By Alex Messick (UCLA) and Rachel Hill (University of Glasgow)
Overview of the Deal
Hannon Armstrong is a major lender of capital to sustainable companies and projects that tackle climate change. In August, Hannon Armstrong issued $375m of 3.75% unsecured notes maturing in 2030 and $125m of 0% convertible notes to mature in August 2023. The Company’s expansion holds the prime objective of using the raised capital to invest in companies that have the intentions to produce zero or negative Carbon Emissions, in line with satisfying the Green Bond Principles of the International Capital Market Association (ICMA). Furthermore, Hannon Armstrong seeks to utilise their raised capital in short-term investment into securities. Hannon Armstrongs stock has since been strong, and has been outperforming the market as their $2.1bn balance sheet portfolio has held onto momentum despite market conditions.
Macroeconomic Trends
Hannon Armstrong’s most recent bond issuance and entire business model lays testimony to ESG’s rising prominence within finance as a viable investment driver. With the Global Pandemic propelling both client awareness and demand for products attuned to ESG, markets have undergone a remarkable shift. Nearly a third of fixed income investors foresee environmental issues impacting corporate bond yields/spreads by 2022, while 1 in 5 claim it's their “fiduciary responsibility” to integrate ESG within their playbooks. Today, sustainable investment products are being popularized not only by client demand, but also as a risk management tool and even as an “impact alpha” generator.
Just as Hannon issued a record $900m green bonds in 2020, global issuance reached a milestone of $1 trillion in total issuance to date back in September. Yet, green bonds represent only around 2% of fixed-income assets today, thus presenting an immense long-term growth opportunity. Despite the historic lack of U.S. regulatory pressure incentivizing sustainable activities relative to the EU’s robust efforts, the states lead the green convertible market. Hannon exemplifies this trend, as three of their six major deals since 2018 occurred in the U.S. However, under a new Biden administration, sustainability within American finance and society are expected to see immense tailwinds. On his first day as president, Biden committed to rejoining the Paris climate accord while signing an executive order several days later which put “the climate crisis at the center of United States Foreign Policy and National Security.”
Finally, the rise in green bonds and ESG investing has come with the increased need of businesses adopting science-based targets and recurring disclosure. 90% of S&P 500 index companies have clear ESG targets and specific annual reports as ESG focus becomes more progressively marketable given consumers increased environmental awareness. Furthermore, the rise of sustainable investments has had a widespread market effect with around every one in three dollars invested in the U.S. economy calculated to be backed by an aspect of the sustainable ordinance- equivalent to over $17 trillion. Thus, as the MSCI Global Green Index has already experienced a record $300 billion in growth over the past 5 years without U.S. regulatory aid, newly invigorated American policy will ensure ESG and sustainable investing’s trajectory are bound to continue surging.
Figure 1: Green Bond Issuance and Growth (ClimateBonds)
Company Details
Hannon Armstrong invests in pioneering companies dedicated to sustainability, efficiency and solutions to climate change. Originally formed in 1981 as Eden Hannon Goodwin & Company the Company made their first renewables deal in 1987 setting out for their path into green solutions.
The U.S. company is the first of this type, managing $6.2bn of assets as they focus on energy storage, sustainable infrastructure and both onshore and offshore renewables in their diversified portfolio.
Founded in: 1981
Headquartered in: Annapolis, Maryland, United States
CEO: Jeffrey W. Eckel
Number of Employees: 60
Market Cap: $5.18bn
TTM Revenue: $95.48m
Bond Details
Figure 2: Current Capital Structure
Figure 3: Bond Structure
Figure 4: Credit Ratings of Hannon Armstrong (Figure-2-Hannon Armstrong))
Fitch and S&P both rate the Company’s unsecured notes and convertible notes BB+ reflective of the stability of Hannon’s credible record and their increasing portfolio diversity.
Projections and Assumptions
Why was this deal done?
Hannon Armstrong's commitment to backing 'climate change solution' projects fuels their bond deal. With the primary objective to use their net earnings in the process of securing or recapitalizing green projects. Furthermore, Hannon Amstrong seeks to back short-term securities that hold interest in the ability to be taxed and filed as a REIT. ICMA’s Green Bond principles aim to direct investment into focus on green impact and pressurize for the availability of information to encourage green investment. The Company assesses selection based on the ratio of the Carbon volume that has been to or will be able to be omitted through the impact of the investment by the investment necessary to have such effect.
The market conditions induced by COVID-19 have had minimal impact on Hannon’s position in comparison to those of other markets as after the initial pandemic hit in March Hannon have been able to maintain stable growth since, as Fitch regarded the Company to be “relatively well-positioned”. The raised capital allows for the Company provision of the increased room for manoeuvre as the ramification of COVID-19 remains to have a wider impact on delaying the speed of processing projects and the increased costs that would otherwise cause issues for reserves and liquidity.
Short & Long-term Analysis
The company’s $375m unsecured senior notes (which were upsized from an original $350m issuance) and $125m convertible notes were followed by two new expansions in their clean energy portfolio. The first was an extension of Hannon’s pre-existing partnership with multinational utilities company, ENGIE. In a joint investment with ENGIE, Hannon invested in a 70 MW solar and solar storage portfolio in early December. Later that month, the company committed a preferred equity investment in Clearway Energy Group, one of the U.S’s largest renewable energy ventures. With $200M of funding already deployed, the investment represents nearly 1.6 GW worth of collective on-shore wind and solar development.
While both respective projects bind Hannon to provide further funding through 2021, the firm anticipates each to generate healthy recurring cash flows. Furthermore, Hannon Armstrong’s 44% GAAP EPS growth YoY and strong financial performance indicates the firm is well positioned to cover the 3.75% interest expense in the short run.
The company recorded an unprecedented year, with stock growing nearly 106% during 2020. Whether this acceleration carries over into 2021 is of much debate, but the change in the U.S. Presidency surely bodes well for the firm. With a new target of reaching an 100% American clean energy economy by 2050, investment opportunities in renewables are projected to rise substantially. With solar now widely constituting the cheapest form of energy, companies like Hannon Armstrong who carry heavy weighting in this renewable, can be expected to capitalize off of this growth the most. With potential regulatory and legislative tailwinds, geopolitical and societal trends toward investing in renewables represents an immense opportunity for Hannon’s continued involvement in such energy projects.
Financial Ratio Analysis
Figure 5: Hannon Armstrong Financial Ratios
Hannon Armstrong has been seeing consistent growth in profitability as reflected by its increasing returns on assets and equities. This should provide future equity and debt investors assurance that Hannon is able to efficiently cover future capital raises.
While the company’s operating cash flow ratio has recently fallen below 0, thus indicating the firm is not able to cover its current liabilities with its cash, the LTM figure of 0.9 is still within a comfortable range. Furthermore, a low ratio may be partially reflective of Hannon’s recent capital intensive investments in renewable energy portfolios and funds.
Though Hannon’s business model is fairly unique for a registered REIT, when spread against the real estate industry, it’s high debt-to-equity ratio is actually fairly conservative when compared to the industry average of around 352%.
The near 65% YoY EPS growth rate has rallied a hefty premium on the firm, as illustrated by the stock price surging 97% within 2020.
Risks and Uncertainties
While market and geopolitical trends bode well for Hannon Armstrong, the firm’s high debt-to-EBITDA and low interest coverage ratio present the risk of the firm being overleveraged. While REITs are known to take on higher levels of leverage to fund long-term growth and investments, Hannon’s near 15x debt-to-EBITDA ratio is nonetheless alarming. Given the company’s unique business model, there aren’t many true public comparables to help contextualize this figure though. With an interest coverage ratio of 1.4x, it’s clear that regardless of comparability, a disruption to Hannon’s earnings would be detrimental given their current obligations and debt levels.
Additionally, despite alternative investments seeing a strong trajectory of growth, demand for oil is expected to rebound after COVID and labor market uncertainties resolve themselves. In this sense, investors in renewables may be underestimating the challenge of competing with pre-existing energy conglomerates as commodity prices begin to stabilize again in 2021 and 2022.