Q1 2022 Hannon Armstrong Sustainable Infrastructure Capital Inc Earnings Call
Greetings and welcome to Hannon Armstrong first quarter 2022 results conference call.
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I'd now like to turn the conference over to your host Niihau got them.
The new director of Investor Relations and capital market.
Thank you and over to you.
Thank you.
Yeah.
Our web site.
Yeah.
This conference call is being webcast live on the Investor Relations page on our website, where a replay will be available later today before the call begins I would like to remind you that some of the comments made in the course of this call are forward looking statements within the meaning of section 27, a of Securities Act of 1933 as amended and section.
21 E of Securities Exchange Act of 934 as amended the government claims the protections.
Safe Harbor for forward looking statements contained in such sections. The forward looking statements made on this call are subject to risks and uncertainties described in the risk factors section of <unk> Form 10-K, and other filings with the SEC actual results may differ materially from those described during the call in.
In addition, all forward looking statements are made as of today and company does not undertake any responsibility to update any forward looking statements based on new circumstances or revised expectations. During this call. We will primarily discuss non-GAAP financial measures, which we will believe which we believe help investors gain a meaningful understanding of our core.
Financial results and guidance are.
Jason of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP.
A reconciliation of GAAP to non-GAAP financial measures is available on our posted earnings release and slide presentation.
Joining me on today's call are Jeff Eckel, the company's chairman and CEO and Jeff Lipson, Our C. F O N E L O.
With that I'd like to turn the call over to Jeff Eckel, who will begin on slide three Jeff. Thank you <unk> and welcome to the Investor Relations role and good afternoon, everyone. Today. We're pleased to report continued strong performance in the first quarter with distributable earnings of 52 per share a 21% increase.
Over last year continued growth in net investment income up 41% from last year and up 10% from Q4 'twenty 'twenty. One also a dividend of 37 and a half cents per share.
Strong NII growth contributed to this strong quarter.
Sets us up for a strong year with our gain on sale revenue added to NII. We demonstrate again that the has a dual revenue business model built on a diverse set of clients technologies and assets continues to work well, despite macroeconomic and industry challenges.
As such we're pleased to reaffirm our prior guidance for annual growth in distributable EPS of 10% to 13% through 'twenty 'twenty, four and 5% to 8% annual growth in our dividend for the same period.
As we do every quarter this quarter, we highlight a carbon count of some projects in this case, two California based solar investments one grid connected at a 0.8 carbon count the one behind the meter at point too with the same grid emissions profile. The difference in the carbon count is the relative cost per kw with it.
Grid connected solar caused three to four times lower than the behind the meter transaction now of course, there are other advantages to behind the meter solar plus storage assets, such as reliability, but we believe measuring and reporting with this level of rigor on carbon count is where the market needs to go.
Turning to slide four we'd like to discuss some of the headline challenges that are top of mind of our investors.
First as we mentioned last quarter, the clean energy industry is continuing to adapt to inflation by raising PPA prices.
Our clients in both grid connected and behind the meter segment are increasing PPA pricing to end customers to manage higher capital costs and inflation.
Meanwhile, renewable ppas or pricing higher the alternatives and gas fired or utility supply power have generally increased as well due to a near tripling of natural gas prices.
As for the impact of Hassey higher inflation has minimal impact on our portfolio due to the largely fixed price O&M contracts and because we price our new investments at current pricing and once the impacts of inflation on a project or understood. We can generally increased pricing with market rates.
Additionally, our portfolio benefits from higher commodity prices and retail rates to the extent there are sales into the wholesale markets.
For behind the meter generation, including residential solar the customer value proposition is improving duty utility rising rates in fact, the long term prospects for elevated natural gas prices is causing us to look more favorably on common equity investments to capture some of that upside.
Next as most of you are aware the anti circumvention investigation initiated by the Department of Commerce is creating disruption in the solar supply chain with a threat of retroactive tariffs on panels imported from South East Asian suppliers.
This is primarily affecting grid connected solar projects due to their tighter PPA pricing and the sheer volume of panels those projects require.
On a grid connected pipeline, we are fortunate to have large companies as clients, who have generally been able to source panels from unaffected supply change.
Well there'd be softness in the solar pipeline six to nine months out I think that is inevitable yet manageable given the diversity of our originated origination platform across the clean energy landscape.
The success of the grid connected wind and solar industries over the last few years has not been matched by investment and transmission systems to move the power to the load this congestion and basis risk causes pricing mismatches under some ppas.
The revenue shortfalls from the project plan.
We have experienced some of this with our portfolio and have adjusted our expected yield accordingly, the preferred nature of many of our grid connected assets is a significant mitigate but not a perfect mitigate for an industry wide problem that is getting the attention it deserves from the industry.
Finally, the brutal war in Ukraine by Russia is a reminder, that energy security is national security. This should be a clear message that notwithstanding the near term challenges of the clean energy industry I've just been discussing we should not lose sight that the clean energy industry is the only viable path to both enter.
Independents and climate change mitigation further reinforcing our investment strategy.
Yeah.
Moving to slide five we provide an update on our 12 month pipeline, which we continue to report is greater than $4 billion.
<unk> with last quarter, the bulk of our pipeline remains behind the meter and is weighted towards energy efficiency. The grid connected portion is weighted towards solar projects that are either operating or in construction or in late stage development and have mitigated the anti dumping issues. We just discussed.
Lastly, our sustainable infrastructure pipeline continues to present opportunities in environmental restoration transportation Standalone stores and renewable natural gas now.
Now I'll turn it over to Jeff L to detail our portfolio performance and financial results.
Thanks, Jeff summarizing our first quarter results on slide six we recorded distributable earnings per share of 52 cents had a strong quarter of distributable net investment income of over 42 million and recorded a gain on sale of approximately $22 million.
On a year over year basis, we continue to demonstrate substantial growth in our distributable net investment income and steady realization of gain on sale fees as our dual revenue model continues to bolster our distributable E. P. S.
In the upper right, we know distributable EPS year over year growth was 21%, resulting from growth in both equity method investment income and interest revenue.
In addition, as shown on the lower right our gain on sale from securitized assets for the first quarter was $22 million, representing an 8% increase year over year.
Lastly, distributable net investment income was over 42 million in the first quarter, reflecting year over year growth of 41% driven by a larger portfolio and ongoing strong margins.
Our net investment income is expected to grow each quarter as we add assets to the balance sheet, providing ongoing stability and visibility into our future earnings growth.
Therefore, we are affirming our guidance of 10% to 13% compound annual growth in distributable EPS through 2024.
Turning to slide seven we detail our $3 $7 billion balance sheet portfolio as of the first quarter of 2022, which has grown 28% from $2 9 billion over the last year.
Our portfolio now includes over 320 investments across eight asset classes with a weighted average life of 18 years.
With no asset class comprising more than 30% of the portfolio. The diversity of our business remains a strength, particularly in a period in which certain asset classes are more impacted by the aforementioned macroeconomic trends.
Our forward looking portfolio yield at quarter end was seven 3% down from seven 5% at year end.
This reduction was primarily the result of a change in distributable earnings accrual rates for two grid connected projects due primarily to congestion in the southwest power pool, which resulted in a modest reduction of our long term IRR expectations for these investments.
These investments continues to perform within our expectations and the grid connected portfolio will likely benefit long term from higher natural gas prices.
Consistent with the past several quarters, our overall portfolio continues to perform very well with 99% of our investments performing within our expectations.
Yes.
Turning to slide eight we detail our Q1 portfolio reconciliation we've.
We funded over $160 million of investments, resulting in portfolio growth of 5% from year end.
Funding expectations of previously closed transactions as shown on the right with over $675 million expected to fund through the end of 2023.
To be clear the amounts in this table reflects closed but unfunded transactions and are entirely incremental to the portfolio growth, we expect from our greater than $4 billion pipeline.
On slide nine we highlight our successful offering in April of $200 million of carbon count exchangeable notes.
These notes carry a coupon of zero percent and mature in 2020 five.
The investors have an option to either exchanged and that's for stock at a 32 and a half per cent premiums subject to dividend adjustments, which at closing was $56 54.
Or receive accreted principal at 3.25% per annum at redemption.
Given the volatile capital markets backdrop, we are pleased with the terms of this financing.
We also issued $50 million of equity in the quarter at an average price of slightly above $48 per share.
With cash proceeds from the notes and the shares combined with availability in our credit facilities and C. P program. Our total available sources of liquidity increased to greater than $930 million.
Yeah.
We have no material debt maturities until 'twenty 'twenty five as we continue to manage our market risk by utilizing modest leverage ladder debt maturities and diverse funding sources.
Turning to slide 10, we reiterate our management of interest rate risk, which is not unique to our business and we take this risk very seriously and our enterprise risk management processes.
Our investment portfolio of over $3 7 billion is comprised of fixed rate loans and equity method investments with yields that are largely unaffected by changes in interest rates.
Combined with our debt, which is 96% fixed rate our existing balance sheet is largely insulated from near term changes in interest rates.
The chart on the left demonstrates our historical ability to actively manage our interest rate risk and grow distributable earnings.
Since 2014, our first full year as a public company, neither the level of rates or the shape of the yield curve as meaningfully diminished our ability to grow earnings.
This is in part because we actively manage our balance sheet and securitization program to maximize our ROE, which was 11, 5% in Q1.
The graph on the right shows our margins had been maintained as our yields have been steady despite a competitive investing environment, while our cost of funds has decreased.
Earlier, our yield is a bit lower this quarter, but our margins continue to be strong as our interest expense as a percent of our average debt balance continued its downward trend in the quarter.
Given current market conditions, we expect incremental term debt issued in 2022 would likely be above our current cost of debt.
However, we expect our aggregate margins to remain relatively consistent and sufficient to achieve our guidance.
We also expect these margins will facilitate continued strong growth in net investment income.
Finally, I would note our securitization strategy has functioned well during our 40 year history, including and much higher interest rate environments. So we remain confident that we can continue to utilize this source of capital as part of our funding and market risk strategies.
In conclusion earnings growth remains robust our guidance is affirmed and our market risk and capital market strategies remain sales.
With that I'll turn the call back over to Jeff.
Thanks, Jeff Great job.
Turning to slide 11, we continued efforts to improve the carbon count methodology, and we're pleased to be recognized by fast company for our innovations and climate solutions investing.
On the social front, our foundation advanced several climate justice initiatives, including efficiency upgrades for nonprofits advil and advancing our climate core fellow program funding of resilience hubs in Baltimore and supporting an online climate Education Library.
Finally, we encourage you to take a deep dive into our 2021 impact report, which includes many new disclosures and details on the progress of our various ESG initiatives is now posted on our website, along with our new and improved proxy.
We will conclude on slide 12.
There's three reasons. We think this is a fantastic business first over our nine years as a public company. We've demonstrated that our dual revenue business model continues to grow earnings in a variety of macro environments, and we're well positioned to continue that growth into the future.
Second our commitment and credibility and ESG attracts and retains the best talent committed to making a positive impact leading to high employee retention, which in turn improves our operating leverage and our ability to solve client problems a direct benefit to shareholders.
Finally, our pipeline of climate solutions investment opportunities as large and growing.
The growth is driven by the twin priorities are addressing climate change, while improving our national energy security and enormous addressable market for years to come.
With that I'll ask the operator to open the line for questions.
Thank you.
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One moment, please while we poll for questions.
The first question comes from the line of Mark Straws with J P. Morgan. Please go ahead.
Yes, good afternoon, and thank you very much for taking our questions. Just wanted to go back to your comments about the the yield coming down a little bit.
It was kind of what drives that how do we reconcile that with just kind of generally increasing PPA rates across the space and then how should we think about that over the near future.
Thank you Chad.
Sure. So thanks for the question Mark we tried to highlight it was a little bit different dynamic this quarter. It wasn't a function of new assets coming on the balance sheet. It was strictly strictly a function of the congestion and S. P. P are causing us to lower the irr's on on a couple of investments and that served to.
<unk> reduced the overall portfolio yield, but I think the trend long term AR should be that these higher PPA prices and higher interest rate environments should gradually result in a higher yield over time. It was a unique a dynamic this quarter that we wanted to highlight.
Okay.
And then the comments about.
Participating in the common equity investments.
Can you go into more detail there or is that kind of across your portfolio or was that in one particular sucks subsegment.
And does that require any kind of change to your.
Your existing partnership models that are that have been existing for for many years now.
So mark over the years, we've what and when we went public we are explicitly said that we would invest in the common equity and in these assets over.
Over the years, we've not exactly found those returns to be all that compelling.
Thus, we structured things more as a preferred if you can't get the return don't take the risk and that's been our philosophy, but now we see the potential.
With five and $6 gas persistent AR and our view for quite a while as.
Renting some opportunities, but the fundamental principle as we can.
We don't want to make any investment where we don't get paid for the risk, but we're not unwilling to take risk. If if we feel we're going to get paid for it.
Okay, and we don't have to make any other changes in our business model or anything.
We actually havoc in you know pure equity and some things are relatively small, but it's not a not a.
Any kind of a change to the business.
Okay very helpful. Thank you.
Thank you.
Okay.
Thank you. The next question comes from the line of Chris Souther with B Riley. Please go ahead.
Hey, guys. Thanks for taking my question here I, just wanted to talk a little bit about the actions in the quarter.
The pipeline could you talk about.
Okay.
This quarter.
Yeah based on the balance sheet growth.
Yeah.
Yes.
Mostly behind the meter stuff that you'd be securitizing, but wanted to see if there are any other segments that weren't captured there and then.
It's kind of a shift in the pipeline, reflecting any challenges you're seeing on the utility grid.
At all.
So we highlighted in the carbon con section two solar projects, one a behind the meter one grid connected so there clearly were solar projects, we didn't call out any other projects. This quarter and you said the shift in the pipeline I don't really see where our pipeline shifted that much.
<unk>.
We did talk about the impact on solar as being something we might see in six to nine months, but that it would be manageable.
Some deals you know as happened has happened every quarter move a move out in time.
It's there's nothing no real big change in the in the pipeline, Jeff anything you'd add to that.
You covered it.
Yeah.
Okay, and then looking at.
I guess yeah.
The elevated.
Receivables held for sale that kind of an indication that securitization.
It's something that we should be expecting kind of a larger number in the next quarter I don't think I've seen you guys break out a number that high since you started kind of breaking that out. So I'm just kind of curious if you could talk about that at all.
Sure So Chris I wouldn't read anything in particular into that it just means we had some assets on the balance sheet at quarter end that we intend to securitize.
Sometimes the timing is such where we closed in one quarter and securitized in the next and in those instances, we do have the held for sale.
<unk> bucket, a little higher than in other quarters, we essentially skirt ties everything we intend to in the held for sales virtually zero. So.
It's sort of a business model or trend issue I would not read anything into that.
Okay I appreciate it thanks guys.
Thank you.
Okay.
Thank you. The next question comes from the line of Ben Gallo with Baird. Please go ahead.
Good evening, guys could you talk about Hey could you talk about the electricity prices in Ppas.
Just how quickly it flows through.
On both the utility side and then on the residential side and then also does it open up other what other opportunities does it open up because of higher electricity prices would be other asset classes out there.
Typically haven't played in.
And I'll leave it there thank you.
Thanks Ben.
You know I think there are two kinds of developments are those that have revenue contracts that can't be changed.
And that lead to a small or even negative development fee for the sponsors.
Those are tough, but those are tremendous wake up calls to the sponsors that the next deal needs to be priced better. So I think it's been a rather instantaneous.
Yeah, well you know as soon as you figure out you have a negative development for you you figure out that is not very fun in your next deal better be better and I think that we're seeing that with.
Distributed solar we're seeing it with.
Grid connected solar and some contracts are getting renegotiated and and modified so I I don't see this as a particularly long lead time item.
No because the industry doesn't have a whole lot of choice, but to do it.
With respect to higher utility prices. That's a great question, we're certainly seeing an uptick in efficiency inter.
Interest in and.
It's you know the economics were in the money before now they're even more in the money.
But you always have a.
Kind of a hedge in energy efficiency, where you've smoothed out the cost of your electricity.
And now people are realizing that the natural gas portion of that price is going up and even the demand charges are going up way better to to conserve so I don't know that it's going to take us into new and exotic technologies.
But more of what we've been doing would be a terrific.
Yeah.
Thank you.
It won't take us too exotic technologies out guarantee that.
[noise].
Thank you.
The next question comes from the line of Julien Smith with Bank of America. Please go ahead.
Hi, guys. This is stepping in for Julien.
So first off I just wanted to ask on the.
Just following up on that.
Portfolio increase then.
Do you mind 79, this quarter and I know you mentioned that the yield declined.
Due to that transmission congestion in basis, but are there any other moving pieces. There I'm just curious on those new additions to the portfolio what kind of impact did those have on the yield.
And are you seeing yards.
It's really flat.
Can you just discuss based on PPA prices going up maybe could you just talk a little bit about that.
Sure on yet so.
As we noted we added 160 million to the portfolio in the quarter and the portfolio is $3 7 billion. So I think the new editions themselves had virtually no impact on the overall portfolio yield just given the math there.
You know I think as a general trend.
As we mentioned earlier as part of Ppas rising inflation interest rates are we're certainly looking to achieve a higher yield on the portfolio as a trend.
Then we had previously and we're optimistic about that trend.
Okay, great. Thanks, and a follow up could you maybe discuss the progress on the co investment.
We're very excited about.
I guess on that on development delays on that investment at this point.
To provide an accurate.
And then I'm, sorry, that'd be helpful.
So what have you.
Right.
I'm not sure we can provide any color there are they're working hard at it and it's a great group that will.
Get those projects developed.
I'm sure they've got a million headaches that we frankly don't know about and that they're managing them, but you know there are every bit as incentivized as anybody in the transaction to get it done so.
No no real color on you.
Okay. Thanks could you also actually provide.
Nathan Andy Energy efficiency opportunity, you just mentioned right now.
Have you seen a pickup in interest already at this point and.
Just how are you looking at that right now just given the dynamics in.
The market today.
Maybe this is me being optimistic but.
I can't believe this.
The increase in utility rates and gas prices doesn't lead to.
An increase in efficiency I may have spoken a little more optimistically it absolutely should on yet.
Well, we'll see.
Great. Thank you I'll jump back in the queue.
Thank you.
Thank you.
The next question comes from the line of Milwaukee with Oppenheimer. Please go ahead.
Good afternoon. Thanks for taking the questions are first one around transmission bottlenecks and.
Potential opportunity.
When we look at the report that Lawrence Berkeley put out at the end of 2021 I think it showed.
Over a terawatt of solar storage et cetera are in the interconnection queue and you.
Even if we assume only 15% to 20% of those projects get built it just seems like the transmission issues will get worse and.
And that may be a solvable problem and something that you can participate in so can you talk a little bit about opportunities are that you may have on the transmission side or in supporting sustainable infrastructure.
Or generally how you think about these congestion issues affecting your opportunity set.
I would say no that our clients are working very hard to.
The produce.
The transmission solutions, but that's never been a short term business never a short term fix we are seeing them add storage or add solar to wind to try to offset some of the impacts.
No. It's it's it's not a not a quick fix.
Some of the utilities are working on it theyre incentives, maybe a little out of alignment with ours, but.
It's it's absolutely got to get fixed.
Okay.
The real fix for it though.
[laughter] alright, well you know to be continued but I think a couple of folks have been asking this question a couple of different ways, but I just wanted to see if we can take a shot at it we're in the markets do you see.
The higher energy prices, most clearly accelerating the sales cycle and I Wonder if you could touch specifically on.
The types of projects that historically have had long development.
Development cycles like the P three investments.
I'm not sure that we would be able to speak to sales cycles by asset class, but you know anybody who's open up their electric bill is set by them.
This is higher than I thought it was.
And it particularly with the additions to the rate base that have been added and by most utilities and it's it's not an easy number to take in a monthly bill.
So what we see primarily now what are the economics are even better for residential solar for C&I solar with storage for energy efficiency.
That and that you know.
Typically we're all economic animals and that should provoke more more business, but we really couldn't say, which asset class might be moving the fastest.
Okay. Appreciate it thank you.
Thank you thanks.
Thank you. The next question comes from the line of Nate Crossett with Aaron Berg. Please go ahead.
Hey, good evening.
Couple of questions first one just on competition just with rates rising have you seen any change in the players that you would normally compete against them.
It turns out they just.
You know their ability to compete for deals and higher funding costs and then maybe you can just kind of.
Go through your funding needs for the rest of the year. It sounds like the pipeline continues to be pretty strong. So how should we think about fund.
Funding that and it looks like he just recently did that Green exchange a senior note deals should we expect disease and more things like that.
Yeah.
So on competition I don't think we've seen.
Too much change.
Most of the new entrants.
<unk> really are not investing in the asset level, they're actually investing in.
At this I'll answer level in new sponsors, particularly two to create development platforms. That's not an area, where we want to be we like like to fund our clients not create competitors to our clients.
But you know there's always a new entrant every quarter, we've we've not seen before and then somebody exits, but it's not a.
Significant change in the competitive profile.
And on the funding platform will continue to use the diverse sources of capital in our in our Arsenal that we've developed.
As we've noted we have substantial dry powder on the credit facility.
We'll probably lean on that a little bit if we're successful converting on a significant amount of the pipeline you should expect us to do a term debt deal at some point this year and will be a relatively consistent issuer on our ATM as well and we will also continue to actively securitize certain assets. So.
The core diverse funding strategy that we've used historically.
Probably all of those sources will get tapped this year.
Okay.
And just maybe one on the portfolio yield is seven three like are you guys kind of articulating that that the lowest we would see this year or.
I guess, how do you see that trending I know you had some longer term comment but is this kind of like a bottom tick quarter in that sense.
We're not saying that specifically I think what we really wanted to highlight was it was not.
New investments that are caused portfolio yields ticked down in the quarter. So we just wanted to make that point.
It's not necessarily a low point for the year, there's a lot of dynamics. There for instance, the securitization activity and taking things off balance sheet are key.
Clearly itself impacts portfolio yield which transactions, which.
Which investments pay off a little bit faster than others effects portfolio yields. So there's a lot of dynamics are in that number. So we're not we're not prepared to say specifically this is the low point of the year.
Okay I'll leave it there thank you.
Thank you.
As there are no further questions. This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation.