FormerXBC Inc XEBEQ

TD Notes

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Renewable Power Sector Update & Outlook

A Closer Look at Sector Growth Prospects and Valuations Year-to-date IPP Sector Valuation Contraction Opens a Window

Canadian renewable independent power producer (IPP) equities have struggled for traction in 2021. The average share-price decline for our coverage universe from respective Q1/21 peaks is 31% — more than double the average decline of 13% for international renewable IPPs over this duration and a negative variance versus strong gains for the broader equity indices. Pressure can be attributed to a few developments: rising interest rates; increasing competition for value-accretive growth initiatives; and component-cost-inflation concerns. Notwithstanding these issues, sector valuations have normalized and we believe that several equities in our coverage universe offer compelling risk-adjusted opportunities.

• The global energy transition investment opportunity-set is expanding and most companies in our coverage have transparent organic growth pipelines. Bloomberg NEF expects that global energy-transition investment, including development of renewable power capacity, will grow at an annual CAGR of 13% over the next 30 years. Canadian renewable-power IPPs have diverse growth prospects across technologies and geographies.

• We believe that pressure on organic renewable power development returns is decelerating. Since 2014, we estimate that the average levered IRR for representative renewable development projects for the companies in our coverage universe has contracted to ~9% from ~18%. This compression reflects more competition from low-cost-of-capital developers for organic wind and solar projects and a transition towards competitive procurements and away from subsidized growth. We believe that pressure on returns has decelerated over the past two years as more rational contract pricing has emerged.
  
  We are upgrading our sector bias to OVERWEIGHT from Market Weight. We are trimming our target prices for most names in our coverage universe (more conservative segment multiples), but the average valuations have contracted to attractive levels, given companies' extension of advanced organic growth pipelines. Based on 12-month forward EV/ EBITDA, the average trading multiple for our coverage universe has contracted to 13.7x, near the long-term average of 13.4x and down from the January peak of 17.6x.