Mike Garland, President and CEO of Pattern Energy (PEGI), is a wind energy veteran who leads one of the most formidable wind energy companies in North America. Mike provides an enormous amount of context and insight into the wind energy business and the outlook for the industry, as well as critical perspectives as to how investors should be thinking about the PEGI investment thesis.
Interview Transcript
Participants
Mike, President and CEO of Pattern Energy Group (PEGI)
Nate Abercrombie, The Stock Podcast
Interview Transcript
Nate: Hello, and thanks for tuning into the IWTB podcast. Our guest today is Mike Garland, president, and CEO of Pattern Energy, ticker symbol PEGI, and more commonly called PEGI. Pattern is a wind energy company and commonly referred to as a yieldco. Yieldcos are a fairly novel type of company. They are very similar to MLPs in that they own and operate infrastructure assets and they pay out most of their cash flows to investors in the form of a dividend, hence the yield in yieldco. Similar to drop down MLPs, many yieldcos fund growth projects by issuing shares or equity to purchase an operating asset from a related party. But the biggest difference between MLPS and yieldcos are the assets they own. While MLPs are primarily oil and gas infrastructure, yieldcos primarily own renewable energy assets.
Nate: PEGI was one of the first publicly traded yieldcos in the US, with an IPO in 2013. PEGI is one of the largest independent owner/operators of wind energy assets in the US and Canada. Just recently, Pattern announced a big entrance into the Japanese market with an acquisition. Pattern owns 2.9 gigawatts of generation capacity. To put that number in perspective, if all of PEGI’s generation was operating at full capacity, Pattern could put Doc Brown’s DeLorean through time almost two and a half times.
Doc: “But I need a nuclear reaction to generate the 1.21 gigawatts…. 1.21 gigawatts. .21 gigawatts. Great Scott.”
Marty: “What the hell is a gigawatt?”
Nate: Yeah, that’s right. If you got that Back to the Future reference, I’m talking to the right people. In all seriousness, the general rule of thumb is that one gigawatt of generation capacity is roughly enough to power 700000 homes. Denver County, where I live, has about 311000 houses. So Pattern’s 2.9 gigawatts of generation, operating at full capacity, could provide enough power for all the houses in 6.5 Denver counties. Suffice it to say, that’s a lot of electricity.
Nate: It’s probably important to provide a little more detail about the yieldco model and how the model became broken a few years back. If you look at Pattern Energy’s corporate structure, you’ll see that PEGI is 92% owned by public investors and 8% owned by Pattern development. You’ll learn more about this in the interview, but one needs to think of Pattern Energy is the owner/operator of assets and Pattern Development as the company that takes all the risk in getting a wind energy facility from concept through construction.
Nate: Pattern Development essentially gets a project across the finish line and then sells the project or wind facility to PEGI. So when you hear backlog or development backlog, that’s in reference to the total number of gigawatts Pattern Development currently has in the race. Based on the most recent investor presentation, backlog consists of about 10 gigawatts of total capacity and about one gigawatt earmarked for potential sale to PEGI.
Nate: Most yieldcos work in a similar way. A few years back, a company called Sun Edison, which was also a yieldco sort of. It owned two other yieldcos called Terraform, and I think it was Terraform Global, became the poster children for renewables in yieldcos. The management team targeted massive growth targets. Sun Edison’s stock price went from about $2 a share in 2012 to $32 a share in 2015. That was the year everything fell apart.
Nate: Investors started to realize that they didn’t know everything they probably should know about Sun Edison and the company eventually filed for Chapter 11 in April of 2016. The whole story is complex and involves some pretty shady deals from what I understand. Hopefully we’ll see a business case or even a documentary someday soon. But the big picture is that the negative publicity and super negative investor sentiment for yieldcos affected the entire space. Leverage or debt levels draw a lot of investor attention, and rightly so, because it’s one of the biggest risks when you’re making an equity investment.
Nate: But investor attention on leveraging debt in the renewable space quite possibly became a little bit of a distraction, depending on how you look at it. And growth is a big concern now, given the uncertain policy outlook in Washington. And the other big concern is the inability, or at least the perceived inability, to fund growth when equity issuance may not be feasible given the extremely high cost of equity in the yieldco space.
Nate: But not all yieldcos are alike. That’s why it’s a real pleasure to have Pattern’s Mike on the program to talk about Pattern’s business model and the outlook for the industry. But before we get to the interview, let’s hit on high-level financials, industry terms, and [cell 00:06:42] side ratings.
Nate: PEGI’s share price, as of this recording, was almost $18 a share. Market cap is about $1.7 billion cash on hand, a little over $100 million. Total debt of about $1.9 billion and a minority interest of about $1.3 billion. This results in an enterprise value, or an EV, of about $4.8 billion. PEGI pays a dividend of $1.69 per share, which means the dividend yield is 9.4% today. You’ll hear more about the dividend during the interview, but PEGI’s board made the decision this past quarter to keep the dividend flat after increasing it about 35% since the IPO in 2013.
Nate: Consensus estimates for 2018 aren’t super helpful, especially after you hear Mike talk about using multiples like EV to EBITDA for a business with so much going on on the tax side of things. But it might be helpful to know that management has provided CAFD guidance of $151 to $181 million. If you’re wondering why the range is as wide as it is, keep in mind that we’re talking about wind energy and you need the wind to blow in order to make money.
Nate: The midpoint of guidance is $161 million, resulting in a CAFD yield of 9.8%. If you’re wondering what CAFD is, you may recall the acronym DCF from the previous interview. Yieldcos have their own term for basically the same metric. This is CAFD, which stands for Cash Available For Distribution. You’ll also hear the acronyms PPA, PTC, ITC. These are all pretty wind or renewable specific. PPA stands for Power Purchase Agreement and it’s essentially a contract that allows a wind facility to sell production at a certain price. These agreements or these PPAs are anywhere from 10 to 25 years long. PTC stands for Production Tax Credit. ITC stands for Investment Tax Credit. And just keep in mind that the PTC is more specific to wind and the ITC is just a little bit more specific to solar.
Nate: And then lastly, you may hear the term ROFO. ROFO stands for Right Of First Offer, which basically means that Pattern Energy has first dibs on buying an asset that Pattern Development would like to sell.
Nate: The Bloomberg Terminal includes ratings and recommendations from 14 sales side analysts, with nine of the 14 having buy ratings on PEGI’s stock. The average price target, including neutral rated or cell rated analysts, is $22.25 a share. With all that covered, let’s get to the interview. I hope you learn something and I hope you enjoy.
Nate: Mike, I can’t say thanks enough for coming onto the program. Getting management teams to agree to an interview hasn’t been the easiest task in the world, and you said yes and I thank you from the bottom of my heart.
Mike: Okay. Well, I hope this goes. It’s interesting. I guess it’s the age thing that most CEOs don’t understand that. There’s been a change in communication approach to life in our business.
Nate: Well, so I was hoping that we could just start out talking about your background and how you got involved in the renewable energy business and the role you played in building Pattern Energy.
Mike: Yeah. Thanks a lot. I have been in the business a long time. I think I did my first wind project in 1989. So I got into the business, really, through energy efficiency and wind renewables. Pattern was spun out of a disaster company called [inaudible 00:10:39] in June of 2009. And the development company basically, we brought a bunch of employees with us, about 80 employees, and we got funding from [inaudible 00:10:55] investment fund and some co-investors and that’s really when we kicked off our business.
Nate: That’s great. So what were some of the critical steps for you and for Pattern and building one of the most, or probably the preeminent, pure-play wind business around today in North America?
Mike: Yeah. The number one step is finding capital that supported our development opportunities. But really, it was hiring smart people and then having a no fear, anything’s possible attitude where we didn’t feel that we couldn’t get things accomplished. We felt like when we though tit through, we could make it happen. So that’s really the thing that drove both our development efforts and our going into the operations business and building one of the best-operating groups in the country.
Mike: So that’s been the driver for us.
