2 High-Yield Dividends That Are Almost Certainly Doomed, and 1 Great Alternative

By Dividends Fool.com


Source: NextEra Energy Partners.

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Yieldcos are a potentially wonderful way for long-term incomeinvestors to profit from the megatrend that is the renewable-energy boom.

But not all yieldcos are created equal. While it's true that NextEra Energy Partners , has taken a beating over the past nine months,its share-price decline pales in comparison with the brutal carnage TerraForm Power and TerraForm Global have faced.

NEP data by YCharts

The reasons for the vast difference in performance highlights one of the most important aspects of successful long-term yieldco investing. Let's take a look at why NextEra Energy Partners is a potentiallygreat addition to your diversified income portfolio and why TerraFormPower and TerraForm Globalare toxic stocks you shouldn't touch with a 10-foot pole.

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Distribution profilewarns of TerraForm troubles

YieldCo Yield Last quarter's distribution coverage ratio (DCR) Projected 5-year annual distribution growth
NextEra Energy Partners 4.7% 9.0 12%-15%
TerraForm Power 14.9% 2.5 6.4%
TerraForm Global 44.4% 1.2 0.7%

Sources: earnings releases, Yahoo Finance, Fastgraphs, management guidance

Note that TerraForm Global recently IPOed, so because of its limited performance record, that table is for the last available quarter's data.

TerraForm yieldcos offerpayouts that are simply too good to be true.In contrast, Wall Street is pricing NextEra Energy Partners as if its payout is about as secure as that of a typical utility.Yet all threeare primarily renewable-energy utilitiesthat pay investors from cash flow generatedfrom assetsbought fromtheir respective sponsors and general partners, NextEra Energy (NYSE: NEE) and SunEdison. One slight difference is thatNextEra Partner's alsoowns natural gas pipelines and gets about 25% of its revenue from this source.

The cash flow is secured by extremely long-term, fixed-fee power purchase agreements, or PPAs, with major electric utilities.Thus one mightexpect all three yields to be roughly the same.

An obviousreason for this enormous yield discrepancy is that NextEra Energy Partners' DCR -- the bestsingle metric of long-term distribution security -- is so much larger than those of its TerraForm peers. This means not only that the yieldco is much less likely to have to cut its payoutin the future, but also that it has plenty of room to achieve management's targeted distribution growth rate of 12% to 15% a year through 2020.

Here's why Wall Street hates TerraForm yieldcos
TerraForm's problems stem from the fact that SunEdison is now likely to declare bankruptcy, courtesy of its monstrous and untenable debt load.

Given the utility nature of TerraForm's assets, this shouldn't necessarily spell doom for the yieldCos' payoutsexcept that SunEdison forced them to massively overpay for assets. Thisresulted in their likewise taking on way too much debt. For example, TerraForm Powernow hold $6 in debt for each dollar of cash on its balance sheet.

Excessive debt can light your money on fire

Company/yieldCo Total Debt Interest Coverage Ratio Weighted Average Cost of Capital (WACC) Return on Invested Capital (ROIC)
NextEra Energy Partners $3.5 Billion 1.83 7.8% 8.2%
TerraForm Power $2.4 Billion 0.89 NA 0.6%
TerraForm Global $525 Million NA NA (2%)
NextEra Energy $29.7 Billion 3.82 4% 6.4%

Sources: Morningstar, Gurufocus, Yahoo Finance, 10-Qs

SunEdison and its yieldCos' balance sheets are, simply put, horrific. The utility business isn't cheap, and large amounts of debt are to be expected. By contrast. NextEra Energy's management has been careful to make sure that its interest costs are always well covered by cash flows, as well as maintaining its debt covenants with creditors. SunEdison cared more about growingas fast as possible at any cost and forced its yieldCos to load up on debt to buy overpriced assets. The faster its yieldcos grew their payouts, themore IDRs it would collect. Now, as a result, all threemay be forced into bankruptcy protection.

After all, TerraForm Power is so burdened by high interest costs that it's barely making any returns on its invested capital.Similarly TerraForm Global is actually losing money on every shareholder dollar it spends on new renewable energy projects.

Meanwhile SunEdison has delayed filing its annual 2015 financial report because of "material weakness" and both TerraForm Power and TerraForm Global have similarly failed to file these legally required documents. In fact, TerraForm Power has delayed its 10-K not once, but twice. Nasdaq has notified both yieldcos that they're in violation of its listing requirements and at risk of being delisted.

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Bottom line
Yieldcos are owned for one reason -- income. Thus, it's essential that investors consider several factors before investing in these high-yield equities. Chief among these are the financial strength of its sponsor, the yieldco's balance sheet, and the long-term security of its payout.

Thanks to SunEdison's short-term-focused, debt-fueled growth binge, both TerraForm Power and TerraForm Global are probably doomed to either follow it into bankruptcy or, at the very least, will probably have to slash their distributions. Contrast this with NextEra Energy Partners, which, thanks to more conservative, long-term-focused management, is well positioned to prosper from theaccelerating renewable-energy bonanza.

The article 2 High-Yield Dividends That Are Almost Certainly Doomed, and 1 Great Alternative originally appeared on Fool.com.

Adam Galas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.