John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
Everyone loves getting a raise.
But what if your boss called you into his or her office and said you're getting a raise, not just this year, but next year and the year after that, too?
That would be pretty sweet.
Well, owning units of Brookfield Renewable Energy Partners LP is kind of like that. Citing its growing cash flow and strong development pipeline, the renewable power producer last year pledged to raise its distribution by 5 per cent to 9 per cent annually, up from its previous growth target of 3 per cent to 5 per cent. The most recent distribution increase, announced in February, was 7 per cent – smack in the middle of its new range.
As a unit holder myself, I'm expecting "the boss" to come through with similar pay raises in the years ahead. Future hikes aren't guaranteed, of course: They have to be approved by the board of directors. But Brookfield Renewable has put its credibility on the line by publicly stating its distribution growth target, and I believe it will deliver.
Here's why.
It produces an essential commodity
When the power went out in our Toronto neighbourhood this week, I was reminded of all the things that depend on electricity: computers, lights, stoves, televisions, refrigerators and smartphone chargers. Demand for power is growing around the world – with renewable sources contributing a rising share – and it's not like there's a new technology on the horizon that will make electricity obsolete. What's more, because building a power plant requires huge amounts of money and expertise, Brookfield Renewable is insulated from competition.
It's diversified
The Bermuda-based limited partnership is one of the world's largest green-power producers, with 250 facilities in Canada, the United States, Brazil, Ireland, Northern Ireland and Portugal that generate more than 7,000 megawatts – enough electricity to power four million homes. About 80 per cent of its production is hydroelectric – spread across 74 river systems – with wind, biomass and gas-fired facilities making up the rest. The diversification by geography and generation technology contributes to stability in its production.
It's growing
Brookfield Renewable aims to deploy $3-billion to $3.5-billion of equity over the next five years on acquisitions, with a focus on hydroelectric facilities, which are among the most reliable, longest-lasting and highest-margin generating assets. It also plans to invest an additional $500-million to $750-million of equity on its own development projects.
"Management has a strong track record of delivering accretive growth," CIBC World Markets analyst David Noseworthy said in a June note, in which he initiated coverage of Brookfield Renewable with a "sector outperformer" rating and a 12- to 18-month price target of $43 . His target conservatively assumes that only a portion of the growth will come to fruition. "Therefore, there is upside to our price target as Brookfield Renewable executes on its growth strategy," he said.
Its earnings are predictable
More than 90 per cent of Brookfield Renewable's output is currently sold under long-term, inflation-linked, power-purchase agreements, which have an average length of about 17 years. The high level of contracted pricing makes for stable and predictable cash flow, which in turn provides security for the distribution. Brookfield Renewable's target payout ratio of 60 per cent to 70 per cent of funds from operations provides an additional buffer. The well-protected distribution is one reason that Robert Cable, senior wealth adviser with ScotiaMcLeod and author of Inevitable Wealth, owns the units personally and for clients. "I do believe that the dividend is not only sustainable but also that it should grow," he said.
The yield is attractive
Brookfield Renewable declares distributions in U.S. dollars. At current exchange rates, the annual distribution of $1.66 (U.S.) is equivalent to about $2.15 (Canadian), for a yield of about 6 per cent. A couple of things to keep in mind: first, if the loonie rises, the value of the distribution will fall in Canadian dollars; second, although a portion of the distribution qualifies for the dividend tax credit, there's also usually some return of capital, Canadian interest and foreign dividend and interest income included. To avoid the tax headaches, I prefer to hold the units in my registered retirement savings plan.
Closing thoughts
Brookfield Renewable is not without risks. The units, already down more than 15 per cent from their April high, took a hit earlier in July when the partnership warned that second-quarter hydroelectric generation in North America and South America will be well below the long-term average because of lower water inflows. It also warned that wind generation will be below average in North America. In addition to such weather-related risks, Brookfield Renewable faces currency and interest-rate uncertainties, among other factors. If bond yields were to rise, for example, the units would be expected to underperform.
Keeping those risks in mind, if Brookfield Renewable continues to grow through acquisitions and development projects, long-term investors stand to benefit from a rising distribution and the potential for capital gains.