Hannon Armstrong Sustainable Infrastructure Capital, Inc. (NYSE:HASI) Q3 2023 Earnings Call Transcript

Hannon Armstrong Sustainable Infrastructure Capital, Inc. (NYSE:HASI) Q3 2023 Earnings Call Transcript November 2, 2023

Hannon Armstrong Sustainable Infrastructure Capital, Inc. misses on earnings expectations. Reported EPS is $0.0002 EPS, expectations were $0.53.

Operator: Greetings and welcome to HASI’s Third Quarter Earnings Conference Call and Webcast. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Neha Gaddam, Senior Director, Investor Relations and Corporate Finance. Please go ahead.

Neha Gaddam: Thank you, operator. Good afternoon, everyone and welcome. Earlier this afternoon HASI distributed a press release detailing our third quarter 2023 results, a copy of which is available on our website. This conference call is being webcast live on our Investor Relations’ page of the website, where a replay will be available later today. Some of the comments made in this call are forward-looking statements, which are subject to risks and uncertainties described in the risk factors section of the company’s Form 10-K and other filings with the SEC. Actual results may differ materially from those stated. Today’s discussions also included some non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is available on our posted earnings release and slide presentation.

Joining me on today’s call are Jeff Lipson, the company’s President and CEO; Marc Pangburn, CFO; and Susan Nickey, our Chief Client Officer. Susan will be available for the QA portion of our presentation. Now I’d like to turn the call over to Jeff, who will began on Slide 3. Jeff?

Jeff Lipson: Thank you, Neha and good afternoon, everyone, and thank you for joining the call. We had an outstanding quarter as measured by nearly every meaningful metric, and the business remains positioned for future success. Before we discuss the quarter, I’ll address an item of recent market perception. A sentiment has emerged recently which has been weighing heavily on stocks related to the energy transition. This perception assumes renewables and other clean energy sources are no longer economically viable due to the higher costs of capital, driven by the higher for longer outlook for interest rates and that this impact will cause a substantial slowdown in project development and deployment of clean energy. We believe this view is not accurate.

In fact, the energy transition is in its early stages and continues to grow on a steady long-term trajectory. Just this week, the American Clean Power Association reported record-breaking third quarter U.S. capacity installations and 10% year-over-year growth in the utility-scale wind, solar and storage project pipeline. Although not every project remains viable, clean energy demand remains elevated, and the levelized cost of renewable energy remains competitive or less expensive than the alternatives. As one example, the AI-driven build-out of data centers has created significant incremental demand for renewable electricity. Likewise, the higher cost of capital and other input costs are being passed on to the end user due to the ongoing growth in demand, particularly from corporate buyers with ambitious net-zero goals and utility off-takers.

These economic dynamics continue to validate our business model as a provider of capital to the energy transition. The energy transition is a long-term, non-cyclical macro trend, and our team is well-situated, enthusiastic and capable of continuing to work with our clients to meet the demands of this transition. Further evidence of the strength of our business model is in our third quarter and year-to-date results. We are reporting record quarterly distributable earnings of $0.62, record quarterly volume of almost $1 billion, and year-to-date total volume of $1.8 billion, which is similar to annual volume over the prior three years. In addition, consistent with our objective discussed throughout this year, we are reporting investment yield on new balance sheet investments year-to-date of greater than 9%, well above the expense of our incremental year-to-date debt, resulting in continued healthy markets.

These results and the outlook for the business allow us to affirm our existing guidance of 10% to 13% EPS growth and 5% to 8% dividend growth through 2024. As Mark will discuss, we have deployed a thoughtful, diverse and strategic capital plan in 2023 despite challenging markets. The $1.5 billion of debt and equity we have raised has resulted in a strong balance sheet and liquidity position and has allowed us to continue to operate the business with a strategic, long-term focus rather than under any short-term duress. This capital raising in 2023, coupled with the substantial investment volumes, has also situated the business such that we do not require incremental equity to achieve our guidance. We always have and remain focused on diversifying our liquidity sources, including our recent initiatives to develop incremental channels of off-balance sheet growth that we refer to as capital likeness.

Turning to Slide four, I would like to discuss how well positioned we are to achieve our EPS guidance in the range of $2.27 to $2.53 per share in 2024. In part due to our success in 2023, increasing the portfolio by $1.2 billion so far this year, we are well situated for earnings growth in 2024. In fact, we can attain the guidance level of EPS without any new equity issuance nor any new balance sheet investments. No incremental debt is necessary and our gain on sale and fees can be consistent with the annual levels over the past three years. Therefore, our path to achieving guidance has limited variables. Turning to Slide five, I believe a company should always have an executable plan to focus the organization. Our action plan in this period of volatile capital markets is displayed here.

General capital scarcity has provided an investment opportunity at even higher level of return than we’ve seen in 2023 year-to-date. The average yield of investments in the pipeline is greater than 10% and these are investments consistent with the risk profile of our existing portfolio. We intend to fund these new attractive investments with balance sheet rotation of seasoned assets and debt issued outside the capital markets. We also plan to expand our securitization program. We’ve utilized to fund $6 billion of investments off balance sheet. The final item in the action plan is to make further progress, executing transactions with private capital providers that allow us to continue investing, utilizing off balance sheet sources of capital.

All of our success in 2023, closing a large volume of transactions at an attractive yield has positioned the business to expand our capital aid initiatives at a reasonable pace. It is important to note that our company has a long history of executing on these action plan items. We have a demonstrated track record of adapting our capital and funding structure in a way that allows us to continue to actively invest and grow our earnings per share. Therefore, this action plan fits well within our comfort zone. Slide Six is a good summary of our year-to-date investment activity highlighted by our $1.8 billion of volume at an average yield greater than 9%. Notably, our fuels, transport and nature segment has been very active, producing 38% or over $600 million of the 2023 volume.

We remain very disciplined regarding margins and expect future investments to be at an attractive margin to our cost of funds. On Slide seven, our investment pipeline of greater than $5 billion is well diversified among non-cyclical and uncorrelated end markets. Customer demand for renewable power continues to drive more opportunities and higher PPA prices allow projects to pass on higher costs. As discussed earlier, energy transition assets remain economic and strongly preferred by many users due to climate goals and cost competitiveness versus alternatives. I will also reiterate that the return profile in these pipeline investments is well above our current portfolio yield and at a strong margin to our cost of funds. Now I’ll turn the call over to Marc Pangburn to detail our financial results.

Marc Pangburn: Thank you, Jeff. I’ll begin on Slide eight by summarizing our financial performance. Simply put, our third quarter and year-to-date execution continues to prove our adaptability to a rapidly changing macroeconomic environment. In the third quarter, we are reporting record distributable EPS of $0.62. We closed a record amount of new transactions at $973 million and these transactions were at record yields. Over the last year, we grew our portfolio by 41%, $5.5 billion and managed assets 22% to $11.5 billion. Continued growth of our portfolio translated to a 20% increase in year-to-date distributable NII to $160 million, meaningfully increasing our long-term recurring income. Amplifying Jeff’s comments earlier around our existing capital light activities, we also recorded $69 million of gain on sale, fees and securitization income for year-to-date 2023, reflecting an 8% increase year-over-year and a notable increase in our securitization income, which is now $13 million for the same period.

This included a balance sheet rotation where we were able to securitize an on-balance sheet portfolio of seasoned land assets at a gain. Turning to Slide nine, our portfolio yield increased for the second quarter in a row from 7.7% to 7.9%. Year-to-date, our yield on the portfolio increased by 40 basis points after being relatively constant for four years. In the third quarter, we funded $865 million. We anticipate funding additional commitments of $645 million through 2024. Year-to-date, our portfolio has grown at a record pace, $1.2 billion compared to a $700 million average over the prior three years and reiterating Jeff’s comments on the business mix, FTN has grown from 4% of the portfolio at year-end ’22 to 13% as of Q3 ’23, driven primarily by R&D.

I’d like to take a moment to reiterate a few common characteristics of our portfolio. We typically invest with some form of preference. Not only do we have preference, we also invest at the asset level. This creates a non-cyclical dynamic where changes in interest rates or client growth have minimal impacts on portfolio performance. It also mitigates corporate risk as the various service providers to projects can be replaced based on performance or disruption at the corporate level. Another common attribute of our investment profile is that we typically do not take development risk. We invest based on asset collateral when the economic value of any particular project has been established. Certain segments of the energy transition are more or less economic today.

For example, energy efficiency, solar and [indiscernible] continue to have strong viability and to briefly address recent industry news, we have no offshore wind in our pipeline or portfolio. On Slide 10, we’re pleased to report growth in margins due to faster growth in our portfolio yield at 7.9% compared to interest expense of 4.9%. We will continue our disciplined investing strategy of pricing new assets at a margin to our current cost of funds. Last quarter, we provided additional context to address questions on our 25 bond refinancing and 26 bond refinancing. As a reminder, the base rate for the expected bond refinances are currently hedged around 3%. Based on the market spreads updated for yesterday, the theoretical refinancing would result in a blended cost of debt of 5.7%.

While we continue to evaluate higher yielding new investment opportunities, even if we close no additional transactions, the spread would result in a greater than 11.5% ROE. Turning to Slide 11, our liquidity remains robust, and I’m pleased to provide additional specificity around our debt-raising activities. Starting on the top left, our liquidity is strong with a total of over $710 million of cash and undrawn revolver capacity. The total liquidity includes $165 million, which relates to an upsize of our unsecured Term Loan A, which was closed after quarter end. Our current leverage is 1.7%, which provides additional room to utilize debt to fund further portfolio growth while operating within our leverage target. 88% of our debt is either fixed or hedged, and the process around the REIT tax conversion is proceeding smoothly.

Now I’d like to highlight recent debt raises, all at rates well below our investment yields. Recently, we have upsized and extended a secure debt facility with a hedged interest rate of 6.9%, upsized our TLA, which carries a hedged interest rate of 6.5%, and issued convertible debt with a total cost of 5.6%, inclusive of an option premium to increase the conversion price. Looking ahead, an example of a path to attractively priced incremental debt, we expect to raise secured debt on our portfolio’s solar assets based on an expected rating of BBB minus. In the quarter, we raised more than $770 million of incremental debt, including the TLA. Year-to-date, we’ve raised approximately $1 billion of debt at a blended rate of 6.5%, driving spreads that resulted in ROEs of greater than 13%.

In summary, record EPS, record closings and record asset yields leading to attractive spreads, positioning us well to achieve guidance with no additional equity capital. With that, I’ll turn the call back to Jeff.

Jeff Lipson: Thanks, Marc. Turning to Slide 12, we update our sustainability initiatives, including two items related to the measurement and reporting of the impact of our investments and a recognition that our team remains active in climate justice community service. We’ll wrap up on Slide 13. We continue to execute on our business plan, producing consistent earnings growth despite challenging capital markets. The long-term fundamentals of our business are very powerful. We continue to operate in growing non-cyclical investment markets, working with active partners, providing capital at the asset level. Our consistent results over several cycles and operating environments provide a demonstrated track record that we intend to replicate and we have a specific action plan to thrive during this period of volatility.

We are very proud of our success in the first three quarters of 2023 and have positioned the business for additional prosperity. I thank our dedicated and talented team for continuing to execute on our goals. That concludes our prepared remarks. Operator, please open the line for questions.

Operator: [Operator instructions] Our first question comes from Noah Kaye with Oppenheimer. Please go ahead.

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Q&A Session

Noah Kaye: Well, thanks for taking the questions. There were a lot of great details in this presentation and congrats on a great quarter. I want to ask you about the balance sheet rotation to start. You called out the real estate securitization and we can see that movement in the balance sheet. Can you talk a little bit about the profiles of additional assets and both, the magnitude of those rotation opportunities and potential incremental lift in average yield you would get from such a rotation?

Marc Pangburn: Sure. So I’d say the profile of the type of investment that would be on our balance sheet and then we could look to securitize would be something that we are likely currently already securitizing, but before it became an asset class that we could reliably securitize, we would close those assets onto our balance sheet and they’ve largely sat on our balance sheet, but they’ve now been seasoned to a point and proven from a securitization perspective that we can look to pull from that. We do have additional opportunities to pursue balance sheet rotations. As you might imagine, it’s ultimately pulling from a static portfolio, so there is a limit to that. I wouldn’t put an exact number on it right now, but I wouldn’t be surprised to continue to see more of it that way.

Jeff Lipson: And I think just to add to that, Noah, and thanks for the question, on the bottom right of Page 11 where Marc referenced additional secured debt, that’s an example of assets that sit on our balance sheet that we can obtain a rating on, which makes them that much easier to securitize and rotate off. So that’s good live evidence of that activity.

Noah Kaye: And that would be sitting within equity method?

Marc Pangburn: Not necessarily. It could either be debt or equity method.

Noah Kaye: Okay. Very helpful. I think just one more. It looks certainly as though RNG has become a significant part of the growth story for the company. You talked a little bit at your Investor Day about additional asset classes, maybe two years to three years down the pike. Maybe you could talk a little bit about where you have conviction or greater interest in those opportunities today, how those asset classes are maturing. Certainly we’d love to hear from Susan as well, if you don’t mind.

Susan Nickey: Sure. Thanks, Noah. Yes, renewable natural gas has been a growth market and has strong projections for a 25% market continued growth. But with corporate demand also looking to decarbonize across all their different sectors, there’s increasing demand and also economies that scale from other renewable fuels or transport and decarbonization of different parts of the industrial sector. So we continue to monitor those and watch as we’re still waiting for guidance on some of the tax credits that are expected to come out at the end of this year, which will also help support the growth and scaling of some of those new sectors.

Noah Kaye: Yes, we’re all hoping for those clarifications and hopefully that’s something we can revisit in future calls. All right, thank you very much.

Operator: Thank you. Our next question comes from the line of Mark Strouse with J.P. Morgan. Please go ahead.

Mark Strouse: Yes, good afternoon. Thanks for taking our questions. I wanted to go to the comments about the yields being above 10% for the pipeline. Can you talk about how broad-based that might be versus how much of that is driven by kind of maybe an increasing mix towards FTN?

Jeff Lipson: I would characterize it, Mark, as broad-based. I think we’re seeing yields at that level, given where markets and capital are right now in really all three of our segments. That’s not overly driven by FTN.

Mark Strouse: Okay. And then I appreciate the commentary about the 2024 targets being able to be met without or I guess, sorry, with the gain on sales being kind of in line with where they’ve been the last few years. How are you thinking about that model, though? Maybe that presents maybe a downside scenario, but are you thinking that 2024 could be a higher year for that line item than what you’ve got this year?