Northland Power: Future Projects Should Energize Growth, Optimism (TSX:NPI:CA)

Please note all $ figures in $ CAD, not USD, unless otherwise stated.

Introduction

It’s no surprise that asset heavy industries like real estate and utilities have been under pressure as central banks increase interest rates, which has put pressure on leveraged companies that use debt financing as part of their operations. With interest rates expected to decline over the next year into 2025, I’ve been looking for companies I think are best suited to benefit from this trend.

In my view, Northland Power (TSX:TSX:NPI:CA) is a top renewable energy company that deserves a closer look. Since I last covered the stock in May, the company has been executing well and I don’t think the market has given management much credit for construction execution.

As such, with commentary in the company’s latest results on a pivot back towards prospective development potential, I believe the outlook looks better, particularly with management mentioning ongoing discussions with corporate PPA counterparties and indications of potential interest on pursuing thermal projects to fill demand.

Recent Results

When looking at Northland Power’s latest quarterly results for Q2’24, the company reported adjusted EBITDA of $268 million, which was above the consensus forecast of $262 million (source: Bloomberg). On free cash flow, FCF per share of $0.20 was above the consensus estimate of 5 cents a share. Part of the reason for the beat was a a gain through the sale of La Lucha, a solar facility in Durango, Mexico that the company announced it was selling back in March.

On the whole, my impression of the quarter was that this results came in better than expected, particularly with management noting that results are now trending towards the high end of previous 2024 guidance ranges. So while guidance targets weren’t increased, we should have more certainty in management’s outlook with potential to overshoot, rather than miss. Overall, when we look at the major items impacting the quarter, Q2’24 reflected relatively robust offshore wind generation, a healthy earnings contribution from the EBSA utility and the asset sale gain.

Because Northland has so many different projects and facilities in its portfolio, it’s helpful to look at them as three main segments: Offshore Wind, Onshore Renewables, and Natural Gas.

In Offshore Wind, generation increased 14% year over year and came in 4% above sellside estimates (source: S&P Capital IQ). Compared to its long-term average, production at DeBu and Nordsee 1 were 11% ahead of the average. This factor contributed to $10 million of higher operating results and higher wind resource was experienced at all three of Northland’s facilities. Offsetting some of this growth, however was lower price realizations, which declined 5% year over year.

For the Onshore Renewables segment, EBITDA came in above estimates and rose 17% for the year thanks to the addition of the New York wind projects and improved generation from the Spanish portfolio. Compared to the offshore wind side of the business, the onshore wind facilities are generally have lower operating costs, but also lower wind resource. For other forms of renewable, we see similar characteristics, but electricity production from solar tends to be less variable than wind. During the first half of the year, Northland’s onshore renewable facilities in North America and Spain contributed about 12% and 10%, respectively, to the adjusted EBITDA.

Finally, in Natural Gas, one of the smaller parts of Northland’s business, the company saw relatively stable capacity payment contract structures, wind good margins. During the quarter, electricity production was 26% higher than Q2’23, but sales of $76 million were in line with last year, mostly as a result of

lower natural gas prices resulting in lower energy rates. Because of this, adjusted EBITDA of $50 million was only marginally higher compared to last year’s figure of $49 million.

In terms of the other items discussed on the earnings call for the quarter, management noted progress towards advancing various development initiatives. This includes securing a 15-year bi-lateral offtake agreement for an Alberta battery project and submitting projects to the recent NYSERDA RFP, where results should be expected some time in September. Management also noted potential interest in thermal development to feed accelerating data center power demand. In my view, firm growth priorities will be dependent on strategic change implemented by the eventual permanent CEO. On the earnings call, Executive Chair, John Brace noted “great progress” on this front. So we should expect a successor will be announced in the near-term.

Another item of note was that the company’s three construction projects remain on schedule and within budget. In particular, Hai Long’s schedule contains substantial winter buffer periods. That project is scheduled to start generating pre-completion revenues by the second half of next year and reach full COD in 2027. The Oneida battery project is on track for 2025 COD and Baltic Power is set for 2026 COD.

Finally, potential sales of mature operating assets are dependent on a clear line of sight towards value-accretive growth. Northland Power has a relatively high dividend payout ratio (above 90% on free cash flow) but management is cognizant that sacrificing current operating cash flow for prospective growth could yield further pressure for this ratio. So while I wouldn’t expect much dividend growth from here, I do think the current dividend is stable.

Development Projects

In my view, I think the market hasn’t given management enough credit for their projects under development. So far, all three construction projects remain on schedule and within budget. At Hai Long (the company’s offshore wind facility in Taiwan with net capacity of 313 MW) pin pile installation continues along with other offshore construction activities. Turbine production has started at the Siemens Gamesa facility in Taiwan and it’s expected that Hai Long will begin to receive turbines in Q2’25. The asset is expected to start generating pre-completion revenue by the second half of next year ahead of scheduled early-2027 COD at the latest. Where domestic content is required, the company has benefitted from a maturing supply chain given that it is one of the later projects from Taiwan’s original offshore wind procurements.

At the company’s offshore wind facility in Poland, Baltic Power, Northland Power is also within budget and on schedule. Management has noted that fabrication of onshore and offshore substations is progressing as expected with major in-water activity expected to start eary-2025 towards an expected 2026 COD.

Lastly, at Oneida, Northland’s battery storage plant in Ontario, the company also remains on track and is moving smoothly as per its construction plan. By the third quarter, management expects that high-voltage transformers should arrive on site and that the project should be up and running and fully online by mid-2025.

Outlook

As for the outlook for Northland Power, I think there’s been a notable shift over the last few quarters on management’s tone on growth. Over the past year, there was consistent messaging around execution on construction of the three mentioned projects. I think this was appropriate given cost inflation, compromised returns for Hai Long, and the more challenging nature of offshore wind construction. Given good construction progress and accelerating power demand, Executive Chair, John Brace, highlighted advances for various mid-term prospective organic projects. This includes a 15-year bilateral PPA with the Alberta Schools Commodities Purchasing Consortium for a battery storage project in Alberta. My expectation is that this should be instrumental in de-risking the project and should create stable and predictable cash flows going forward.

In addition, Northland has has also submitted onshore renewable projects to the recent NYSERDA RFP in New York, with results expected in September. In total, the company’s net under-construction capacity is 1.051 GW (37% of current net installed capacity) and the prospective growth pipeline totals 6.6 GW. On the earnings call, management mentioned that it has open dialogues with corporate counterparties, including data center developers/operators, regarding potential bilateral PPAs. Management indicated a willingness to build thermal capacity (an expertise) to provide a flexible power option for potential partners. To me, this indicates that those ambitions could extend beyond the company’s current gas-fired power platform in western Canada and Ontario. The initial PPA for the Nordsee One offshore wind asset is due to expire 2027 and I would expect that management is already reviewing options to recontract that asset, potentially with a corporate offtaker.

Finally, from a balance sheet perspective, Northland has a pretty flexible balance sheet and, based on recent asset sales and commentary from management, I think we can expect that asset sales should help fund earlier-stage growth opportunities or will at least be considered carefully to manage the company’s payout ratio. At quarter end, the company had available liquidity of $821 million, representing a little over 6% of assets.

With total loans and borrowings of $7.25 billion, 123% the size of the company’s market capitalization, debt makes up a significant portion of the company’s enterprise value. However, I think investors should keep in mind that a large portion is structured as non-recourse, secured credit arrangements at the subsidiary and asset level. As shown below, some of these maturities extend out as far as 2042 and all have rates below 6.6%. So with a low cost of debt and laddered maturities, I don’t view Northland as having too much balance sheet risk.

Regarding asset sales, management indicated that any prospective asset sale would only occur in tandem with an incremental value-accretive development initiatives. With an expected dividend payout ratio of 93% in 2025, I’d expect that Northland would be careful in giving up immediate contracted cash operating flow for mid-to-long term growth. This strategic approach should help maintain financial stability while positioning the company for future expansion and profitability.

Valuation and Wrap Up

Analysts seem to be quite bullish on Northland Power’s near-term outlook, with 12 out of 13 analysts having ‘buy’ ratings and only one analyst having a ‘hold’ rating. With average price target of $29.85, the sellside is forecasting one year price appreciation of 30% over the next year, not including the 5.2% dividend yield.

At the current valuation of 9.3x EV/EBITDA, Northland Power is trading cheaper than it was back when I reviewed it in May (at 10.3x). At 9.3x EV/EBITDA, the company trades at a discount to the peer group average of 14.7x EV/EBITDA (source: S&P Capital IQ). Even on a forward multiples (including P/E), we can see that Northland Power trades much cheaper than other companies in the renewable energy sector.

In my view, given that the company is poised to deliver high-single digit EBITDA and double-digit earnings growth over the next three years, I believe paying a high-single digit EBITDA multiple is a bargain price. Since most of the company’s capex costs are growth capex, as opposed to maintenance capex, EBITDA is a good proxy for cash flows.

One potential concern investors may have is on the dividend. However, as I alluded to earlier, Northland Power has flexibility when it comes to asset sales and has demonstrated that it can generate organic growth at many of its projects. So while the dividend is unlikely to grow much given the high payout ratio above 90%, dividend increases could be a possibility in the future when new projects come on line.

In summary, I continue to be bullish on Northland Power’s outlook and it would be one of my preferred plays in the renewable energy space. Amidst the backdrop of lower interest rates, I think the company’s solid execution across its major projects, robust financial performance during the latest quarter, and strategic focus on both organic growth and potential asset sales paint a positive picture for its future. While the high dividend payout ratio may temper immediate expectations for dividend growth, Northland’s commitment to maintaining a flexible balance sheet and pursuing value-accretive developments underscores its potential for long-term capital appreciation. With a favorable valuation relative to peers and promising growth prospects, I believe Northland Power is well-positioned to benefit from declining interest rates and rising energy demands. As such, I think it presents itself as an attractive investment that has both growth and income characteristics. For these reasons, I’m maintaining my ‘buy’ rating on Northland Power.

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