Author: John Heinzl

What is wrong with Brookfield Renewable Partners LP (BEP-UN-T)? The unit price is down by nearly half from its high in 2021, and I’m wondering if it’s time to move on.

First, let me provide some perspective.

Renewable-power producers soared in late 2020 and early 2021 after Joe Biden, whose platform included major investments in green energy, won the U.S. presidential election. But as momentum-focused traders piled into the space, renewable valuations soared to unsustainable levels, setting the stage for a sector-wide retreat.

Sharply rising interest rates delivered another body blow to the sector, making it more expensive to build wind and solar farms and further compressing renewable stock valuations.

Now, with a much less eco-friendly U.S. president in the White House and the administration’s erratic tariff policies sowing confusion, investor sentiment toward renewable-power producers has remained under pressure.

So, is it time to pull the plug on renewable-power stocks? I don’t think so.

As the world transitions away from fossil fuels, the fundamentals for renewable power remain strong. Demand for electricity continues to grow, driven by electric vehicles, greater use of air conditioning as the climate warms and, perhaps most important, growth of power-hungry data centres used for cloud computing and artificial intelligence.

Brookfield Renewable is already seeing benefits from the AI boom. Last year, the company and parent Brookfield Asset Management Ltd. announced a framework agreement with Microsoft Corp. to bring 10.5 gigawatts of renewable generating capacity online between 2026 and 2030 in the United States and Europe – enough to power about 1.8 million homes.

Similar deals could follow.

“We expect to continue to partner with global technology players on both a project-by-project basis and by larger framework agreements given the persistence of the supply-demand imbalance we are seeing globally,” Connor Teskey, chief executive officer of Brookfield Renewable, said on the first-quarter conference call this month.

Some analysts say Brookfield Renewable’s sluggish share price doesn’t reflect the full benefits of the Microsoft deal and the long runway of other growth projects.

“We believe BEP has the most impressive … operating portfolio in the Canadian IPP [independent power producer] sector,” Mark Jarvi, an analyst with CIBC Capital Markets, said in a note after the release of Brookfield Renewable’s first-quarter results.

“Further, its operations are heavily weighted to high-quality, long-life hydro assets which command a premium valuation,” Mr. Jarvi said. He rates Brookfield Renewable an “outperformer” with a price target of US$30. The units closed Friday at US$24.49 on the New York Stock Exchange and at $34.19 on the Toronto Stock Exchange.

Brookfield Renewable’s strategy of growing via development projects and acquisitions will allow it to continue hiking its distribution, Mr. Jarvi said. In January, the partnership raised its payout by 5 per cent to US$1.492 on an annualized basis – the 14th consecutive annual increase. The units now yield about 6.1 per cent.

(The partnership’s sister corporation, Brookfield Renewable Corp. (BEPC), pays the same distribution, but its stock price is higher, and it therefore has a lower yield of about 5 per cent. Another difference is that the corporation’s cash payouts consist entirely of eligible dividends, whereas the partnership’s distributions typically include eligible dividends, foreign income and capital gains.)

Despite the supportive fundamentals, not all analysts are sold on the Brookfield Renewable story.

In a note after the release of first-quarter results, analysts Benjamin Butler and Dimitry Khmelnitsky at Veritas Investment Research said tariffs and permitting delays for U.S. wind projects “add uncertainty to BEP’s development outlook.”

Moreover, the analysts said growth in funds from operations (FFO) – a measure of cash flow – is “largely driven by gains on asset sales, as opposed to asset-level cash flow growth.”

Excluding gains on dispositions, Veritas estimates that FFO declined by about 25 per cent year-over-year in the first quarter. That compares with headline FFO growth of about 6 per cent reported by Brookfield Renewable.

“BEP’s growing reliance on asset monetizations raises concerns about the sustainability of its cash flow,” the analysts said.

Veritas has a “sell” recommendation and a “value estimate” of US$20 on the units – the lowest on the Street, according to analysts surveyed by Refinitiv.

In an e-mailed statement, Brookfield Renewable disputed Veritas’s characterization.

“Renewable power by its nature is resource-dependent, meaning that in a given quarter or given year it is typical to experience variability in cash flows from power generation, particularly with respect to our strategic hydro portfolio,” it said.

“At the same time, as our development activities have scaled over the past several years, asset sales have also grown into a more routine … part of our earnings, which has helped to enhance the diversification of our cash flows and offset some of the variability that comes from resource dependent impact of lower hydrology.”

Further, Brookfield Renewable said it expects asset sales to remain elevated because it is seeing “more capital recycling opportunities than ever before,” and these deals provide cash to fund further growth. It added that “the long-term growth trajectory of the underlying cash flows of our business is strong and diversified.”

While Brookfield Renewable is not without risks, it’s fair to say that the depressed unit price is already reflecting at least some of the challenges facing the business, which could help to limit future downside. As always, do your own due diligence before investing in any security, and maintain a diversified portfolio to control your risk.

Disclosure: The author owns BEP.UN units.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

Now that Fairfax Financial Holdings Ltd. (FFH) has signed a letter of intent to acquire The Keg Royalties Income Fund (KEG.UN), do you think other restaurant royalty companies will be bought out?

There does seem to be a trend of restaurant parent companies acquiring their royalty affiliates. In October, A&W Food Services of Canada Inc. merged with A&W Revenue Royalties Income Fund, citing “a more conventional capital structure that can be leveraged to finance growth initiatives.” The combined company now trades on the Toronto Stock Exchange under the symbol AW.

This week, Keg Royalties announced it has signed a letter of intent that would see Fairfax Financial acquire all outstanding units of the fund, other than those it already owns, for $18.60 each – a 31-per-cent premium to the price before the proposal was announced. The Keg steakhouse chain is owned by Recipe Unlimited Corp. – parent of Swiss Chalet, Harvey’s, East Side Mario’s and other brands – which was taken private by Fairfax Financial in 2022.

Based on recent stock market action, some investors may be betting that other royalty companies could eventually get swallowed up. In the three trading sessions following the Fairfax-Keg announcement on Monday morning, shares of Pizza Pizza Royalty Corp. (PZA) rose 2.3 per cent and units of Boston Pizza Royalties Income Fund (BPF.UN) gained 4.5 per cent. Both chains also released first-quarter results this week, with same-store sales rising 1.2 per cent at Pizza Pizza and 4.4 per cent at Boston Pizza.

Royalty funds are unusual in that they don’t own the restaurant chains themselves. Rather, they own the restaurant trademarks, which they license to the operating company in exchange for a royalty based on a percentage – typically 4 per cent to 9 per cent – of sales by restaurants in the “royalty pool.” That royalty income, in turn, funds cash distributions to shareholders.

The high yields of royalty stocks make them popular with retail investors. Keg Royalties and Pizza Pizza Royalty both yield more than 6 per cent, Boston Pizza Royalties yields more than 7 per cent, and SIR Royalty Income Fund (SRV.UN) – owner of the Jack Astor’s casual dining chain – yields about 9 per cent.

Although restaurant royalty funds share a similar structure, each has its own characteristics. Pizza Pizza Royalty, for example, is a corporation, not a fund like the other entities.

In the case of Boston Pizza, the “operating company has a single individual owner in Jim Treliving,” said Nick Corcoran, an analyst who covers Boston Pizza Royalties at Acumen Capital. “It would ultimately be up to Mr. Treliving to pursue a sale of the operating company or combination with the income fund.”

I wouldn’t invest in a royalty fund based solely on expectations of a buyout. It’s more prudent to consider the investment’s merits on their own and treat any potential transaction as a bonus. In other words, enjoy your main course of dividends, but don’t expect a free dessert.

In my tax-free savings account and registered retirement income fund, I have been holding some Brompton investment funds for 14 years. My Brompton Life & Banc Split Corp. Class A shares (LBS) show a negative book value of $3,547. My purchase cost was $32,135, and the current market value is $31,814. My annual yield is about 14 per cent. What would happen if I sold the fund in this negative book value situation? Would it reduce my gain?

The negative book value will not affect the proceeds you receive from selling your shares. Assuming you enter a market order to sell (as opposed to a limit order that specifies your asking price), the price will be determined by the bids available at the time.

Keep in mind that, because bid and ask prices are constantly changing, the price you receive may differ slightly from the price of the previous trade.

Nor will the negative book value have any tax consequences in your case. Because you hold the shares in a registered account, you will not face any taxes on capital gains or investment income.

The only time an investment’s book value – also known as adjusted cost base (ACB) – comes into play for tax purposes is when the securities are held in a non-registered account. In such cases, you would calculate your capital gain (or loss) by subtracting the book value from the sale proceeds.

Hypothetically speaking, say your shares were held in a non-registered account and you sold them for proceeds of $31,814. You would have a realized capital gain of $35,361 (calculated as $31,814 minus the ACB of negative $3,547, which is the same as adding $3,547).

You may be wondering where the negative book value came from. Well, if you own an investment that distributes return of capital (ROC), as LBS and many other high-yielding funds do, each ROC distribution must be subtracted from your ACB. (Evidently, your broker has been doing this for you.) If you receive enough ROC over the years, your book value can drop to zero.

In a non-registered account, once the ACB or book value hits zero, any subsequent ROC distributions are taxed in the same year as capital gains and are no longer deducted. So, in a non-registered account, the book value cannot technically drop below zero. But as you’ve discovered, in a registered account it can and does happen.

Disclosure: The author owns PZA, BPF.UN and KEG.UN personally.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.