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NextEra Energy: Best in Class, But at a Price

By Roger S. Conrad, on Jan. 30, 2019

There wasn’t much special about NextEra Energy (NYSE: NEE) a decade ago. But the former FPL Group has since nearly doubled the return on the Dow Jones Utility Average and topped the S&P 500 by 70 percentage points, while emerging as America’s favorite power company.

Those returns were well earned. NextEra was first in the sector to recognize the potential of renewable energy. And as a result, it’s the undisputed leader in both onshore wind (16 percent US market share) and solar (11 percent).

The company originated 6.5 gigawatts of renewable energy generating projects last year, twice the prior year’s record level. That’s mostly facilities under long-term contract to utilities through the unregulated Energy Resources unit, which contributes approximately 30 percent of overall earnings. A bigger opportunity, however, is shaping up at the regulated Florida utilities including Gulf Power, which NextEra acquired this year from Southern Company (NYSE: SO).

The Florida Power & Light unit produced ten times more solar energy in 2018 as it did in 2016. And this month, management announced deployment of 30 million more solar panels by 2030. That would increase the utility’s current solar output 11-fold, enough to supply 2.2 million homes.

In addition, 40 percent of the renewable energy projects NextEra announced last year feature battery storage. Solar plus storage is already proven on a commercial basis in Hawaii, with 262 megawatts operating or in development.

The Sunshine state should prove equally hospitable. NextEra expects to offer solar power as cheaply as 2.5 to 3 cents per kilowatt-hour by early in the next decade, combined with 5 to 7.5 cents per kwh for 4-hour storage. That’s near-baseload generation and it’s price competitive with anything except the newest natural gas units.

Management again touted the “disruptive” potential of renewables plus storage during the fourth quarter earnings and guidance call. And it’s arguably become as big a selling point for the stock as is consistent annual earnings growth of 6 to 8 percent coupled with 12 to 14 percent yearly dividend hikes through 2023.

Those forecasts are set to hold even if PG&E Corp (NYSE: PCG) defaults on its power contracts. And management may have forestalled that by quickly convincing the Federal Energy Regulatory Commission to assert “concurrent jurisdiction” with bankruptcy courts over California wholesale power contracts.

NextEra also may be preparing for an end run around PG&E, buying the power cable that services 40 percent of San Francisco’s electricity needs in a deal set to close later this year. The city authority is committed to the state’s renewable energy goals and is considering buying some utility assets.

The PG&E story is still in its early stages. Our contention is any eventual resolution will have to make California power suppliers whole to ensure enough investment for de-carbonization, hardening the system against fire and to replace electricity from the Diablo Canyon nuclear power plant, which closes for good in 2025. But whatever the outcome, NextEra Energy will continue extending its first mover advantage in wind and solar energy, ensuring its ongoing robust business growth.

That’s the very definition of a “best in class” company. The question is whether that makes the stock worth its lofty current price. Looking at the key valuation criteria for the 15 companies currently in the Dow Jones Utility Average (DJUA), as well as analysts’ recommendations a few observations emerge.

NextEra is clearly the most popular stock in the DJUA with Wall Street analysts. Of the 20 tracked by Bloomberg Research that cover it, 15 rate the stock a “buy” versus 4 “holds” and one sell.

Takeaway two is the stock sells at the second highest multiple to projected 2019 earnings on the list. And the only company higher is not actually in the power business, American Water Works (NYSE: AWK). NextEra also has the second lowest dividend yield on the list, again following American Water.

The company does also stand out in terms of dividend growth, raising its payout by 13 percent last year. And it’s likely to be at the top of the class in 2019 as well, with a similar boost to be announced in mid-February.

Investors, however, will have to pay up to collect that: Not only does the stock trade at a P/E some 30 percent higher and a dividend yield 25 percent lower than the DJUA. But the P/E is nearly twice what it was seven years ago while the yield is little more than half.

In this business, money managers who bet against consistent winners don’t keep their jobs for long, particularly when that stock is 17.3 percent of the DJUA. And utility-focused portfolios that have been underweighted on NextEra have almost certainly underperformed. In fact, even a 10 percent holding has been a bearish disaster.

Not surprisingly, the stock has been heavily accumulated by exchange traded funds governed by passive investing strategies. Blackrock, State Street and Vanguard combined have consistently controlled more than 20 percent of the stock in recent months.

The bottom line: NextEra Energy has a very attractive long-term growth profile. But it’s quite vulnerable to a selloff if the sky-high expectations baked into the share price are punctured. One good alternative is its NextEra Energy Partners (NYSE: NEP) unit. The dividend is two percentage points higher with an identical PG&E bankruptcy-proof long-term growth rate.

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