Investors who embrace Canadian renewable energy stocks for the good of the planet have been rewarded this year with a pleasant side benefit: The stocks have soared, delivering gains that mock the fossil fuel-clinging political leadership in Washington.
The share price of Northland Power Inc., which operates wind farms and solar facilities in Canada and Europe, has risen 27 per cent this year. Algonquin Power & Utilities Corp., which owns wind, solar and hydroelectric generating facilities in Canada and the United States, is up 34 per cent.
And Brookfield Renewable Partners LP, which invests globally in hydro, wind and solar assets, is up nearly 72 per cent.
Not bad for utilities, and these returns don’t include the stocks’ impressive dividends. The gains have easily beaten the broad S&P/TSX Composite Index, which is up 18.7 per cent this year. And consider that the fossil-fuel heavy S&P/TSX Energy Index trails with gains of just 12.6 per cent.
Where does the hot renewable energy sector go from here?
There are a number of sources behind this year’s rally. Concerns about global economic growth earlier in the year drove down bond yields and raised the attractiveness of defensive utilities, including green ones.
Renewable energy stocks are also benefiting from rising investor interest in socially responsible investing. According to Bank of America, assets under management for ESG (environmental, social and governance) funds have increased at a compound annual growth rate of 70 per cent over the past five years.
There’s an attractive growth profile here, too. Renewable energy capacity is rising at a brisk clip, even with a climate-change skeptic in the White House.
According to the U.S. Energy Information Administration, wind, solar and other non-hydro renewable energy will provide 12 per cent of U.S. utility-scale electricity generation in 2020, up from 9 per cent in 2018.
EIA’s longer-term forecast looks even better. By 2050, total renewable energy generation (including hydro) will account for 31 per cent of the grid, up from 18 per cent in 2018, as the importance of coal and nuclear energy decline. A U.S. president with a more favourable disposition toward wind and solar could raise these estimates.
“The cost of renewables has come down substantially over the past five to 10 years, to the point where they are competitive even without subsidies,” Chris Namovicz, EIA’s renewable electricity analysis team leader, said in an interview.
Canadian renewable energy companies are tapping into this upbeat environment. Algonquin Power & Utilities, which gets most of its revenue from the United States, is spending US$2.5-billion on renewable energy projects over the next five years. These projects, which include wind farms in Texas and Illinois, should increase the company’s renewable energy capacity by 68 per cent.
At Brookfield Renewable Partners, funds from operations (or FFO, a measure of cash flow) have increased 25.5 per cent so far in 2019, driven by hydro, wind and solar facilities in the United States, Canada, Europe, India and Colombia. The company, an arm of Brookfield Asset Management Inc., is also creating a new corporate structure that should make the shares available to widely held exchange-traded funds (ETFs).
Investors have noticed, evidently.
Brookfield’s unit price has been rising faster than its cash dividend. As a result, the dividend yield is now 4.5 per cent, down from a spectacular 7.4 per cent at the start of the year.
Similarly, Northland Power’s yield is now 4.4 per cent, down from 5.5 per cent. And Algonquin’s yield is 4 per cent, down from 5.1 per cent at the start of the year, even though the company raised its quarterly payout by 10 per cent in May.
As well, valuations are rising. Algonquin’s price-to-earnings ratio is now 22.5 (based on reported profits), up from a bargain P/E ratio of 13 at the start of the year.
Robert Hope, an analyst at Bank of Nova Scotia, downgraded the stock on Dec. 4 to “sector perform” from “sector outperform,” based partly on valuation concerns. He thinks the rally is over for now, especially if bond yields rise, leaving investors with a nice dividend but little else.
Investors, then, might want to wait for a sell-off in defensive, interest-rate sensitive stocks before pouncing.
Thursday offered a glimpse into what can happen. The yield on the 10-year U.S. Treasury bond yield surged amid speculation that the United States and China were close to a trade deal – and Canadian utilities stocks fell 1.1 per cent, marking their biggest decline in two months.
Buying into a protracted downturn could make sense, given renewable energy’s strong growth prospects over the long term.
David Quezada, an analyst at Raymond James, said in a recent note that Algonquin Power’s capital spending plans will support earnings growth of 9 per cent to 11 per cent, “which we believe places Algonquin well above most North American utility peers.”
Bill Cabel, an analyst at Desjardins Securities, believes that Northland Power, whose shares have lagged their renewable energy peers this year, is a deal given the company’s promising offshore wind projects in Germany and Taiwan.
He noted after the company reported its third-quarter financial results last month that the shares traded at 9.7 times enterprise value to estimated 2020 EBITDA (earnings before interest, taxes, depreciation and amortization), compared with a considerably higher peer average of 12. Even after recent gains, Northland shares trade at just 10.2 times EV/EBITDA.
“Given the company’s contracted growth pipeline and attractive offshore wind assets, we believe the significant discount versus peers is unwarranted," Mr. Cabel said in a note.
Yes, rising bond yields and steep valuations are potential obstacles to a continuing rally in renewable energy stocks after an impressive year. But renewable energy itself looks like a solid long-term bet.