A couple of months ago, I wrote about one of my favorite high-yield securities that most investors have no idea exists.

I’m talking about yieldcos.

Originally created as a nifty way to reduce funding costs and increase the appeal of renewable energy projects to investors, this a special class of securities that bundles the steady demand of a power utility with stable cash flows.

Right now, yieldcos have been hammered by rising rates. And that’s setting up a rare opportunity to lock in some sky-high yields, which is why we’re doubling down over at High-Yield Investing.

We’ll get to that in a second. But first, let’s recap yieldcos for newer readers who may not be acquainted.

Yieldcos: The Basics

Think of yieldcos as similar to a master limited partnership (MLP) or real estate investment trusts (REITs). Both throw off high levels of tax-advantaged income. But instead of oil and gas pipelines, or real estate, yieldcos own renewable power plants.

Yieldcos sell the electricity output from their wind and solar plants to utilities under power purchase agreements (PPAs). These offtake agreements are often in force for 20 years or more, providing steady, recurring income. And they are generally based on volume rather than wholesale electricity prices (just as pipeline tariffs are insensitive to fluctuating commodity prices).

Yieldcos always have a larger parent (or sponsor) that maintains an equity ownership interest. The sponsor typically bears the expense associated with constructing these costly plants. Once operational, they are “dropped down” to the yieldco. From there, variable operating expenses are minimal – the sun and wind do most of the work. And with electricity buyers already lined up, yieldcos haul in predictable, low-risk cash flows.

It’s usually a win-win for everybody.

If you’re interested in the finer points of this structure (including the tax benefits), you may want to review my previous article. But just know that because their assets are depreciated over time. So some yieldcos won’t owe a penny in federal income taxes until well into the next decade.

This not only allows for larger dividends, but they also reduce your cost basis. And when you sell, you’ll likely only have to pay the long-term capital gains rate rather than your ordinary income tax rate.

My Favorite Yieldco

My favorite yieldco, NextEra Energy Partners (NYSE: NEP), recently hit a new 52-week low. After briefly stabilizing near $60 in May, the stock nosedived to near $20. That fully erased what had been nice gains.

Backed by NextEra Energy (NYSE: NEE) and its $100 billion market cap, NextEra Partners was created in 2014 and endowed with a large collection of wind and solar power-generating assets. The output from those plants has been pre-sold under contract to dozens of creditworthy utilities and industrial users.

At the time of my initial recommendation, NEP had just purchased six new wind and solar plants from its parent for $1 billion. The electricity from these facilities was already contracted out and stood to generate approximately $100 million in incremental annual cash flow. That’s a healthy cash yield of around 10%.

And there have been more of these lucrative drop-downs since. The portfolio has expanded nine-fold since inception to 10,000+ megawatts, making NEP the world’s seventh-largest producer of clean, renewable energy.

So what’s the problem?

What’s The Deal?

For starters, the relentless surge in Treasury yields has decreased investor appetite for utility stocks. Due to the fixed income nature of regulated utility operations, this rate-sensitive group often behaves like bonds. With risk-free yields rising to 4.8%, the 4.7% payout on stocks like Duke Energy (NYSE: DUK) has recently lost some of its appeal.

But that’s only half the story.

The bigger issue is that corporate borrowing costs are on the rise. And yieldcos depend heavily on debt-fueled growth. Between that and falling share prices (a devalued currency), purchasing new projects from sponsors is getting harder.

NextEra Energy Partners is no exception.

As recently as May, NEP was still targeting 12% to 15% dividend growth through 2026. With Cash Available for Distribution (CAFD) forecast to run at an annual pace of $815 million, annualized dividends were expected to climb from $3.25 to around $3.70 within the next 12 months.

Unfortunately, in light of current conditions, management is now tapping the breaks. The optimistic 12%-15% growth forecast over the next few years has been adjusted to a new range of 5% to 8%.

Here’s how CEO John Ketchum sums it up:

“Tighter monetary policy and higher interest rates obviously affect the financing needed to grow distributions at 12%, and the burden of financing this growth has had an impact on NextEra Energy Partners’ unit price and yield. In the current market environment, the partnership believes revising its growth expectations for now is the appropriate decision for unitholders and better positions it to continue to deliver long-term value.”

NEP Looks Like A Bargain Right Now

I’ve seen companies slash their dividend in half with less punishment. And this isn’t even a cut, simply a deceleration from the previous 12% growth to around 6%.

Remember, even with zero growth, the current annualized distribution of $3.42 already represents a market-topping yield above 14%. With a market cap of $2 billion, the entire business is currently valued at less than three times next year’s projected cash flows of $775 million.

NEP is also selling for less than half its book value.

Some of that discount stems from creative but convoluted convertible share financing arrangements on the books. The market generally prefers simplicity and transparency. To alleviate the situation, management has recently sold off some non-core assets. It is using the proceeds to eliminate these obligations. That will clean up the capital structure while also eliminating the need for near-term stock issuance.

Both should appease the market.

Closing Thoughts

I’m not too bothered about stalled acquisition activity. The company already has enough on its plate right now. Further dropdowns will resume once financing costs are more favorable. When interest rates finally moderate, the renewable energy sector (and NEP in particular) will regain favor.

Until then, I am taking advantage of this overreaction. So we added to our long-term position over at High-Yield Investing.

In the meantime, if you’re looking for more high-yield ideas, then you need to see this…