Power Partnership NRG Yield Charges Up After IPO


Fueled by a broad portfolio of quality power generation operations, NRG Yield, a recent IPO, is fully stoked for growth and returns.

NRG Yield ( NYLD ) was formed by major U.S. independent power producerNRG Energy ( NRG ) to own and operate a portfolio of long-term contracted renewable energy, conventional generation facilities and thermal infrastructure assets in the U.S., and pay regular dividends to shareholders.

As an independent power producer, NRG Yield sells power to utilities at market-based rates. Its contracted generation portfolio consists of 21 assets, including three natural gas or multifuel facilities, eight utility-scale solar and wind generation facilities and two portfolios of distributed solar facilities. It also owns thermal infrastructure assets.

NRG took its offspring public on July 17 at $22, above the initial offering range of $19 to $21.

NRG retains a 65.5% economic and voting interest in NRG Yield. Its rationale behind taking it public as a separate entity had to do with creating a pure-play company with operating, financial and tax characteristics that would appeal to dividend growth-oriented investors looking for exposure to the contracted power sector, says a company filing with the SEC.

Long-Term Power Player

NRG has one of the largest power generation portfolios in the U.S., with approximately 45,105 megawatts of fossil fuel and nuclear generation capacity in 345 active generating units at 88 plants as of Dec. 31.

But most of these assets are under shorter-term duration contracts of one year or less, with a small portion in long-term contracts of 25 years and beyond, says Citi Research analyst Shahriar Pourreza. That's where NRG Yield comes in. NRG "sold down" its long-term contracted assets to create NRG Yield, composed of long-term project assets with an average life of 17 years, Pourreza says.

"They created this entity that would take these long-term contracted assets, show them to the market saying 'Here's some assets we don't think the market is valuing correctly,'" he said.

NRG Yield owns more "stable assets" with more concrete contracts in place than NRG, adds Renaissance Capital analyst Nick Einhorn.

"NRG felt these assets could get a higher valuation if they were in a distinct company," Einhorn said. "A lot of oil companies have sold off some of their pipelines or infrastructure type of assets as limited partnerships.

"It's taking some very stable assets and making them their own company," he said. "It attracts a different investor base looking for a different strategy."

NRG Yield stock has climbed as high as 29.45 since its IPO, and shares are now trading around 28.

Name Says It

The attraction? NRG Yield is yielding between 5% and 6% on a forward basis, almost 1% to 2% higher than what an average utility is yielding, Pourreza says.

He adds that NRG Yield also offers "cash flow certainty" because it's fully contracted for a long time. So it knows with certainty what it will pay out in distributions.

Pourreza says NRG Yield is growing its cash flow between 10% and 15% annually with the current asset mix as well as future dropdown assets.

Its initial dividend is 30 cents per share per quarter.

NRG Yield holds a right of first offer for six additional contracted assets currently owned by NRG. These assets, combined with a number of repowering opportunities in earlier stages of development within NRG, provide NRG Yield a significant platform for future growth, NRG said in the SEC filing.

More assets coming into the entity create more cash flow, Pourreza says, which means dividends will continue to grow beyond typical utilities' growth rate.

"Driven by a pipeline of six drop-down candidates, many potential third-party deals, and over five repowering opportunities, we expect NRG Yield's visible growth profile to lead to a 12% dividend growth rate for the future," Pourreza wrote in an initiation report -- with a buy rating.

NRG Yield gave investors good news in its first financial report as a public company Aug. 14. Second-quarter revenue grew 88% to $79 million. It earned 51 cents a share.

Adjusted EBITDA grew 144% vs. a year earlier to $61 million, primarily driven by assets that came online during the fourth quarter of 2012 through the first half of 2013.

It delivered a pro-rated initial dividend of 23 cents per share based on an initial quarterly dividend of 30 cents, expected to be declared and paid during the fourth quarter.

EBITDA represents net income before interest including loss on debt extinguishment, taxes, depreciation and amortization. Adjusted EBITDA represents EBITDA adjusted for mark-to-market gains or losses, asset write-offs and impairments, and factors the company doesn't consider indicative of future operating performance.

NRG Yield should benefit from the growth prospects in the renewable space. According to U.S. Energy Information Administration estimates, between 2011 and 2035, 29% of all new electric generation will be solar, wind and thermal, notes Pourreza in a report.

In solar, NRG Yield's largest project is the California Valley Solar Ranch, with a forecasted EBITDA contribution of $45 million a year. The company has a 48.95% stake in the solar farm, which is located in San Luis Obispo County, and NRG owns the remainder.

SunPower ( SPWR ), a large U.S.-based solar company, is developing the project, called CVSR for short. Until 2011, it was the owner.

Projects Of All Kinds

CVSR construction is ahead of schedule with the final phase expected to come online in the fourth quarter, NRG said in a press release. Power from this project is being sold toPG&E Corp. 's (PGE) Pacific Gas and Electric Co. under two separate 25-year power purchase agreements.

Its conventional operations consist of natural gas and dual-fired generation assets, Marsh Landing and GenConn. In May, it completed the construction of the Marsh Landing natural gas-fired peaking generation facility on a site near Antioch, Calif. Marsh Landing sells all the energy and capacity it generates and ancillary products and services to Pacific Gas and Electric under a 10-year tolling agreement.

But NRG Yield faces some risks, writes Pourreza: It is exposed to interest rate, environmental, legislative, management execution, re-contracting, construction, capital markets, and weather risks.

"In our view, the largest risk to valuation is a rising interest-rate environment or government policy changes," Pourreza said.

Analysts polled by Thomson Reuters expect the company to report full-year earnings of 91 cents a share. They see 2014 earnings growing 12%. They forecast a 5% rise in 2015 and a 32% increase in 2016.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas

Referenced Stocks: NRG , NYLD , SPWR

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