Analyzing NextEra Energy's Dividend Outlook Amid Slowdown in Renewable Asset Sales

NextEra Energy's (NEE) shares have traded down around 10% the past couple of days after the firm's subsidiary, NextEra Energy Partners (NEP), revised its growth outlook from 12-15% per year to 5-8%, citing "tighter monetary policy and higher interest rate" headwinds.

This update matters because NEE uses its relationship with NEP to help finance its renewable energy projects (~25% of profits) in a tax-efficient and flexible manner.

Essentially, NEP, which operates as a YieldCo, raises external debt and equity capital from investors to buy NEE's completed renewable projects, thus allowing the parent company to recoup development expenses quickly.

In exchange, the YieldCo, which is 55% owned by NEE, gains a cash flow producing asset to help pay an attractive distribution to income investors, with revenues locked in under long-term power agreements with other large utilities in dozens of states and Canadian provinces. 

 

However, this relationship doesn't function well when NEP is locked out from issuing equity at attractive valuations and faces rising debt costs, as we're seeing today.

While this news highlights the increased challenges of operating in a higher interest-rate world, the market may have overreacted.

Over the last five years, NEP has spent an average of $1.5 billion annually acquiring assets. Most of these payments have presumably gone to NEE (plus a few hundred million dollars per year in distribution and incentive distribution rights fees).

While that might sound like a lot of money, NEE is a massive company with annual capital expenditures of around $20 billion. The funding from asset sales to NEP covers a relatively small portion of NEE's total outlays.

NEE's operating cash flow, which has averaged around $8 billion annually over the past three years, and its ability to tap debt markets and recycle capital from other non-core areas of its business are much more meaningful financing sources.

Coupled with interest rate hedges in place and equity needs that are expected to remain "very manageable and minimal," this gave management confidence to reaffirm NEE's 6% to 8% annual EPS growth rate target from 2024 through 2026.

Even if NEE ended up needing to replace funding from NEP with additional equity sales over the next few years, issuing $1 billion to $2 billion of stock annually wouldn't result in too much dilution given NEE's market cap near $120 billion.

That said, this development and the direct impact of higher interest rates on NEE will somewhat reduce the company's financial flexibility and could require management to be more methodical when selecting growth projects.

To better reflect this more challenging financing environment and the corresponding slower growth prospects in the firm's renewable business, we are downgrading NextEra Energy's Dividend Safety Score from 99 to 90 within our Very Safe bucket.

Despite the modest downgrade, NEE's dividend remains healthy with a payout ratio near 60% and the backing of the firm's regulated electric utility in Florida (75% of profits), a state with the fastest population growth and constructive regulatory oversight.

As home to the nation's largest electric utility, NEE has earned a stellar A- rated balance sheet that further supports the firm's already well-covered dividend and green energy ambitions.

The firm remains a leader in the renewable energy space, an industry garnering lots of attention as governments act to combat climate change by providing tax credits and other stimulus efforts.

While tighter financing conditions may temper growth in this space, the long-term tailwinds fueling green energy don't seem likely to fade anytime soon.

If we were NEE shareholders, we would ignore the noise surrounding the stock and maintain our holding with a focus on the firm's positive long-term prospects.

We will continue to monitor NEE and NEP, providing updates as needed.