Hannon Armstrong Is A 'Blue Light Special' Worth Buying

Businessmen use a magnifying glass to analyze the company's data and statistics from the chart.Getty

As my loyal readers know, I’m bargain shopper and that means I am constantly on the prowl for good buys. Sometimes spotting a bargain is easy, because the dividend yield is high or there’s an earnings miss.

Alternatively, the bargain may not be so obvious, because the shares are thinly traded, or the stock has modest analyst coverage.

If you ask me, the true secret to finding bargains is to be somewhat of a detective and find the inexpensive stock before someone else does. That means you have to act like Sherlock Holmes, “I am the last and highest court of appeal in detection".

Today I will become the so-called chief detective officer on Forbes.com in which I will examine a bargain stock known as Hannon Armstrong (HASI).

Source: HASI Investor Presentation

This Is Not Your Typical REIT

Hannon Armstrong listed shares in April 2013, just in time for the IRS to issue a notice of proposed rule-making clarifying the definition of real property for REITs (REG - 150760 -13), in which the IRS provided clearness as to what constitutes real property for REIT purposes.

Simply put, the ruling paved the way for Hannon Armstrong to utilize a REIT platform allowing the company to aggregate assets in multiple categories, all pertaining to clean energy real estate projects.

The company participates in three large market segments (behind the meter, grid connected, and sustainable energy), and its unique operating model provides the company with a competitive advantage in which the company generates long-term, recurring and predictable cash flows.

The market opportunity continues to grow in the overall sustainable infrastructure markets, and the company sees greater market opportunity in assets that are behind the meter (energy efficiency) as opposed to grid-connected (wind and solar) assets such as power plants.

Source: HASI Investor Presentation

One of the primary differentiators for Hannon Armstrong is that the company focuses on high credit quality assets, and that's reflected in the portfolio, which, excluding equity method investments, consists of 43% of assets from government obligors and 30% of transactions from commercial investment grade obligors, with 27% of contracts not rated (equity in renewable energy).The remainder of the transactions are equity method investments, which we do not rate.

This simply means that the potential for default is extremely low, and of course, you would expect the yields to be lower on higher-quality revenue sources. Also, an as another risk mitigator, the portfolio is widely diversified, comprising more than 175 separate investments with an average investment size of $11 million.

Hannon Armstrong initiates transactions from the top tier energy service companies, manufacturers, project developers, utilities, and owner operators in the industry. The company targets around $1 billion of originations annually and the company targets ROE (return on equity) of approximately 10%. In the third quarter ROE exceeded 12% due to higher portfolio yield and higher gain on sale fees.

Also, in the third quarter the company recorded GAAP profit of $16.5 million, an increase of $8.6 million from the same quarter last year, and GAAP earnings of $0.30 per share and core earnings of $0.36 per share. Originations for the quarter were a record $553 million, bringing the year-to-date total to over $850 million.

How We Play It?

Many analysts find it difficult to evaluate Hannon Armstrong because the company does not fit squarely into any property sector. In some ways the company looks like a utility, and in other ways, the company looks more like a net lease REIT or a commercial mortgage REIT.

The accurate way to think about Hannon Armstrong, as explained by the company’s CEO (on a recent earnings call) is “investing in the future of energy, which…is decentralized, digitalized, and decarbonized. These three trends represent a part of $100 trillion global market opportunity to mitigate and adapt to climate change”.

But wait, I promised you that I would put on the detective hat and point you to this so-called blue light special (as I write this article, I am reminded of the fate of Sears and K-Mart, as the iconic retailer “could face full liquidation”).

Hannon Armstrong shares have declined by over 18% over the last 30 days, and the dividend yield is now a juicy 6.8%. We have previously scored the REIT as a BUY, but we are upgrading shares to a Strong Buy, given the broad range of capital solutions that the company provides. The company was a top pick (for us) in 2016, +33% (total return), and we suspect that 2019 could produce similar results, we target 25% annual returns (in 2019).

Yes, Hannon Armstrong is a “screaming buy”, but up until now, it seems that “the world is full of obvious things which nobody by any chance ever observes (Sherlock Holmes)”. Hannon Armstrong is a ‘Blue Light’ special worth buying.

I own shares in HASI.

Hannon Armstrong Is A 'Blue Light Special' Worth Buying curated from Forbes - Real Estate