Yield Cos? More like Yield Can’ts!

Forgive the cheesy title. Terrible jokes, dinosaurs, and which planet would offer the best alternative to Earth are common ground in the Wunder office (Venus - in case you were curious. It would require some kind of air bubble mechanism…but that’s another post).

Anyway.

In April, Carol Clouse at Institutional Investor reached an interesting conclusion that yield cos – dividend growth-oriented public companies – are not everything they have cracked up to be.

Instead, they have become the financial equivalent of American Idol (RIP); you’re hoping for another champion in Kelly Clarkson, but end up with William Hung, a Ricky Martin train wreck.

Here’s the problem: Despite expectations of 10% to 15% annual returns, they’re actually not much higher than ten-year U.S. treasuries, clocking in at 3%. Pattern Energy Group’s is 4.5%, making it the energy industry’s highest to date.

This disconnect isn’t a death knell for the structure but offers pause for thought. Yes, yield cos provide a number of benefits: They decrease capital costs, introduce new investors to the renewable sector, and spur financial innovations, among others. If you’re an institutional investor and willing to wait it out as the market matures and expands, then yield cos hold great potential, but you might be waiting a while.

The reality is that you can do better. Here are two reasons why yield cos are a lazy renewable investment if you're really looking to benefit from industry growth.

Syphoning Off Risk is Why Your Returns Suck

Yield cos were created to offer a predictable, steady cash flow and de-risk renewable investments.

They work by public companies syphoning off volatile activities - such as development and construction - into separate income streams. This allows investors to receive dividends generated by underlying property performance alone.

Still, it’s important to note that current financing procedures used by the majority of companies in the renewable space take on risk unnecessarily, because they use due diligence processes ill-suited to the industry. It’s like chopping vegetables with a samurai sword. Sure, it will get the job done, but it’s really not the best tool to do so.

Building a model that can more accurately perform due diligence reduces risk in the upfront, ensuring only fully vetted, high quality deals are offered as an investment opportunity.

Taking it back to our vegetable analogy, it’s the equivalent of using a mandoline slicer: faster, easier, prettier shaped carrots – a tool designed for the job in hand and that job alone.

It’s a Band-Aid solution to a larger financing problem

One of the undeniable benefits of yield cos are the reduction of capital costs.

This is a good thing all round, but only certain properties are likely to benefit.

Residential and large commercial are already well serviced, but smaller, viable commercial properties have redheaded stepchild status. Large commercial due diligence processes require too many man hours to be used on projects of a smaller status, and using credit scores instead, as is done with residential, is a bad proxy for underlying market performance. The result of this is that yield cos help raise capital for large commercial properties and not for this middle section, leaving potential investments on the table.

An investment vehicle created to increase access to only area of a market is not a solution – it’s an interim fix until something better comes along.

At Wunder, we developed an approach and due diligence model to address these two issues, focusing on light commercial solar and different data sets to assess risk.

While yield cos and the conversations they generate about the future of renewables and investor appetite are welcomed, they are not a silver bullet for renewables. And, as they tarnish slightly in the eyes of the market, one hopes this makes way for something new that truly tackles deep-seated industry issues to rise up instead.

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A modified version of this post appeared on The Alpha Pages

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