10 Clean Energy Stocks For 2016

Tom Konrad CFA The History and Future of the "10 Clean Energy Stocks" Model Portfolios 2016 will be the eighth and possibly final year I publish a list of ten clean energy stocks I expect to do well in the coming year.  This series has evolved from a simple, off-the-cuff list in 2008, to a full blown model portfolio, with predetermined benchmarks and monthly updates on performance and significant news for the 10 stocks.  While there is much overlap between the model portfolio and my own holdings (both personal and in managed accounts), the model portfolio is designed to be easily reproduced by a small investor who only spends a few hours a year on his or her investments. Trading is kept to a minimum by retaining many names from each annual list, and only trading in the middle of the year in extreme cases.  There has been only one intra-year trade so far, in 2013 in the event of a bankruptcy. Despite (or perhaps because of) the lack of trading, the model portfolios have performed well, at least relative to clean energy stocks in general.  The model portfolio has outperformed its benchmark every year since 2008 except 2013.  That year it returned 25% compared to the benchmark's 60% return. In the early years, the model portfolio mirrored the Clean Energy sector's notorious volatility.  More recently, I have attempted to focus the portfolio on less risky stocks, and this has allowed the portfolio to consistently outperform its benchmarks. The move to less risky stocks has also been a function of my growing personal focus on high yield Clean Energy stocks.  The only current Clean Energy mutual fund or ETF is the Global X YieldCo ETF ( YLCO ), which was launched in May.  Its low liquidity and worse performance will probably prevent it from gathering enough assets for long term viability. I've been talking to investment advisory groups and mutual fund companies about possibly launching a mutual fund or other pooled fund based on a Global Green Equity Income Portfolio (GGEIP) which I've been managing in a seed account since the end of 2013.  The seed account has had excellent returns (up 6.6% in 2014 and 12.6% in 2015) while YLCO and fossil fuel based income alternatives have mostly fallen. If I am successful in making GGEIP available to retail investors, SEC rules will likely prevent me from continuing to update the list regularly.  That is why this may be the last such model portfolio.  Or it may continue in a slightly different form: Aurelien Windenberger has offered to continue the updates if I am unable to. The Making of 10 for 2016 Not only are income stocks my personal focus, but I believe that late 2015 will prove to be to be the best buying opportunity for clean energy Yieldcos.  Yieldcos are public companies that own long term contracted clean energy assets such as solar and wind farms, and use the cash flows to pay a high dividend to shareholders.  Many Yieldcos are listed subsidiaries of larger renewable energy developers.  These stocks became market darlings in 2014 and early 2015, when investors flocked to them because they had seemingly created a magic formula to combine high current dividends with a high dividend growth rate.  In fact, as I pointed out shortly before the bubble burst , the current dividends were unimpressive, and the cheap capital provided by seemingly endless investor enthusiasm was essential for the high dividend growth rates. The Yieldco bubble popped over the summer, and I believe we have already seen the lowest point to which the sector as a whole will fall.  That said, many Yieldcos remain amazingly cheap on an absolute basis, and so the best valued Yieldcos will form the core of this list.  I recently wrote an article looking at Yieldco valuations using the dividend discount valuation model .  An updated version of the most important graph from that article follows; the Yieldcos in this list will be selected because of their attractive valuations on this chart.   Read the article linked above for a full explanation of how to interpret the chart. What Is A "Clean Energy" Stock? Many followers of this series have noted that I tend to stay away from well-known green stocks, like Tesla (NASD: TSLA ) and the solar manufacturers and installers most people think of first when they think of clean energy.  This is not just because I prefer less volatile stocks. It's also because I believe that avoiding well-followed stocks gives me a better chance of finding great values that other investors have overlooked.  While some of these stocks may indeed be good values, they clearly have not been overlooked.  For any investor with limited time to do research (i.e. all investors), deciding where that limited time can (and can't) be spent most productively may be the most important part of the research process.  Investors who skip this step will inevitably squander valuable time researching stocks that are already well priced by the market.  I try to avoid such stocks with some quick tools that help me quickly eliminate most stocks as potential candidates for further research, which I wrote about here .  One of those tools is simply eliminating any company that might make good cocktail party conversation.  Whenever I tell people I what I do, those who are interested in investing always bring up Tesla and/or solar stocks.  Which is precisely why I seldom have much to say about such stocks, and you won't see any of them in this list.  While I don't try to be a boring conversation partner, I do try to keep my portfolio as boring as possible.  Two other tools I use are looking for buying by company insiders, and low beta.  Among less followed stocks with limited public information, I believe that the actions of insiders is a very important indicator of a company's prospects.  Low correlation with the overall market, or "Beta,"  not only indicates less risky stocks, but much recent research has found that (contrary to traditional market theory) that low volatility and low Beta stocks tend to outperform the market as a whole over time.  For similar reasons, there are a couple stocks in this list that are not obviously "Clean Energy" stocks.  For my purposes, if a company's products or services reduce the use of dirty energy (i.e. fossil fuels), then it is a clean energy company.  Renewable energy manufacturers, installers, and owners (such as Yieldcos) obviously qualify, but so do companies that sell insulation or help others manage vehicles more efficiently, even if those companies' primary customers are fossil fuel companies themselves.  The following table shows this year's list in rough order of riskiness (by my own subjective assessment) along with market Beta and a summary of recent insider trading activity.  Ticker Yield Beta Insider Buying? 1 PEGI 6.7% 1.22 More buying than selling 2 RNW.TO 8.0% 0.63 Buying, no selling 3 EVA 11.25% N/A* No trades since IPO 4 GPP 10.51% N/A* No trades since IPO 5 NYLD/A 5.8% 1.02 Buying, no selling 6 HASI 6.3% 1.22 Buying, no selling 7 MIXT 4.3% -0.13 More buying than selling 8 GLBL 22.4% 1.22 No trades since IPO 9 REGI - 1.01 More buying than selling 10 AMRC - 1.1 Buying, no selling *EVA and GPP have not been public long enough to calculate Beta accurately. Benchmarks This year's list consists of eight income stocks and two value/growth stocks.  As in 2015, the benchmark for the income stocks will be YLCO, and the benchmark for the value/growth stocks will be the Powershares/Wilderhill Clean Energy ETF ( PBW ).  I will benchmark the 10 stock model portfolio as a whole against an 80%/20% blend of the two, and also compare it to the Russell 2000 index ETF (IWM) to show how its performance compares to the broader universe of small cap stocks. Income Stocks Added for 2016 Pattern Energy (NASD: PEGI ) 12/31/15 Price: $20.91.  Annual Dividend: $1.488 (7.1%).  Beta: 1.22.  Low Target: $18.  High Target: $35.   Pattern is a Yieldco owning mostly wind projects in North America.  While Pattern is smaller than most other Yieldcos, and has a more limited development pipeline from its sponsor, it has historically been able to acquire new projects at higher cash flow yields than its bigger rivals with higher profile sponsors.  The higher cash flow yields of Pattern's projects are in part due to its emphasis on wind projects, and stronger independence at the Yieldco. Wind farms tend to have higher returns than solar because wind production varies more from year to year than solar, and the higher cash flow yields are compensation for higher risk.  That said, the risk of variable production from wind farms is easily diversifiable.  Since average wind speeds in one location have little correlation with wind speed in locations on other parts of the globe, let alone with solar production or the stock market in general, wind production risk production risk will have little effect on a highly diversified stock portfolio, and so the higher returns from owning wind farms come without significant added risk for the stock market investor. The stronger independence of Pattern Energy from Pattern Development is by design. When Pattern Development offers Pattern Energy a wind farm for potential purchase, a committee of independent board members uses outside consultants to value that farm before price is ever discussed.  The purchase only takes place if the eventual price falls within the range of that initial valuation. Enviva Partners, LP (NYSE: EVA ) 12/31/15 Price: $18.15.  Annual Dividend: $1.76 (9.7%).  Low Target: $13.  High Target: $26.   Enviva Partners is a Master Limited Partnership (MLP) which owns wood pellet manufacturing and transportation infrastructure.  Unlike wind and solar, the IRS considers wood products to be natural resources, allowing Enviva to use the tax advantaged MLP structure.  The advantage of this structure is that returns to investors can be higher because MLPs avoid taxation at the corporate level. The disadvantage is that MLPs are partnerships, and limited partners (shareholders) receive K-1 tax forms which usually include Unrelated Business Taxable Income (UBTI) which, if the MLP is owned within an IRA or other taxable account, means that the account will have to file a separate tax return with the IRS.  The added paperwork means that most investors will prefer to own MLPs in taxable brokerage accounts. Most of Enviva's customers are European power companies, which buy the partnership's wood pellets under long term contracts.  This market is expected to continue to grow quickly because converting coal plants to burn sustainably sourced wood pellets is easily one of the most cost effective ways for an electricity utility to reduce its carbon footprint.  Enviva has most of its plants in the US Southeast, where the warm climate and plentiful rainfall results in fast growing forests which lend themselves to sustainable forestry.  Some newspaper articles have questioned Enviva's sustainability practices with allegations of wood from clear-cutting old growth hardwood forests.  While I believe it is possible that some wood from such clear cutting may have found its way into Enviva's plants, I am confident that sale of wood to Enviva was not the motive for such clearcutting, and the company's presence as a long term source of demand is more likely to encourage sustainable forestry than the opposite.  First of all, Enviva's plants cannot accommodate large logs, just the small trees and branches which might otherwise be burned in place or left to decay (and release its stored carbon) on the forest floor.  Second, the vast majority of Enviva's plants have FSC certification, which I consider to be the gold standard of sustainable certification for wood products.  They would not be able to achieve this certification if they made a practice of accepting wood from unsustainable forestry operations. Hence Enviva easily meets my green criterion that the company's operations have the net effect of reducing greenhouse gas emissions. Green Plains Partners, LP (NYSE: GPP ) 12/31/15 Price: $16.25.  Annual Dividend: $1.60 (9.8