With the new administration in Washington, the United States is expected to shift more aggressively toward renewable power. That's great news for companies like Hannon Armstrong Sustainable Infrastructure (NYSE: HASI), which invest in the space. But is that enough to make this real estate investment trust (REIT) worth buying? Here's what you need to know.
A global shift
There's no doubt that the world is largely looking to reduce the amount of carbon it produces. That has huge implications for the way power is produced, stored, and consumed. REIT Hannon Armstrong is looking to ride along this giant, long-term trend by owning clean energy assets.
At this point, the portfolio is broken down roughly 60%/40% between what management calls behind-the-meter (distributed solar, storage, and energy efficiency) and grid-connected assets. Hannon Armstrong has around 200 or so investments within its $2.2 billion portfolio. The average contract life on those investments is roughly 16 years, meaning it has more than a decade of steady, growing cash flows ahead.
Meanwhile, the REIT has a robust pipeline of new projects as it looks to keep growing. At the end of the third quarter of 2020, management pegged its future growth spending at $2.5 billion. The breakdown of that spending was across the behind-the-meter (62% of the total), grid-connected (27%), and sustainable infrastructure (11%, comprised of things like stormwater remediation and ecological restoration investments) segments of its business. That last category only makes up 1% of Hannon Armstrong's portfolio today, little more than a rounding error, but it could become more material over time. And all of that spending is expected to fall within the next 12 months or so.
Making things even more attractive is that the REIT appears to have ample access to cheap capital. That includes bonds, where Hannon Armstrong was recently able to issue debt with a modest 3.75% interest rate and convertible bonds with a 0% coupon. And it includes stock, with shares up roughly 230% since mid-March 2020. This should keep financing costs low and help support all the growth investments in the pipeline. But it also exposes the big problem here.
You need to put Hannon Armstrong's share price gains since mid-March into perspective. The S&P 500 Index was up about 55% over the same span. In fact, Hannon Armstrong's gain was roughly in line with that of Zoom Video Communication (NASDAQ: ZM), which advanced 257%. The average REIT, using Vanguard Real Estate ETF (NYSE: VNQ) as a proxy, was up just 30% or so. To sum it up, Hannon Armstrong is being treated like a high-growth technology company by investors. But, in the end, it's just a real estate company.
The dividend is the true tell-all here, given that Hannon Armstrong is offering a scant 2% dividend yield. The average REIT yields 3.9%. Hannon Armstrong's yield is near the lowest levels in its history and well below its recent range, which had been trending between 5% and 7% for several years.
Investors have taken to these shares in a very big way. Looking at valuation another way, the REIT's P/E ratio is over 40 (Hannon Armstrong provides earnings, not funds from operations like most REITs). That's a number you'd expect from a technology company, not a REIT -- which are by design meant to pass income on to shareholders in a tax-efficient manner.
In fact, REITs are generally considered to be boring dividend stocks. But Hannon Armstrong is anything but boring, and the income it offers today is paltry. Which brings up an interesting comparison. A couple of years ago utility The Southern Co. (NYSE: SO) pulled away from investing in renewable power because it thought the project yields were too low and counterparty risks increasingly too high. In other words, competition for investment in the space had tilted the risk/reward profile in a negative way. The logic at Southern was that it's a conservative, income-oriented investment and that the renewable power space no longer matched up with that. It seems like a REIT might be viewed in a similar way.
Take a deep breath
Investors looking at Hannon Armstrong should keep Southern's call in the back of their minds. The REIT is an interesting way to invest in renewable power, but investors are pricing in a lot of good news. This doesn't look like a good choice for conservative types today, particularly those with an income focus.
And even growth-oriented investors should be cautious after the massive stock gains here. To buy Hannon Armstrong at recent price levels, you need to believe its growth will continue to be strong for a very long time into the future. If investors begin to doubt that story, meanwhile, the stock is likely to fall. All in, this looks like a REIT for the wish list but not the buy list right now.