Hydroelectric Power Stations For Zero Down And No Monthly Payments
Is it possible to buy an income trust with no money down and still own it free and clear in less than 7.5 years?
While browsing the Standard & Poors and DBRS rating pages looking for income trusts with strong stability ratings, I came across the power utility trust, Boralex Power Income Fund, which is rated SR-2(stable) and STA-2(low) respectively. You won’t find the typical income trust suspects. The fund doles out distribution using internal cash flow without eroding balance sheet (debt/equity = 0.30) or diluting share count. They own 10 power stations in Quebec and the state of New York:
- 7 hydroelectric power stations (51% of total output)
- 2 wood residue (33%)
- 1 natural gas-fired cogeneration plant (16%)
These power stations have amazing longevity with a couple dating back prior to the First World War. Furthermore, each station has power purchase agreements ranging anywhere between 20 and 40 years. As long as water continues to flow on rivers and population continues to grow, Boralex will continue to electrify investors’ bank accounts. Isn’t this a simple antidote in an investment landscape whipsawed by assets-backed commercial papers and recession chatters?
The strong stability does come with a handicap, however; the trust has virtually no growth prospect, which is why a cheap entry price is so paramount. The trust traditionally trades between $9 and $10, and despite hovering around $9 recently, the 10% yield was simply not up to snuff to justify the lackluster growth. Not being deterred, I shelved the trust onto my watch list just in case bargain surfaces.
Lo and behold, the trust has since been constantly banging at my door screaming, “new 52-week low!” Even the Financial Webrings forum is picking up on the story.
Not wanting to pass up a good opportunity, I raided half a position on Friday at $6.60. You ready for this? With its annual distribution at 90 cents, the trust is yielding a generous 13.64%! Not only that, most of the distribution is in the forms of return of capital and dividend, and with only a ninth in income, the distribution is practically tax-free. Even with no distribution increases, the trust’s compounded return will still eclipse the broader market. In case you’re curious, I mortgaged my water dams with a margin loan, but this is more lucrative than buying a Vancouver property with no money down. Just for fun, I calculated it’d take 7.5 years to wave farewell to the mortgage without forking a single dime. That’s assuming a marginal tax rate of 30%, and a tax-deductible 6.25% interests from Interactive Brokers.
So why is the trust being punished? The answer likely lies in the unfavourable hydrology in the 3rd quarter. Hydrology is fickle science. Due to unusually low water level, their hydroelectric segment generated 22.8% less than historical average, even though that’s only for one quarter. It was only a year ago when the water current was exceptionally strong, while year-to-date, the segment is down only 6%.
In my opinion, investors are unjustly extrapolating this poor quarter well into future return.
The water dams look the same, smell the same, sound the same, and feel the same as yesterday, a week ago, a month ago, 10 years ago and will likely remain the same decades into the future. The only difference is they’re 40% cheaper than the 52-week high. Moreover, these hydroelectric stations represent only half the eggs in the basket. The other half is humming along just fine; the 2 wood-residue thermal power stations and a natural gas-fired cogeneration plant have revenues steaming 7.5% and 20.0% higher respectively.
Having said that, there is no free lunch here. The production isn’t guaranteed, and we don’t know if the 2011 income trust tax ruling will choke cash flow. In my opinion though, as long as the trust is held outside of RRSP, the after-tax distribution shouldn’t change much, but I won’t go into the math here. Since power trusts are generally considered stable and boring, coupled with Boralex’s conservative balance sheet and high ratings from S&P and DBRS, I feel the distribution is safe, and the higher yield offers a margin of safety in a rare event of a distribution cut.
Interesting find…I was aware of BLX as a utility, but with the trust trading right around book value, its an interesting investment. I might have to take a good look at this one, thanks JG :)!!!