National Bank While falling bond yields have brought some support to renewable power stocks, National Bank Financial analyst Rupert Merer is “baking-in rate stability from here.”
“Renewable stocks have seen some tailwinds recently, with slightly lower bond yields,” he said. “The Canada 10-year yield is now at 3.1 per cent, down from highs of close to 3.5 per cent in early March (but up from recent lows of 2.8 per cent). This has provided some relief for the sector, but with NBF’s 12-month forecast at 2.7 per cent, rates could be range-bound for some time. In addition, easing inflation and supply chain issues are reducing concerns about risks to returns on growth in the sector.”
However, in a research report released Wednesday, Mr. Merer pointed to inflation and improving weather could potentially drive asset valuations moving forward. He also thinks the Canadian federal budget could “speed up” development.
“Renewable power IPPs, with largely CPI-indexed contracted cash flows, are poised to benefit from tailwinds to power prices from inflation,” he said. “Inflation has been a headwind to returns on some growth projects, but growth contributes an average of only 10 per cent to our target prices, while operating assets make up a much larger 80-per-cent share of our valuation. We expect to see the benefits of inflation start to materialize in 2023 as most contracts adjust annually, following high inflation in 2022. Although weather has been a headwind in the last few quarters (and could be in Q1 too), we believe sentiment could improve this year.”
“Canada’s budget announcement is expected to expedite the development of projects for some of our IPP coverage. The proposed 15-per-cent refundable tax credit falls short of the U.S.’s 30-per-cent IRA, but should increase the competitiveness of renewable energy and accelerate growth. We believe that this support will reduce power prices for new generation in Canada, but ultimately should not have an impact on returns. While the overall impact is positive, we would not expect persistent, outsized returns on new projects.”
With a decline in bond yields and a “dropping” market risk premium, Mr. Merer lowered his discount rate for IPP stocks in his coverage universe, leading to higher targets for five companies. He did warn that “further increases won’t come as easily.”
His changes are:
- Boralex Inc. ( “outperform”) to $46 from $42. The average on the Street is $46.85.
- Brookfield Renewable Partners LP ( “outperform”) to US$34 from US$31. Average: US$37.80.
- Innergex Renewable Energy Inc. ( “outperform”) to $21 from $20. Average: $19.23.
- Northland Power Inc. ( “outperform”) to $42 from $40. Average: $44.80.
- TransAlta Renewables Inc. (“sector perform”) to $13.25 from $12.75. Average: $13.3
“The highest returns to target are for PIF [“outperform” and $20 target], INE, ARR [“outperform” and $11.75 target], NPI and AQN [“sector perform” and US$10 target], but for long-term growth BEP and BLX are well positioned,” he said. “To move targets higher, we would likely need to see lower yield forecasts or large investment initiatives.”
“Our highest return to target is for PIF, which trades at an implied discount rate of more than 14 per cent by our estimates, likely given its developing market exposure. This is followed by INE, at an implied discount rate of 8.9 per cent, following a soft Q4 with poor performance across its operating fleet. With good weather, we believe that INE could outperform its peers this year. However, this is not certain to happen in Q1.”