What's a "YieldCo"? (Hint: It's Green)

Quick: Name as many energy stocks as you can that fit these criteria:

• Better than 12% annualized total returns over the past 5 years
• Positive returns over the last 12 months
• Greater than 3% dividend yield
• Currently trading 5% or more below its own 52-week high

There aren't very many. A handful of NYSE-listed pipeline companies make the cut, including these:

• Enbridge Energy Partners (EEP) (which I wrote about on 12/3/2014)
• Williams Companies (WMB) (which just announced the acquisition of its own pipeline business)
• Western Gas Partners (WES)
• MarkWest Energy Partners (MWE)
• Spectra Energy Partners (SEP)

One refiner, HollyFrontier (NYSE: HFC), meets all the criteria as well.

Another one is China Petroleum & Chemical Corp ADR (NYSE:SNP). Ken Fisher wrote about SNP in his long-running column for the upcoming May 25, 2015 Forbes issue (online now, here). In recommending SNP, Fisher opined, "You want what does well in good and bad basic oil realities – implying a big market, yet governmental protection."

Finally, in addition to those 5 pipeline companies, one refiner, and one China stock, one "YieldCo" meets the criteria. "YieldCo," you ask? Sounds good, right? But what is it?

What's a "YieldCo"?

Okay, first, "YieldCo" is a smushed-together term that comes from the more boring phrase "yield company." But since you and I are cool, trendy, and handsome, I'll use the term "YieldCo" (sans quote marks from now on) throughout this article.

Basically, a YieldCo owns cash-generating assets, typically in the "green energy" industry (think solar, wind, hydro, geothermal, etc.). A YieldCo's cash flow typically comes from long-term contracts to sell the power its projects produce to utilities and other buyers. Since the contracts are often locked in for many years (in many cases 15 years or longer), the income can be quite steady. Finally, a YieldCo often pays tax-advantaged or tax-free income to shareholders, made possible – at least for a time (usually several years) – by accelerated depreciation of the YieldCo's assets. More on YieldCo taxation later.

With that in mind, here's what a YieldCo typically is NOT: YieldCos typically don't engage in research, development, innovation, or construction of energy technology. A YieldCo, very simply, owns a portfolio of completed energy projects that already sell power to utilities and other buyers under long-term contracts (called "offtake agreements") that are already in place. So again, a YieldCo tends to have much more stable, predictable cash flow than a company doing R&D and construction. In fact, a number of "green energy" companies have spun off their completed, cash-flow-generating projects into a YieldCos once the long-term contracts are in place, specifically to take advantage of lower costs of capital that a YieldCo can command, when compared to the cost of capital for more volatile R&D and construction firms. The parent company often owns a substantial number of the YieldCo's shares.

If you're familiar with MLPs and REITs, those structures are a decent comparison to YieldCos. Again, though, the taxation of YieldCos is different than either MLPs or REITs. The YieldCo structure often provides tax-deferred distributions to shareholders for several years, followed by qualified dividends and capital gains. That may sound like an MLP, but the way a YieldCo qualifies for its tax treatment is different than the MLP tax laws, as described later.

Let's look at a few specific YieldCos, and you'll quickly get the idea what these companies are about.

For one, NRG Energy (NYSE:NRG) spun off NRG Yield (NYSE:NYLD) in July 2013 and remains NYLD's majority shareholder.

NYLD owns about 36 projects including solar, wind, and thermal, as well as about 5 conventional energy projects. Here's a complete list of the company's projects, including a map, as posted on the company's website. In its Q1 earnings report last week, NYLD announced that its project portfolio generated about $122 Million in EBITDA during the first 3 months, with about $6 Million in Cash Available for Distribution to shareholders after servicing the company's debt, etc. Further, NYLD announced its next dividend, which came in 18% higher than last year's. The company continues to project 15% or better dividend increases in future years. In terms of taxation, NYLD currently has enough accelerated depreciation to offset revenues for tax purposes for several years. This means NYLD’s distributions will be considered a non-taxable "return of capital" until some future date if, in fact, NYLD uses up all its depreciation. Of course, the return of capital also reduces your cost basis, and when you go to sell your shares, you'll pay capital gains taxes based on the adjusted basis. After NYLD uses up its current supply of accelerated depreciation, future distributions would likely be treated as qualified dividends; though it's also possible if the YieldCo has continued to grow, it may have acquired new projects that provide additional depreciation.

The table below compares NYLD to 2 other yield-focused green energy companies (note: technically, HASI has converted to REIT status, so it's not a YieldCo). Brookfield Renewable Energy (NYSE:BEP) is the one that meets the criteria I mentioned at the beginning of this article. The other 2 simply haven't been around long enough to meet my arbitrary target for 5-year returns (maybe they would've, maybe they wouldn't have, I guess). However, these 3 have all achieved better than 15%+ performance over the last 12 months, a 3%+ dividend yield, and trading at least 5% below their own 52-week high (as shown in the table). Brookfield's power portfolio is nearly 78% hydroelectric. Its distribution is comprised of a combination of return of capital, eligible dividends, interest from Canadian sources, and other foreign dividends and interest.

Data from Morningstar, through 5/11/2015. Returns longer than 1 year annualized.

If you're interested in further reading, here's a Wall Street Journal article from May 5, 2015, that talks about a number of YieldCos (including some of the more recent IPOs).

A non-traded alternative

One other YieldCo-like investment is a pre-IPO fund managed by veterans of Macquarie's renewable energy and infrastructure business, along with strategic partners with GGIC (formerly Guggenheim Global Infrastructure Company).

The Greenbacker Renewable Energy Fund, available to qualified investors through advisors, currently owns 82 solar facilities in 7 states, with an average of 16 years remaining on contracts to sell power to offtakers like Duke Energy, Denver International Airport, Denver Public Schools, Orlando Utilities Commission, Kauai Island Utility. All told, Greenbacker pays a 6.0 - 6.53% yield (depending on whether you pay a commission going in), which the manager expects to remain tax deferred for at least 10 years (with adjustments to cost basis, of course). The fund expects to continue to raise funds and acquiring projects including solar and wind. Unlike NYLD and other YieldCos, Greenbacker was not a spinoff and isn't majority owned by a parent company. At some point, management's goal is to list the fund on an exchange. Other possibilities, besides an IPO, could include selling or continuing to own and operate the portfolio.

Best,
Adam Feik
INO.com Contributor - Energies

Disclosure: I'm in the process of making an investment in Greenbacker Renewable Energy Fund, but I don't own any other investments mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.