In the two months since the last update, most of the stocks in my Ten Clean Energy model stocks portfolio have reported first quarter earnings. There were few surprises, and those were mostly pleasant ones, allowing the model portfolio to add to its gains, and pull a little farther ahead of its benchmark.  

For the year to the end of May, the model portfolio is up 13.8%, 2% ahead of its benchmark.The benchmark is an 80/20 blend of the clean energy income benchmark (the Yieldco ETF YLCO) and the clean energy growth benchmark (Clean Energy ETF PBW), with the ratio matching the 80/20 mix of income and growth stocks in the model portfolio.

The 8 income stocks again led the pack, with an average total return of 15.2% for the year to date. The Green Global Equity Income Portfolio (GGEIP), an income and green focused strategy I manage also did well, up 13.5%. For comparison, the income benchmark YLCO produced a solid 11.4% return.

The two growth stocks recovered from losses early in the year and are now up 9.4%, but still behind PBW at 12.9%.

Stock discussion

Income Stocks

Pattern Energy Group (Nasdaq:PEGI)

12/31/16 Price: $18.99.Annual Dividend: $1.63 (8.6%). Expected 2017 dividend: $1.64 to $1.67.  Low Target: $18.High Target: $30.  
5/31/17 Price: $22.56.YTD Dividend: $0.408 (2.2%).Annualized Dividend: $1.655.YTD Total Return: 21.2%

Wind-focused Yieldco Pattern Energy Group advanced in strongly in April ahead of first quarter earnings. Earnings did not disappoint, and the Yieldco added to those gains in May. Guidance for 2017 Cash Flow Available for Distribution (CAFD) is $140 to $165 million, which would be 5% to 24% increase on 2016 CAFD.  

Growth has been slowing for Pattern, mainly because the low share price following the Yieldco bust at the end of 2015 has prevented the company from raising much equity capital. I expect that the share price will need to rise into the high 20s before we see large equity issuance from Pattern.With lower growth, they are also lowering their quarterly dividend increases.Since the IPO in 2014, the average quarterly increase has been 2.7%, but the company only increased its dividend 2% in the fourth quarter of 2016 and 1.4% this quarter.This lower rate of increases seems prudent, given that CAFD may only grow 5% this year at the low end.

Less prudent in a time when the company needs to be careful with its cash is the Yieldco’s consideration of an investment in the early stage projects of its parent, Pattern Development. In general, I think it is a good idea for Yieldcos to invest in project development with some of their resources, and eventually, as they grow larger, do much of their project development in house. That said, the time to invest in relatively risky but potentially high return businesses is when the stock is highly valued. When money is tight, as it is now for Patten and most other Yieldcos, it’s best to focus on investments that will increase the dividend in the short term. The time to invest in Pattern Development will be after the stock price recovers. Even small investments in early stage projects like the one being considered will only delay further stock price recovery.

8point3 Energy Partners (Nasdaq:CAFD)
12/31/16 Price: $12.98.Annual Dividend: $1.00 (7.7%). Expected 2017 dividend: $1.00 to $1.05.  Low Target: $10.High Target: $20. 
5/31/17 Price: $13.64.YTD Dividend: $0.257 (2.0%)Annualized Dividend: $1.028.YTD Total Return: 7.1%

I took a deeper look at Solar-only Yieldco 8point3’s plans to refinance its company level debt with amortizing debt in March. The company abandoned these plans April when one of its sponsors, First Solar (FSLR), announced that it was considering selling its stake in the Yieldco.

While I believe the refinancing plans were prudent, I found that they would have reduced 8point3’s CAFD below the level needed to sustain its current dividend. To make matters worse, the Yieldco announced a dividend increase while the refinancing plans were still in place. This behavior basically meant that 8point3 was hoping that its unsustainable dividend increases would cause investors to buy the stock and drive up the stock price. This hoped-for stock rebound would allow 8point3 to make new investments and increase cash flow enough to avoid a dividend cut.

In short, 8point3 was acting like it expected a return to the Yieldco bubble of 2014 and early 2015.

The abandonment of 8point3’s (prudent) plans to refinance its company-level interest only debt with project-level amortizing debt leaves sufficient cash flow to pay its current dividend, but does not address the reason for that plan in the first place.  8point3’s debt matures in 2020, and it is an open question if lenders will be willing to refinance it at comparable terms. If the stock price recovers, the company will issue new equity and grow itself out of the problem. If not, the only option open to 8point3 in 2019 may be refinancing with project level, amortizing debt. That will greatly reduce CAFD, leading to a large dividend cut. The company’s recent dividend increases only make this future problem worse.

This strategy of hoping that the stock market will bail the company out of its financing problems, at the same time as one (if not both) of its sponsors are looking for the exits is, in my opinion, irresponsible corporate management. While the high yield puts a floor on the stock price in the near term, I believe that long term investors are becoming increasingly skeptical of the company. This skepticism should also put a ceiling on the share price, and prevent management’s hopes of a share price recovery from coming to fruition.  

As the maturity of 8point3’s debt moves closer, the consequences of the inevitable refinancing will loom larger in investors’ minds. I don’t know when it will happen, but at some point, the stock price will have to drop to reflect 8point3’s much lower expected CAFD and dividend after refinancing.

Because of this, I have started selling short calls on the stock, in order to profit from my prediction that the share price is likely to be capped in the near term, and fall in the medium term.

Hannon Armstrong Sustainable Infrastructure (NYSE:HASI).