Description

Abengoa Yield owns utility-scale renewable generation, conventional generation, and electric transmission assets. The company generates roughly 65% of its EBITDA from solar plants, 15% from electric transmission, 15% from conventional plants, and 5% from wind and water plants. All assets have contracted or regulated revenues with investment grade counterparties, many of whom are state-owned enterprises. The weighted average remaining life of these agreements is 24 years. ABY is the YieldCo vehicle for the sponsor company Abengoa (ABG SM), a diversified Spanish engineering and construction company.

Thesis

NPV of $28/share solely from existing operations (e.g., no asset growth)

A DCF analysis is rather straight-forward. ABY has the longest weighted average contract duration in the YieldCo space at 24 years, versus roughly 15 for the industry overall. ABY also provides the greatest amount of project-level detail relative to other YieldCo’s.

Since its IPO in June 2014, ABY closed on 3 tranches of acquisitions from its sponsor (referred to as ROFO 1 through 3) and announced a fourth acquisition (ROFO 4) on July 2015. Based only on assets through ROFO 3—since ROFO 4 has not closed yet—we estimate a run-rate EBITDA of US$730mm. For reference, 2Q 2015 reported EBITDA was US$160mm; the delta to the annual US$730mm is driven by full ROFO 3 contribution (ROFO 3 closed in May 2015 with an estimated annual EBITDA of US$150mm) and small contribution from a ramp in US solar assets (Solana/Mojave; more on this below).

Adjustments for future cash flow stream include:

• Escalators: contracts typically have inflation adjustments, which we estimate to be 1.4% on a weighted average basis.
• Output: unlike solar PV, parabolic trough CSP (concentrated solar power) output declines at a 40 bps CAGR, most of it actually due to the steam turbine cycle, not the solar field.
• Currency: on May 2015, in conjunction with the ROFO 3 dropdown, ABY entered into a 5-year currency swap agreement with its sponsor at a EURUSD cross of 1.13; approximately 35% of cash flows are from Spanish solar assets.
• Cash taxes: ABY currently pays minimal cash tax. In 2019, ABY will start paying taxes on its ACT asset in Mexico, with the balance of the assets not paying meaningful cash taxes until 2025+. This assumes no additional dropdowns or acquisitions, which could defer cash tax payments.
• Solana (US project): ABY is currently netting ~45% of cash flows generated. We estimate this will flip to 75% in 2019/20 once its tax equity partner Liberty meets its hurdle rate.
• Debt/interest expense: We assume straight line amortization over 19 years (~5 years before the weighted average contract length) on a pro-forma consolidated gross debt of US$5.5bn. In reality, project debt amortization is likely higher in the back- than front-end, which would increase the NPV.

For the discount rate, we break down our assumptions into weighted average rates: (1) 6.4% for asset-specific risk (6%-7.5% depending on whether it’s solar, wind, transmission, or water), (2) 1.1% for country risk (based on respective countries’ CDS rate), and (3) 0.7% in other risk (based on a qualitative assessment of regulatory and operational risk). This yields a blended discount rate of 8.2%. This yields a $28 NPV for ABY’s existing assets; put differently, at the current $20 stock price, the market is pricing in a 12% discount rate on what are contracted, visible cash flows.

Upside from ROFO 4

While ABY has not closed the announced ROFO 4 acquisition ($371mm in total purchase price), there is enough liquidity from its revolver (US$290mm capacity) plus cash on hand (US$155mm) to finance the transaction. The company’s stated goal is to raise long-term debt and free up its revolver; however, given high cost to borrow in the current environment (debt yields of 6%-9% throughout the industry versus the revolver at Libor + 250 bps), ABY will likely keep the debt on the revolver for now. We estimate that ROFO 4 will be 9% CAFD accretive.

No IDRs + longer contract duration + low counterparty risk

ABY is one of three YieldCo’s (PEGI and NYLD being others) without an incentive distribution right (IDR) structure. This is an important distinction as IDRs significantly increase a YieldCo’s cost of capital. At ‘high splits’ (NEP and TERP), a YieldCo would have to pay half of its incremental cash distribution to its sponsor. This can lead to 200-400 bps increase in cost of equity capital; at worst (as what happened to some MLPs), the incremental cost of equity capital can nearly double.

Another attractive aspect of ABY is the long duration of its contracted assets (24 years) relative to peers (15 years). This makes an NPV analysis much more straight-forward for ABY as we can ascribe a 0 terminal value to all of the assets. ABY’s offtakers are all investment grade counterparties and/or state-owned enterprises.

On a forward dividend yield basis, ABY trades at 10.5% versus peer average of 7.6%

We see the company’s $2.10-$2.15 dividend target for 2016e as conservative; we think the company can do $2.45 in CAFD/shr for 2016e assuming marginal ramp-up contribution from Solana and Mojave. A full ramp of Solana including production from its molten salt storage presents upside of approximately $0.15 in CAFD/share.

For comparison, we include in ABY’s peer group NYLD (6.5% forward yield), PEGI (8.1%), NEP (4.7%), and TERP (8.3%). Prior to the recent sell-off, ABY traded at a ~50 bps discount on a NTM dividend yield basis. We exclude CAFD (6.6%) and GLBL (13.5%) in the average given lack of comparable historical data (recent IPOs) and vastly different risk profile. For reference, GLBL generates all of its cash flows from emerging markets: Brazil (28%), India (20%), China (8%), South Africa (7%), and other Latam (30%).

Upside to $45/share under normalized market conditions

Including ROFO 4, ABY could do $2.35 in annualized dividends by the end of 2016. Assuming the company's 10%-15% dividend growth profile (2x CAFD backlog identified at ABG) we think the market will price ABY at a 5% dividend yield, implying a ~$45 share price target for 2016. While this is not a base-case price target today, if conditions normalize both at the sponsor level and across the YieldCo space, we think the $45 target is reasonable.

Opportunity is driven by extreme risk aversion in both the YieldCo space and at the sponsor level

Since June, the forward dividend yield for the space widened by 150~400 bps excluding ABY, which widened by an astonishing 550 bps. Underperformance is explained by the thesis that its sponsor, ABG, faces liquidity pressure and may have to restructure or file for creditor protection.

Risks

ABY’s sponsor, ABG files for creditor protection

While we acknowledge such risk, we think ABY stock more than reflects this scenario. This is the primary reason our analysis focused on an NPV analysis and a detailed look at ABY’s current cash flow profile and not a dividend yield + growth metric that most analysts focus on for YieldCos. The latter analysis would produce a $40+ target price.

Key risks and next steps if ABG files:

• O&M contracts: as the sponsor, ABG is responsible and has contracted with ABY to perform maintenance functions. If ABG files, the concern is that ABY will not be able to keep the plants running as efficiently. However, (1) even if ABG files, it is unlikely that ABG stops performing all maintenance functions; we estimate ABG currently makes 50%+ cash margins for its services, (2) there are several large companies with expertise that could step in and replace the contracts (Acciona, Iberdrola, Siemens), and (3) ABY could insource such functions over time.
• Project debt financing: there are currently 5 assets with technical cross-default measures at the project financing level. 3 of which expire in 4Q 2015 (and has been operational and generating cash flows for 2+ years) and 2 of which the creditor is the Department of Energy. While it would be a technical default, it is highly unlikely that project finance creditors will trigger a default and force ABY to refinance; there is no precedence for this as long as the assets produce intended cash flows.
• Drop-down pipeline: will likely go to 0 at least over the ensuing 12-18 months while ABG restructures its debt. However, our NPV analysis assumes no further dropdowns (even ROFO 4). Further, across yield instruments (REITs, utilities, MLPs), a 0%-2% dividend grower typically trades at a 7%-9% dividend yield. Double-digit dividend yield typically implies a secularly declining or dividend-cut risk scenario. ABY’s dividend is likely to grow 0%-2% near-term without further dropdowns due to inflation escalation, Solana ramp, and tax equity flip.
• Drawdown risk: while we see low fundamental risk in the event ABG files, we acknowledge the market may initially over-react.

CFO Eduard Soler recently and abruptly stepped down

While market speculation abounds as to the reason why, we believe it was politically driven. Risk that the CFO stepped down due to potential accounting issues, while possible, is low in our opinion. ABY owns assets and concessions that are project financed, most of which have been operating for 2+ years. Cash flow is cash flow and we believe creditors’ due diligence would have spanned greater access and visibility to project financials and projections.

Brazil currency risk

We do not think this is a meaningful risk factor, but mention it as many sell side and buy side analysts appear to misunderstand the situation. ABY generates US$18mm in cash flow (relative to ~$250mm of CAFD) from its preferred equity interest in a Brazilian transmission asset called ACBH.

• There is minimal risk for cash flows over the next 4 years (5 years at IPO) as payments are escrowed at a NY-based bank in USD terms.
• Beyond 2020, we estimate that the USDBRL cross will have to go to 6.00 (not completely impossible) before the equity tranche—owned by ABG—is wiped out. From that point forward, currency devaluation will have a linear effect as all debt and costs are in local currency.

“EM” currency risk

We again do not see meaningful currency risk. While some may cite that “30% of cash flows are from Latin America”, we note that 17% is in Mexico, where the counterparty is Pemex, a state-owned and investment grade rated company. An additional 7% is from Peru where ABY owns transmission lines and where the counterparty is the Peruvian government. In both instances, contracts are USD-denominated.

Catalyst

- Successful rights offering and resolution of liquidity issues at the sponsor (ABG) level. 

- Continued execution and dividend raise to $2.10 on an annualized basis by 2Q 2016.