NextEra Energy: A Premium Company With A Premium Rating (NYSE:NEE)
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Florida, the Sunshine State, is home to several icons, the heat of Miami and Disneyworld, but also one of the S&P 500’s best-performing utility stocks, NextEra Energy Inc (NYSE:NEE).
Data from YCharts
NextEra Energy is special in the utility industry because it boasts a growing regulated power distribution network (Florida Power & Light) as well as a strong stake in a growing power generation and transportation business through NextEra Energy Resources (NEP). Owning and controlling the regulated utilities provides a predictable cash flow that the company can opportunistically invest in higher growth investments such as solar farms via NEPs.
In addition to a strong business model, NextEra also benefits from the superior demographics of Florida in the Sun Belt, one of the fastest growing states in the nation.
In this article, I’ll examine NextEra’s business performance from a strategic and financial perspective, and provide my commentary on where I think the stock could go from here.
Increased demand = higher revenue
Let’s start with the basics. Regulated utilities provide energy (gas and electricity) to their customers at tariffs regulated by the local governments in which they operate. The energy suppliers accept a lower price in return for a state-recognized monopoly.
There are advantages and disadvantages with this arrangement. On the plus side, you have very consistent earnings in almost all market cycles. On the other hand, it can be difficult to achieve growth. Steady earnings and little/no growth are why the industry is so attractive to many retirees looking for bond-like predictability.
But not all utilities have no growth, one company that has managed to buck this trend is NextEra. For full year 2022, NextEra increased its earnings per share from $2.55 to $2.90, over 13.7%! When you consider how painful the past year has been for oh so many companies, 13.7% stands out as particularly noteworthy.
But how did they do it? my point of view? Two reasons: An excellent regulated company NextEra Energy Resources.
FP&L is the largest utility provider in the state of Florida and controls most of Florida’s East Coast and a significant portion of Southwest Florida.
Since the early 21st century, Florida’s population has grown like a weed, growing from 16 million to over 22 million in less than 25 years. Florida’s population has grown so rapidly that in 2022 it topped the US for population growth for the first time ever.
Florida’s low taxes and warm weather attract businesses and retirees alike. In the author’s view, this trend can be expected to continue as Americans flee high-tax states like California and New York, or generally colder areas like the Northeast and Midwest. As more high-net-worth individuals move to low-tax states like Florida, it can further burden high-tax states, leading to even higher taxes that only exacerbate the problem.
Such population growth creates a kind of rising tide that allows NextEra to earn more and more each year, driven by an ever-growing demand stream from consumers and businesses moving in from other states.
Further supporting NextEra’s growth are the initiatives at NextEra Energy Resources. Although not the focus of this article, it is worth noting that this subsidiary offers a significant growth opportunity for the parent company through its various green energy projects.
NEP invests in wind, natural gas, nuclear, solar, storage, pipeline and transmission projects across the country, not just in Florida, to build where environmental and financial conditions are best.
These projects are often launched in conjunction with an electricity supply agreement, in which customers pay a predictable price for a fixed amount of electricity over a long period of time. This provides the company with financial predictability and makes financing these large projects much more viable. Its focus on green energy may allow them to sell their energy at a premium to companies and communities mandated to make the green energy transition, offering additional benefits to investors.
Speaking of upside, let’s take a look at how NextEra has performed compared to some of its peers. For this article, I want to effectively highlight these companies’ ability to grow (both revenue and earnings), return on invested capital, and dividend growth.
Sales and EPS
Data from YCharts
Right off the bat, we begin to understand why NextEra is so popular, as it has clearly outgrown its peers. NextEra has grown its revenue by about 48% over the past decade, and while that may seem low, it’s pretty fast in the utility world. That 48% increase in revenue was enough to allow NextEra to double its earnings per share over the same period due to its operational leverage. Competitors like Dominion (D) and ConEd (ED) only managed to post 30% growth in their EPS over the same period, underscoring NextEra’s relative strength.
Data from YCharts
Turning our attention to return on invested capital, we see that all 4 of these companies perform relatively poorly on this metric. This is due to the strict price regulations and the huge capital requirements for investments in maintenance and new projects. While NextEra is lower overall, it still has the highest ROIC in this peer group at around 4% compared to its peers, which are closer to 3%.
Data from YCharts
As a utility, investors almost demand a dividend. Big dividends are common in the utility industry, but what’s often unusual is rapid dividend growth.
NextEra is one of those rare exceptions that meets this metric, having nearly tripled its payout in the last decade! While that’s impressive, I expect dividend growth to moderate going forward as long-term dividend growth should track earnings growth, which looks closer to 10% based on its long-term track record.
No investment is risk-free, and yes, that includes ever-growing companies like NextEra. To me, the biggest risk for NextEra is tightening financial conditions that are making debt and equity issuance more expensive. As the Fed has hiked rates, banks have started to slow lending and investors are demanding higher yields, which is pushing yields higher. Higher interest rates pull asset prices down, which also makes equity financing more expensive.
After last weekend’s bank collapses, one might expect lending to remain below pre-coronavirus levels, although this could be offset at least in part by lower interest rates recently priced in as investors doubt the Fed’s ability to continue raising interest rates given the extreme pressure being placed on several Regional Banks (KRE).
It’s hard to say what impact all of this will have on NextEra, but as capital markets close, growth opportunities will likely slow and would likely need to be funded with a greater mix of internal capital.
evaluation and conclusion
In summary, NextEra Energy is a well-run company that has shown some really impressive growth over the past decade. The Company benefits from a highly regulated business through its Florida Power & Light subsidiary and a significant stake in the growing power generation and transportation businesses through NextEra Energy Resources.
Additionally, Florida’s rapidly growing population is creating increasing demand for electricity, which will support NextEra’s growth. In terms of financial performance, NextEra has significantly outperformed its peers, has delivered strong returns on invested capital, and has best-in-class dividend growth.
These are all reasons NextEra is a popular utility stock among investors, and the company’s growth trajectory suggests it could continue to be a solid investment…
Data from YCharts
But looking at NextEra’s valuation compared to its peers, it appears that the market has identified its superior business model by betting a premium multiplier on its expected earnings of ~25x compared to its peers, which range between the 14- trade up to 20 times expected profits.
This puts investors in a difficult position, how much more is it worth paying for a great company than a good company?
Given the heightened uncertainty in the market and the fact that 2-year Treasuries are yielding more than 4%, I’m not convinced that a 4% earnings yield growing in the low double digits is an investment I consider in is attractive enough at this stage . If profits dropped to 20x expected profits, I would be much more interested in going long. For now, this company remains on my watch list.
I rate NextEra Energy Hold.
I hope you enjoyed reading my article! If you liked it or want to discuss something mentioned, please let me know in the comment section. Applause!