HA Sustainable Infrastructure Capital, Inc. (HASI) Q4 2014 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Hannon Armstrong’s 2014 Year End Earnings Conference Call. Management will be utilizing a slide presentation for this call, which is available now for download under Investor Relations page at investors.hannonarmstrong.com. Today’s call is being recorded and we have allocated 1 hour for prepared remarks and question and answer. All participants will be in a listen-only mode. [Operator Instructions] At this time, I would like to turn the conference call over to Ms. Amanda Cimaglia, Manager, Investor Relations for the company. Thank you. You may now begin.

Thank you, operator. Good afternoon, everyone. By now, you should have received a copy of the earnings release for the company’s fourth quarter 2014 results. On the call today, we will start out with a business review from Jeffrey Eckel, our President and CEO followed by Brendan Herron, our CFO, who will review our fourth quarter 2014 financial results. As a reminder, a replay of this call will be available later today on the Investor Relations page of our website. Before we begin, I would like to remind you that some of the comments made on today’s call are forward-looking statements and within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities and Exchange Act of 1934 as amended. The company claims the protections of the Safe Harbor for forward-looking statements contained in such sections. The forward-looking statements made in this call are subject to the risks and uncertainties described in the Risk Factors section of the company’s Form 10-K and other filings with the SEC. Actual results may differ materially from those described during the call. In addition, all forward-looking statements are made as of today and the company does not undertake any responsibility to update any forward-looking statements based on new circumstances or revised expectations. With that, I would like to turn the call over to Jeff Eckel, President and CEO who will begin on Slide 3. Jeff?

Thanks, Amanda and good afternoon, everyone and thank you for listening to HASI’s Q4 earnings call. Today, we are announcing core earnings of $0.27 per share or $7.1 million for the quarter and $0.93 per share or $20.3 million for the year. This represents a 23% increase in core earnings per share from Q3 and is in excess of our recent 18% increase in the dividend in Q4. Even with the recent stock performance, we are still paying our shareholders a 6.3% dividend yield based on Friday’s closing price of $16.63. Now that we have ramped the business and achieved our initial targets, we are prepared to offer 2-year guidance of 14% to 16% annual core EPS growth for 2015 and 2016. This would put our core EPS at the end of 2016 in the range of $1.21 to $1.25 per share. Turning to Page 4, I want to highlight our 2014 targets and achievements. As I said, we grew core earnings 23% against the target of 13% to 15%. We targeted closing $800 million of new business in 2014 and instead closed $875 million, a 9% increase. This allowed us to reach our $1 billion balance sheet goal and we continued to increase our leverage as planned with our balance sheet now levered at 1.9 to 1 and 40% of our interest rates fixed. Our historic focus on distributed energy assets remains core and we have been able to complement that business with attractive ways to invest in the utility scale wind and solar markets. We believe these results demonstrate our relentless focus on execution. Turning to Page 5, we show how our high-quality pipeline has and will continue to drive growth in the business. At the 2013 IPO, we have approximately $200 million of assets on balance sheet. Since the IPO, we have closed $1.5 billion of new business and built the balance sheet to $1 billion comprised of over 80 assets. Our 2015 pipeline remains at more than $2 billion representing over 125 discreet investment opportunities, which are continually optimized for risk-adjusted yields. To be clear, we do not expect to close $2 billion in new business in 2015, but the depth and diversity of the pipeline gives us a terrific opportunity to continue to build an attractive diversified balance sheet. YieldCos have received well-deserved investor appreciation for their ability to forecast their drop-down pipeline with projects form their parent sponsor. HASI does not have a parent sponsor, but rather a diverse set of national and global companies some we have financed for 15 years, which drives our future pipeline. If we simply maintain our market share in the markets we are already in, we estimate our pipeline will consist of more than $4 billion of investable assets in over 300 transactions in 2016 and 2017. We believe an important aspect to our sustainable dividend is the large number of well-diversified assets that make up our balance sheet and a viable pipeline of new opportunities with attractive margins that will fuel our growth over the next several years. We believe we will achieve our 14% to 16% annual growth rate for core earnings per share for 2015 and 2016 through a mix of balance sheet growth, increasing financial leverage, margin expansion and as importantly as those three factors together the operating leverage from our internally managed business. Being internally managed with no fees going to related third-parties, 100% of the enterprise value drops down on the shareholders. Turning to Page 6, the chart on the left conveys the approximate size of our three primary markets: efficiency, wind and solar. Efficiency is by most measures the most economic of all clean energy technologies and will continue to be a primary market for HASI. Wind is by far the largest renewable energy market to-date and we see significant opportunities in utility scale wind projects, whether new builds or from the approximately 65 gigawatts of installed capacity in the U.S. Solar continues its meteoric rise in both the retail and utility markets and we are investing in both markets. The chart on the right shows how HASI complements the industry incumbents. The efficiency wind and solar markets often require financing that is compatible with many relatively small assets and/or have tenures that are generally longer than many banks are comfortable with and shorter and smaller than most insurance company investors are seeking. This is the opportunity we are addressing in the marketplace and it also creates additional opportunities to partner with the industry incumbents as well. This flexibility in deal size and tenor is one of our competitive advantages. We also enjoy a low cost of capital relative to BDCs and private equity and hedge funds and we are conscious that growth presents some new risks and we will take a clear view of the risks and rewards in all three markets to grow our business. Turning to Page 7, we summarized our strategy in three connected activities. It all starts with our clients, the leading participants in the industry from whom we originate programmatic investments with a positive greenhouse gas profile. This means we avoid one-off investments without a plan for replicable execution or those with greenhouse gas emissions. Our ability to execute on programmatic transactions is only as good as the team we have at HASI. With an average tenure of over 12 years, our clients enjoy stability in their relationship with us, not offered by many financial service firms. Michael Porter says the only true sustainable competitive advantage is having a lower cost than your competitors. And we believe our ability to aggregate high-quality, diversified portfolios of assets with a verifiable greenhouse gas profile will over time allow us to lower our cost of capital by offering investors excellent returns from assets on the right side of the climate issue. For instance, investors in our sustainable yield bonds will have a greenhouse gas metric on each issuance that we believe will help them discriminate where they put capital in a world increasingly defined by carbon. To be clear, we do not believe any investors giving up return or taking more risk simply because we measure greenhouse gas impact. Instead, we believe better risk-adjusted returns will be the outcome. When we put these three activities together, our strong execution of programmatic transactions and a competitive cost of capital will help us serve our clients even better as we provide the financing necessary to achieve the rapid adoption of the clean energy technologies they are selling. Now, I will turn it over to Brendan to detail our financial performance and credit quality.

Thanks, Jeff. Turning to the Q4 results, we generated $11.7 million of core investment revenue, a 90% increase from Q4 last year. We consider Q4 of 2013 to be the first quarter in which we are fully ramped following the IPO and thus have moved to year-over-year comparisons. The core investment income increase is due to an increase in the size of our balance sheet to over $1 billion at the end of 2014 from just under $600 million at the same time last year. The increase in core investment revenue was offset by higher interest expense as we increased our leverage to 1.9 to 1 from 1.2 to 1 last year. And we ended the year with 40% of our non-match-funded debt at fixed rates. We also realized $3.8 million of other investment revenue in the quarter which again exceeded the level of other expenses core allowing all of our investment income to continue to contribute to core earnings. Our core total revenue net of investment interest expense was $10 million in Q4, an increase from $6.2 million last year. For the year our core total revenue net of investment interest expense grew over 100% to $31.3 million as compared to $14.7 million in 2013. Other expenses core increased slightly to $2.9 million from $2.5 million last year and to $11 million for the year versus $9.2 million last year. Core earnings rose to $7.1 million compared to $3.7 million in the same quarter last year. As Jeff said core EPS grew 23% over Q4 2013 to $0.27 per share and by 100% for the year ended December 31, 2014 to $0.93 per share. For the quarter we closed $375 million of new business and ended the year at $875 million of closed transactions. On a look forward basis, our average portfolio yield is approximately 6% with our energy efficiency assets yielding approximately 4.6% and our renewable energy assets yielding approximately 6.6%. A couple of things to note, first this was the first quarter of our $144 million investment in the wind projects. As we discussed last year we are using an effective interest method for core purposes versus the hypothetical liquidation of book value or HLBV method used under GAAP. Under the structure of the transaction, we are allocated a large percentage of the cash, for example over $20 million in 2015. We evaluated and negotiated this transaction on a discounted cash flow basis and thus will adjust core earnings to reflect the effective interest being realized on the transaction similar to how we account for many of our financing receivables. In both GAAP and core interest expense on the debt used to finance the investment is included with no adjustment in the investment interest expense line. The core revenues adjusted for this transaction were $2.4 million for the quarter. We recorded in GAAP $1.5 million of interest expense related to the $115 million non-recourse debt. As mentioned in 2015 we expect this investment to return approximately $20 million in cash distributions of which we expect approximately half to be core earnings and the remaining half to be reflected as return of our capital. We will be allocated only small portion of the book earnings and thus our GAAP accounting will reflect only a small amount earnings. For example, less than $1 million of loss in 2015 which will be reported at the bottom of the income statement. We expect similar results going forward over the next several year. As an example the amortization associated with the deal by 2021 when the non-recourse debt becomes due only approximately $20 million of the $115 million debt will remain on unamortized. The GAAP to core adjustment is largely a timing difference with core reflecting an effective yield, i.e., a constant return on the investment versus GAAP which will reflect a larger return on capital in the early years and a large earnings impact in the later years. Secondly, while we had a strong Q4 both in originations and earnings and while we are providing guidance of 14% to 16%, the new business and originations are not necessarily consistent on a quarter-to-quarter basis due to the timing of transactions. Thus we caution against either annualizing Q4 originations or Q4 earnings, but believe that our annual guidance is more appropriate reflection of our business. Finally, to make sure everyone is clear on our dividend policy, we have based on a study of long-term dividend payers to decided that we will establish a practice where we intend to adjust our dividend once a year. Thus in December, our Board will increase our dividend – thus in December our Board increased our dividend by 18% to the $0.26 per share based on our earnings at the time and our future outlook. Our intention is to maintain this dividend till we further analyze it at a similar time next year. Turning to Page 9, one of the things that makes our business unique is our focus on a diversified portfolio of high credit quality assets. Our debt in real estate portfolio continues to be 98% investment grade rated at December 31, 2014. This consists 46% of our assets from government obligors and 52% commercial transactions with only 2% or $15 million not considered investment grade. Given the nature of the wind, the equity investment we did not include the equity investment in this analysis. Our portfolio is widely diversified with over 80 projects and an average outstanding loan balance of approximately $11 million per project. Turning to Page 10, we want to focus on the strength of our balance sheet. On the asset side, we have grown to over $1 billion with an average portfolio yield of approximately 6%. Just as importantly, these transactions are generally structured so we have either senior debt or have a preferred position in the capital stack. For example, our real estate transactions are senior to the senior debt in the utility scale solar projects and our wind equity investment is the senior slice of capital as there was no project debt. On the debt side we have been able to lock-in 40% of our non-match-funded debt at fixed rates and largely achieved our 2 to 1 leverage target. Giving continued low short-term rates, we are looking to increase our non-match-funded fixed rate debt to 50% to 70% fixed rates. Given our goal of further fixing out our debt our Board has approved increasing our leverage target to 2.5 to 1. As reported in January we have and expect to continue to have a large percentage of our dividends classified as return of capital. The percentage of dividends that is taxed is based on a tax calculation of the REIT’s taxable income divided by the dividends paid. Our return of capital is primarily the result of various tax attributes we have in the REIT and the fact that a portion of our business typically the renewables side is operated in our taxable REIT subsidiary or TRS. Our TRS is in effect a YieldCo within our REIT structure. And we have enough attributes that we like most YieldCos are able to shelter our TRS income and thus not pay tax at the TRS level. Since the TRS’ income is not included in the REIT’s income for tax purposes we end up with what has averaged to be over 60% of our dividend treated as a return of capital. While we are not giving a target here, we do expect to have a significant percentage of our dividend treated as return of capital in the future. Turning to Slide 11, we wanted to show how our capital structure had evolved since the IPO and how we are thinking about it evolving in the future. Right after the IPO we entered into our credit facility, we had a maximum capacity of $700 million. Since that time we have been able to increase that facility to have a maximum capacity of $1.35 billion and added a year to the maturity. We have also been able to add two layers of fixed rate debt and complete two follow-on offerings, both accretive to book value and at progressively higher share prices. Moving forward into 2015 and beyond, we expect to raise additional equity to fund our growth using both traditional equity raises as well as an ATM. We also expect to add additional sustainable yield bonds both publicly rated and private and eventually add term debt to our capital structure. It is likely we will use the latter approach to this debt and have multiple maturities. As we mentioned earlier, we will be targeting increased leverage up to the target of 2.5 to 1 and 50% to 70% fixed rate debt. Turning to Slide 12, as Jeff mentioned we have continued to focus on execution and have achieved many of the metrics and targets we have previously discussed on this call. We have a diversified portfolio of cash flow investments that are generally structured as senior or preferred in the capital stack. Unlike MLPs our markets have little to no correlation to oil as oil is used for approximately only 1% of U.S. electric generation. Similarly, we are not exposed to commercial real estate. We believe that we are well positioned to continue to grow the business, have a low correlation with many other investments and with our dividend in excess of 6% offer an attractive alternative to many other choices. I will now turn it back to Jeff who will warp up the presentation.

Thanks Brendan. To summarize we believe the investment proposition represented by HASI is the combination of our yield, growth and quality. Yield comes from our long duration assets currently yielding 6%. Growth comes from our deep pipeline and the growing efficacy wind and solar markets as well as operating leverage. Quality is represented by the high credit ratings of our obligors, proven technologies and diversity of assets. Finally, a note of thanks to the HASI team again. We talked a lot about the value to investors of our internally managed platform. I am fortunate to get to work with them. All 28 people who comprised that platform worked very hard in 2014 and are continuing that effort in 2015. We appreciate you listening to our Q4 update. And will now open the call up for a few questions.

Thank you. [Operator Instructions] The first question is from Philip Shen of ROTH Capital. Please go ahead.

Hey, guys. Congrats on closing out 2014 with strength.

Thanks Philip.

Thanks Philip.

In 2014, you targeted and delivered $1 billion of assets, what is your asset targeted for 2015? And also given the visibility you have into your portfolio, how do you expect the mix in your portfolio by segment to shift if at all?

Well, first let’s talk about the shift. I think we had a pie chart in the prior quarter that showed our pipeline by the donut shape. And you could see what we have tried to do with the pipeline chart is the rectangles are really the approximate mix of efficiency wind and solar assets. It’s not a lot different than the last quarter nor is it a lot different than what we have closed. As to the first part of your question, we closed $875 million. Our target was $800 million. We certainly expect to be able to do every bit of the $875 million again in 2015.

Great, thanks Jeff. I think I heard you guys say that the Board has approved a 2.5 to 1 leverage ratio, is that correct?

Correct.

Great. So in the quarter you maintained your 1.9 times ratio. How do you expect to see your leverage ratio change and evolve through the year, can you – anyway, please go ahead.

Yes. So, what we intend to do is add additional layers of fixed rate debt through doing ABS transactions and that will allow us to take up our leverage target. And we think those two, as we have talked about on previous calls we think those will go hand in hand and by taking interest rate risk off the table, we are going to set a target of 50% to 70% fixed rate debt. By taking interest rate risk off the table, we think it’s appropriate to add additional leverage.

Great, thanks Brendan. One more and I will jump back in the queue. In the quarter, you guys had a nice bump in your renewable yields. How do you expect your segment yields to evolve through the year and what are the drivers of these yield expansions?

So, I think on the energy efficiency side as we have talked about on previous calls, a large percentage of the energy efficiency has historically been federal and state local government, so because of the high credit quality there, you tend to get a little bit tighter spread. Renewables, we continue to see good opportunities in that marketplace. And with us we have been able to expand our yields there and we have been able to do some things that we think are structurally advantaged. So, the real estate, the wind transactions are good examples of structure advantage, where we are not only able to get a very attractive risk-adjusted return, but we have structural seniority in the transaction.

Thanks to you both. Congrats again. I will jump back in queue.

Thank you. The next question is from Aditya Satghare of FBR Capital. Please go ahead.

Thank you. Good evening all. Two questions here. One is on Slide #5, is there a good way for us to think about when you talk about the $2 billion future projects and then $4 billion of future deal flow. What part of that is existing and operating assets versus assets which still have to be developed and constructed?

That’s a great question. I would say the – on the efficiency side virtually all of them still have to be constructed. On the solar side, probably most of them still have to be constructed. On the wind side, it’s because of the success of wind over the last decade there is a lot of opportunity of existing assets that are already developed and operating. And yet there is also a new build market that’s surprisingly robust. So the new wind turbine technologies are so efficient now that they are really still quite economic in even today’s low power price market.

Got it. And then – and second question maybe sort of a broad commentary, how should we think about some of the trends you are seeing in the asset yields by category given some of the competition we see in the market?

Well, I think a lot of the competition you see in the market is on the equity side. And we certainly think from the numbers we have heard that people are paying. If I was a seller I would be very attracted at selling at some of those prices. On the debt side, I think on the renewable energy side we have said throughout the quarters that we need to pick our markets. I think the large scale, well sponsored renewable energy project that’s fully contracted does not have a senior debt yield that looks that interesting to us and hasn’t for about a year. But that’s where we have found ways to add value to our clients through the land transactions and on the wind equity investments. I think the senior debt is frankly less bid up than may be the equity side on renewable energies. But you still have to pick your spots.

Got it. Thank you. Thanks for the update and I appreciate all the new disclosure here.

Thanks Aditya.

Thank you. [Operator Instructions] The next question is from Tyler Frank of Robert W. Baird. Please go ahead.

Hi, guys. Thanks for taking the question and congratulations of the nice quarter. Can you discuss just a little bit of what drove Q4 being so strong in terms of the amount of transactions that you were able to close during the quarter. And then how should we think about 2015, I know you just said you expect to do at least $875 million in transactions this year, but can you give us a sense on how you expect those transactions to flow through on a quarterly basis?

Well I think Brendan summarized it as quarter-to-quarter, I think the difference between Q3 and Q4 is pretty sizable in 2014. Yet we don’t really look at that as very significant from our core earnings power. If something doesn’t happen in Q3, it happens in Q4. We had some transactions that were pretty interesting to do at the end of the year and it was a great quarter. But really with infrastructure, what happens this quarter and next quarter is really not as important to us as it probably is to the market. The transactions in the pipeline generally don’t go away they generally do get pushed out in time. And given enough transactions, we will be able to have pretty good quarters and pretty reliable quarters.

Great. And then in terms of your guidance for this year, should – how should we think about that in terms of prospective capital raises, does that – is that including an equity raise this year and do you need to get two and half one – 2.5 to 1 in terms of your leverage ratio to hit that guidance?

So, the answer is we do include in our analysis additional capital raises. And as we have talked about in the past, you can kind of take the target assume a percentage of hold transactions which increased this year and then and divide by a leverage target. We don’t anticipate getting to the 2.5. It will take us during the year to get to the 2.5 as I think we have talked about before especially with our intention to do 8 larger ABS $100 million type byte size of ABS transactions, they tend to be a little bit lumpy, so much like some of the deal originations lumpy. So, those things will happen when they happen. The two and a half is a gradual goal for us. It’s not something we are going to do with some of them we will be working on, but not necessarily achieve, don’t look for us to achieve it in Q1, for example. And so we will continue to kind of make our progress towards that much as we did with the 2 to 1 in the past.

Okay, great. Thanks guys.

Thank you. We have no further questions at this time. I would like to turn the floor back over to management for any additional or closing remarks.

Thanks for the great questions. And we are – Brendan and I will be hitting the road and talking to a lot of investors and a lot of analysts here in the next few weeks. So, we look forward to expanding on this. Thanks so much.