Is NEP's Dividend Safe Following Guidance Cut?
NextEra Energy Partners (NEP) stunned investors on Wednesday by revising its earnings and distribution growth outlook from a 12% to 15% range down to 5% to 8%, citing "tighter monetary policy and higher interest rates" as an impediment to reaching the double-digit growth rates the BB rated firm was targeting just two months ago.
Essentially, this means NEP expects to make fewer purchases of assets over the next few years from its parent NextEra Energy (NEE), which owns roughly 55% of NEP.
Despite guidance still projecting mid-single-digit growth, the company's stock dropped a staggering 20% yesterday as investors reacted to the news.
While investors may be disappointed with NEP's tempered growth outlook, the firm's payout is still projected to remain covered by distributable cash flow, and management doesn't expect it will need to worry about issuing any equity to fund its growth plans until 2027.
While investors may be disappointed with NEP's tempered growth outlook, the firm's payout is still projected to remain covered by distributable cash flow, and management doesn't expect it will need to worry about issuing any equity to fund its growth plans until 2027.
Based on what we know today, we are reaffirming NextEra Energy Partner's Borderline Safe Dividend Safety Score.
That said, NEP investors need to be comfortable with several wild cards that seem like lower probability events but could disrupt management’s plans.
Most immediately, NEP needs to find a buyer at a reasonable price for its natural gas pipeline assets that it intends to sell to simplify its capital structure and become a 100% pure-play renewable energy company.
Today, NEP generates most of its profit from renewable energy, including wind (60% of profits) and solar (20%), but the remaining 20% comes from natural gas pipelines.
If NEP struggles to field reasonable offers for its natural gas assets, perhaps due to tighter credit market conditions, the company would need to find another way to fund its maturing convertible equity financing portfolio.
Without raising cash from selling its pipelines, NEP would likely need to issue shares to meet these maturities, resulting in painful dilution and an unsustainable payout ratio.
Assuming NEP's divestiture plans work out to avoid this worst-case scenario, the influence of parent NEE over the company raises the next longer-term uncertainty for investors to consider.
To offset NEP's lost cash flow from the pipeline sale, NEE has agreed to suspend the incentive distribution rights (IDRs) fees it is entitled to through 2026.
Once that period ends, would NEP desire to follow the lead of other partnerships by buying out NEE's IDRs to lower its cost of capital? This would be a costly endeavor for NEP, likely resulting in a significant share issuance that could once more stretch the firm's payout ratio and threaten the distribution's safety.
There’s also the issue of NEE’s ultimate end game with NEP. NEP was initially created to act as a financing vehicle, raising capital from income investors to buy NEE’s assets. That model doesn’t work with NEP locked out from issuing equity at attractive valuations and facing rising debt costs.
With majority ownership and the IDRs, perhaps NEE would look to opportunistically acquire NEP, further building out its portfolio of renewables at an attractive price. This could lock in losses for NEP investors, depending on the timing and the terms of a deal.
Most utilities prefer to move towards pure-play regulated business models, but NEE could be an exception given its current footprint as one of the nation's largest renewable power producers and stated intentions to focus solely on green energy.
Finally, like its peers, NEP’s longer-term outlook is beholden to the fate of renewable energy fundamentals. What will future tax credits look like? Where will power prices be when contracts renew? Numerous factors reside outside of management's control.
The outcome of these issues could once more alter NEP’s outlook and financing needs, for better or worse.
Following yesterday's sell-off, NEP’s valuation has come down to more interesting levels. Trading at around 9x distributable cash flow, the stock sits at a meaningful discount to competing BBB+ rated Brookfield Renewable Partner's (BEP) 16x multiple.
However, investors need to be comfortable with NEP’s lingering financing risks and perhaps murkier outlook with its intertwined relationship with NEE. As conservative investors, we prefer to own stocks with a narrower range of outcomes, like some of those on this list of companies with dividend yields over 4%.
That said, NEP investors need to be comfortable with several wild cards that seem like lower probability events but could disrupt management’s plans.
Most immediately, NEP needs to find a buyer at a reasonable price for its natural gas pipeline assets that it intends to sell to simplify its capital structure and become a 100% pure-play renewable energy company.
Today, NEP generates most of its profit from renewable energy, including wind (60% of profits) and solar (20%), but the remaining 20% comes from natural gas pipelines.
If NEP struggles to field reasonable offers for its natural gas assets, perhaps due to tighter credit market conditions, the company would need to find another way to fund its maturing convertible equity financing portfolio.
Without raising cash from selling its pipelines, NEP would likely need to issue shares to meet these maturities, resulting in painful dilution and an unsustainable payout ratio.
Assuming NEP's divestiture plans work out to avoid this worst-case scenario, the influence of parent NEE over the company raises the next longer-term uncertainty for investors to consider.
To offset NEP's lost cash flow from the pipeline sale, NEE has agreed to suspend the incentive distribution rights (IDRs) fees it is entitled to through 2026.
Once that period ends, would NEP desire to follow the lead of other partnerships by buying out NEE's IDRs to lower its cost of capital? This would be a costly endeavor for NEP, likely resulting in a significant share issuance that could once more stretch the firm's payout ratio and threaten the distribution's safety.
There’s also the issue of NEE’s ultimate end game with NEP. NEP was initially created to act as a financing vehicle, raising capital from income investors to buy NEE’s assets. That model doesn’t work with NEP locked out from issuing equity at attractive valuations and facing rising debt costs.
With majority ownership and the IDRs, perhaps NEE would look to opportunistically acquire NEP, further building out its portfolio of renewables at an attractive price. This could lock in losses for NEP investors, depending on the timing and the terms of a deal.
Most utilities prefer to move towards pure-play regulated business models, but NEE could be an exception given its current footprint as one of the nation's largest renewable power producers and stated intentions to focus solely on green energy.
Finally, like its peers, NEP’s longer-term outlook is beholden to the fate of renewable energy fundamentals. What will future tax credits look like? Where will power prices be when contracts renew? Numerous factors reside outside of management's control.
The outcome of these issues could once more alter NEP’s outlook and financing needs, for better or worse.
Following yesterday's sell-off, NEP’s valuation has come down to more interesting levels. Trading at around 9x distributable cash flow, the stock sits at a meaningful discount to competing BBB+ rated Brookfield Renewable Partner's (BEP) 16x multiple.
However, investors need to be comfortable with NEP’s lingering financing risks and perhaps murkier outlook with its intertwined relationship with NEE. As conservative investors, we prefer to own stocks with a narrower range of outcomes, like some of those on this list of companies with dividend yields over 4%.
That said, we'll continue to monitor NextEra Energy Partners and provide updates as needed.
