

Call it a cosmic practical joke, if you will. Balanced and conservative investors got into trouble over the last 12 months, as the more bonds they owned, the worse their portfolios did. Rob Carrick explains.

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Will the stock market gains of this summer stick around? We won’t know for several months. What we do know is that several of the most widely held technology stocks have staged strong rallies. But based on what? Their latest financials aren’t particularly encouraging. Gordon Pape takes a look.

Canadian auto parts stocks a cheap play on improving global supply chain

You generally want to steer clear of the auto sector when recessionary forces are approaching. This may be the time to break that rule, reports Tim Shufelt.

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Monday’s analyst upgrades and downgrades

Monday’s Insider Report: President buys dividend stock after it tumbled on weaker-than-expected earnings

Ask Globe Investor

Question: Your recent article regarding Capital Power Corp. (CPXX-T) stated that the dividend payout ratio is between 45 per cent and 55 per cent, yet my discount broker and Globe Investor both indicate the ratio is between 195 per cent and 205 per cent. Am I missing something?

Answer: There are different ways to calculate a company’s payout ratio. Doing it the wrong way can make a dividend look unsustainable when it’s actually quite safe.

Capital Power is a great example. In my column, I wrote that the power producer “expects its payout ratio will remain below its long-term target range of 45 per cent to 55 per cent of AFFO – a conservative cash-flow measure – giving the dividend plenty of protection.”

The key word to focus on here is AFFO, or adjusted funds from operations. AFFO represents the net cash available from operating activities after adjusting for maintenance capital expenditures, preferred share dividends and other items. Essentially, AFFO measures the net cash available to fund the company’s growth, repay debt and pay common share dividends.

Based on this measure, Capital Power’s dividend is indeed very secure, which is why the company is projecting the dividend will continue to grow at about 6 per cent annually through 2025.

However, you wouldn’t know that based on the bloated dividend payout ratio published by discount brokers and financial websites. These payout ratios are typically calculated as a percentage of earnings, not AFFO. This can paint a misleading picture, because earnings of power producers (and some other companies) are often depressed by accounting items such as depreciation that don’t affect the company’s cash flow or its ability to pay dividends.

The result is that some companies appear to be paying out way more than they can afford. I often hear from readers who fear a dividend cut is imminent based on a seemingly egregious earnings payout ratio, when there is actually no risk at all.

As I’ve said many times, please don’t rely on the payout ratios published by third-party websites. These are machine-generated numbers that lack important context. They may be correct in some cases, but very misleading in others. You’re better off going directly to the company’s website and reading its financial reports and investor presentations to learn about its payout ratio and the sustainability of its dividend.

--John Heinzl

What’s up in the days ahead

With peak travel mayhem behind us, is it time to load up on Air Canada stock? David Berman will share some thoughts.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff