The Long and Short
Solar Star project finance bonds seem undervalued
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Project finance bonds issued by Solar Star Funding LLC (BRKHEC: Baa1/BBB/BBB) look like good value. The bonds have unique sinking fund structures that amortize through their final roughly 10-year maturity dates. Credit support is underpinned by long-term power purchase agreements that run through the final maturity of both issues outstanding. And while ratings are capped by the project’s ultimate counterparty, Southern California Edison (SCE), Solar Star is owned by BHE Renewables, which is a wholly owned subsidiary of Berkshire Hathaway Energy (BRKHEC: A3/A-), providing additional implicit support to holders as well. At current valuation, investors appear well compensated for the ongoing risks inherent to SCE and potential liabilities related to the recent California Wildfires.
The Solar Star project consists of two solar power generating facilities developed by SunPower and purchased by BRKHEC in 2012 that have been operating since 2015 when both bonds were originally issued. Combined, they consist of 586-megawatt capacity of photovoltaic power generating facilities constructed on 3,200 acres in Kern and Los Angeles counties in California. The bonds were originally issued with principal amounts outstanding of $325 million and $1 billion, which now currently have roughly $213.8 million and $698.1 million outstanding, respectively. Both bonds have a final maturity date of June 30, 2035, and the sinking fund schedules will run through that date. Again, the power purchase agreements (PPAs) with SCE are structured to run through the final maturities of the bonds as well.
Both bond issues are 144a private placements. The larger structure remains index eligible and therefore trades at a premium to the lower-coupon, smaller issue that is now under the $300 million threshold (Exhibit 1). The bonds are unique and difficult to classify as the project finance nature of operations imply comparable valuation to other energy credits outstanding in the investment grade index. However, given their ultimate ownership by BRKHEC and that the power purchase agreements are directly tied to SCE, the bonds are classified as electric utility credits for index purposes. Nevertheless, current spread levels appear attractively valued against comparable ‘BBB’ credit in either sector of the broad index, electric utilities or energy (exhibit 2).
Exhibit 1. Solar Star bonds (highlighted) in the context of the Berkshire Hathaway Energy debt complex
Source: Santander US Capital Markets LLC, Bloomberg/TRACE – G-spread pricing indications
The core credit stability of the bonds is provided by the PPAs which commenced in 2015 with a base price of roughly $80 per megawatt hour and has increased by 2.5% annually since then. The prices are further adjusted for time-of-day, which then results in higher average prices than the contractual minimum.
As Solar Star’s sole counterparty, SCE underpins much of the credit quality and ultimate ratings for the project finance bonds. As a result, recent rating actions have reflected the ongoing uncertainty regarding SCE’s ultimate liability to the January California wildfires. In February, S&P revised the outlook on Solar Star’s ‘BBB’ rating to Negative from Stable, reflecting the risk that the agency could take negative action on the ‘BBB’ ratings of SCE. More recently, Fitch placed their ‘BBB’ ratings on watch negative as well.
SCE and their ultimate parent company Edison International (EIX: Baa2/BBB/BBB) remain potentially liable to the Eaton fire, though investigations remain ongoing. The company has acknowledged that their equipment may have contributed to the fires and could therefore incur material losses. A key factor in the ultimate assessment of liability in these investigations will be the determination of whether SCE acted prudently or not. Of specific concern is the extent to which potential liabilities might exceed the existing $21 billion AB1054 utility-caused wildfire fund, which protects SCE/EIX, but does not have an automatic replenishing mechanism. California lawmakers go into recess in mid-July, so the issue could remain unresolved until they reconvene in September.
Exhibit 2. Fair Value Curves for BBB-rated Energy (red) and Utility (blue) credits
Source: Santander US Capital Markets LLC, Bloomberg LP – BVAL credit curves
Additional credit concerns more specific to Solar Star include recent equipment problems beginning in 2023, which the company has largely addressed, but have resulted in expenses that negatively affected debt service coverage metrics for at least the current year. Debt service coverage typically runs in the 1.50-1.75x range and is projected to be in the low 1.20-1.30x range throughout much of 2025. Nevertheless, management projects it returning to normalized levels after this year and the rating agencies appear confident in Solar Star’s ability to hit those targets in relatively short order as the issues appear largely resolved.
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