By: Dividend Sensei
Risks To Keep In Mind
While NYLD’s dividend is low risk due to its highly stable cash flow and favorable business model there are nonetheless certain risks potential investors need to be aware of.
The first is that renewable energy has benefitted from large tax benefits via the solar incentive tax credit and the wind product tax credit. However, the last time those were extended was December 2015. Solar projects begin in 2019 or earlier get a 30% tax credit. In 2021 and 2022 that falls to 26% and 22%, respectively, and then disappears in 2023. For wind the production tax credit are 60% for projects started in 2018 and 40% for 2019. Beyond 2022 and 2019 solar and wind tax credits expire. Because yieldCos use tax equity financing as part of their funding model the expiration of these tax credits could potentially slow their future growth potential.
The good news is that because solar and wind project costs have fallen by about 75% in the past decade they are becoming cost competitive with gas fired power plants and are already cheaper than coal and nuclear, even when tax credits are excluded. Analysts are forecasting continued project costs (and thus overall power generation costs) continuing to fall over the long-term which should ensure steady growth in renewable power over the long-term. However, the reason I mention tax credits expiring is because it ties into two other risks with NYLD that investors need to be aware of.
First, while falling costs for wind and solar are great in terms of driving strong project growth in the coming decades, it also potentially acts as a double eddged sword. That’s because PPAs do expire eventually but solar and wind projects have useful lives that are usually from 30 to 50 years. This means at some point all yieldCos will have to renegotiate them at market rates, which are likely to be far lower than current ones. This means that yieldCos will need to keep growing their asset bases quickly to offset their eventual contract cliffs when PPAs will be renewed at lower rates.
Finally we have funding risk. Because yieldCos use non recourse, self amortizing debt almost all of them have junk bond credit ratings. This means that should interest rates rise high enough their borrowing costs could rise to levels that make it hard to grow profitably (cost of capital could rise to match cash yields on new investments). And since yieldCos must also access equity markets to raise growth capital there is some equity risk as well. Specifically that if their share prices fall low enough then the cost of equity could rise too high to fund profitable growth. While NYLD’s price recovery has once more allowed it to profitably access equity markets that might change in a bear market when all stock prices fall sharply. This ultimately means that while a recession won’t put NRG Yield’s dividend at risk, it might temporarily slow its growth potential.
Bottom Line: NRG Yield Is A Great High-Yield Way To Profit From The Rise Of Green Energy
YieldCos are a great way for high-yield dividend growth investors to cash in on the boom in green energy, which is a long-term secular mega trend. NRG Yield, thanks to its generous, low risk, and rapidly growing dividend, is one of my top choices in this industry. That’s because now that GIP is taking over as its sponsor, potentially opening it up to international growth opportunities, NRG Yield’s growth potential is better than ever. And with the stock still massively undervalued the combination of high-yield, fast dividend growth, and multiple expansion could easily allow this stock to deliver 20+% total returns over the coming decade.