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More Cash from Global Warming

February 06, 2020

Last week, I explained why renewable energy isn’t just a fad.

The economics of working with wind, solar, hydropower and other renewables, including energy from waste (EFW), continues to make sense for the bottom line.

The proof is in one of my more successful utilities inside Profitable Investing: NextEra Energy (NEE)—the largest renewable energy producer in the world.

Since being added to the portfolio in 2008, it has generated a total return of 590.64%, which is fantastic when compared to the S&P Utilities Index’s return of 198.00% for the same period.

And it is even more impressive when compared to the S&P 500 Index, which only managed to return 235.62% for the same time.

Clean, green or renewable energy—whatever you call it—is becoming a bigger and more profitable business.

Nasdaq Clean Edge US Liquid Series Index—Source: Bloomberg Finance L.P.

It’s interesting to note that the Nasdaq Clean Edge US Liquid Series Index above, which has a wide variety of US-listed renewable energy companies, really didn’t begin to take off until after the 2016 US general elections.

This shows that clean energy is now beyond politics. It’s just good business.

The Real Deal

NextEra Energy should continue to perform well for Profitable Investing subscribers from its conventional and massive renewable energy assets.

But today I want to focus on another great behind-the-scenes company in the renewable energy market, Hannon Armstrong Sustainable Infrastructure Capital (HASI), which is set up as a real estate investment trust (REIT).

As a REIT, it operates largely outside of Federal corporate tax liability. It invests in and finances projects in renewable energy that are built and operated on real estate properties. And thanks to the Tax Cuts & Jobs Act of 2017, individual shareholders have a particular line item giveaway in that 20% of the dividend distributions from HASI (like for all US REITs) is deductible from taxable liability.

Hannon Armstrong is based in the very pretty town of Annapolis, Maryland. It has been around since the 1980s as Hannon Armstrong Capital. In 2012, it formed its current company into a REIT, and it went public in 2013.

The REIT provides lending and debt financing in addition to taking equity stakes in the renewable and energy efficiency markets. It does so through both private and publicly funded projects with a large collection of US government properties. This provides a highly dependable credit behind its investments, as Uncle Sam has the power of the US Treasury behind his wallet.

Furthermore, much of its investment projects come with underlying guarantees from not just the US government but state and local governments as well. All of this aids the credibility of the company and the security of its underlying assets and cash flows.

It’s not the biggest in the renewable business, having some $5.7 billion in assets in its portfolio. But it has been adding assets at a pace that’s now reported to be running at $1 billion per year.

It has investments in nearly 200 projects, predominantly in the US. And its portfolio is primarily generating investment interest on financing, amounting to 55% of revenue, with 20% on rental income on its properties. The remaining portion comes from equity participation revenues and portfolio investments.

Revenues are up over the trailing year by 30.5%. And that revenue has climbed over the past five years by 199%. As a REIT-organized financial company, its net interest margin (NIM)—the difference between what it pays to finance itself and what it earns in interest—is a fat 12.1%.

Compared to a traditional financial, its return on assets is well above average at 1.9%. In turn, it has a return on equity of 5.8%. It is a bit more expensive to run the company due to its current size, with an efficiency ratio (the ratio of how much it costs to earn each dollar of revenue) of 64.3%. I would like to see more scale in the company and some cost controls by management, but that should be in the works given the ramp up in its portfolio.

As a REIT, debts are part of the capital structure, so its debt to assets ratio of 57.6% is reasonable and sustainable given US credit market conditions now and in the foreseeable future.

The shares have returned 320% since coming to the public market in April 2013.

Hannon Armstrong Total Return—Source: Bloomberg Finance L.P.

Note in the total return graph that the shares provided a good return in 2018 in line with the REIT segment, even during the turbulent fourth quarter. And from 2019 to date, the shares are getting more attention with rising price and dividend income.

Dividend distributions are running at $0.335, which yields 3.8%, above the average for REIT dividend yields as measured by the Bloomberg US REITs Index. And those distributions have been on the rise by an average over the past five years of 7.8%.

Hannon Armstrong shares are up, yet they are still a relative value. On a price to book basis, the effective value of the net assets is running at 2.6 times, which is below the average for the Bloomberg US REITs Index.

HASI also provides not just a behind-the-scenes profit opportunity with yield in the renewable energy market, but an important hedge leading into the 2020 elections.

Renewables have been working well for the past few years. If that continues, as I expect, the company should do well for us at Profitable Investing.

All My Best,

Neil George
Editor, Income Investor’s Digest & Profitable Investing
Author, Income for Life