Yahoo Finance NextEra Energy: A Top Contrarian Idea for 2024
NextEra Energy Inc. (NYSE:NEE), the world's largest producer of renewable energy from solar and wind power, had a forgettable 2023 in the stock market with the stock losing more than 30% of its market value. This disappointing performance came on the back of rising interest rates and its subsidiary, NextEra Energy Partners (NYSE:NEP), slashing limited partnership distribution per unit growth to 6% through 2026 from a high of 13.5% previously.
The underperformance of NextEra stock in 2023 should not have come as a surprise to prudent investors who keep tabs on market trends. Historically, utilities have performed poorly when interest rates rise, and there was no exception this time around. In the last 12 months, the S&P 500 utilities sector has lost more than 12%, making it the worst-performing sector in the index.
On the back of this lackluster performance in 2023, many utilities stocks have entered the cheaply valued territory. NextEra Energy is one such company, and even more interestingly, it seems well-positioned for a notable turnaround this year. NextEra's attractive dividend, reasonable valuation and the improving odds for a rate cut this year make the company a top contrarian play for 2024.
The investment thesis for NextEra
To understand NextEra's appeal as a long-term investment, investors need to dig deep to evaluate the different business segments of the company in detail.
Florida Power & Light, NextEra's regulated utility business in Florida, enjoys a near monopoly in its market as it is the largest rate-regulated utility in the state. This gives the company meaningful control in the state with FPL enjoying exclusive rights to charge customers prices that enable it to earn returns that exceed its cost of capital.
FPL enjoys a favorable regulatory environment in Florida and the company, historically, has been on the right side of regulatory decisions. As a regulated utility, maintaining a healthy relationship with policymakers is key to long-term success, and the company has shown its commitment to building and maintaining an open line of communication with key regulators in the region.
NextEra's renewable energy business, conducted through NextEra Energy Resources, is well-positioned to capture the lucrative opportunity in the clean energy space, which is another reason to be bullish about its prospects. The company has a 31-gigawatt operating portfolio and a development pipeline of approximately 300 gigawatts of renewables and storage projects. Energy Resources aims to benefit significantly from the expected growth of renewable energy's share in the U.S. power generation mix.
According to the International Energy Agency, renewables will contribute to more than 80% of new power generation capacity by 2030, with solar power accounting for more than half of it. NextEra's renewable business will play a key role in helping the U.S. achieve these lofty expectations. The company's existing solar power assets will prove to be indispensable in the long run, which paints a promising picture of what the future holds for NextEra.
In the third quarter of 2023, Energy Resources reported its best renewables and storage origination ever, adding over 3,200 megawatts to the backlog. This demonstrates the strong demand for new renewable generation today, and how NextEra is making the most of this robust demand. There is visibility into the company's renewable energy growth, as evident from the continued growth of the pipeline. This eliminates some of the uncertainty associated with expected growth.
The company is carrying out strategic investments to improve the efficiency of its renewable energy business. A couple of months ago, NextEra announced a strategic plan to repower approximately 740 megawatts of wind facilities through 2026 by investing in existing projects to enhance performance, refresh equipment and secure new production tax credits. When these planned investments are executed, the renewable energy business will be substantially more efficient than it is today, which should pave the way for higher returns on deployed capital.
The company's battery storage business is another bright spot. The company added roughly 250 megawatts of standalone battery storage projects co-located with existing wind and solar facilities to its backlog in the third quarter. This focus on battery storage aligns with the growing need for energy capacity and the ability to provide grid support.
Overall, NextEra Energy is a well-managed business with the potential to tap into a few key growth areas in the coming years. With the Fed expected to cut rates this year, the market sentiment toward renewable energy companies and utilities should improve in the coming months, paving the way for NextEra stock to erase recent losses.
Balance sheet health
With interest rates shooting through the roof, investors have increasingly turned skeptical about the balance sheet health of NextEra Energy. Utilities companies often carry a substantial debt burden on their balance sheets as regular infrastructure development investments are required to build and maintain capacity. NextEra currently carries $59 billion in long-term debt, which may seem daunting in isolation. The bigger picture reveals a different story.
The company is committed to maintaining financial discipline and passing on projects that do not meet investment return expectations. Management has pledged to keep the total equity capital need below $3 billion through 2026, which is encouraging at a time when the market is turning cautious about its liquidity profile.
NextEra Energy Partners, on the other hand, is focused on executing its transition plan, which includes selling assets and managing equity buyouts. The current expectation is for distributions per unit growth of 6% through 2026, which is still attractive despite being lower than initial projections.
As one of the largest clean energy companies in the world, NextEra enjoys access to substantial capital through its strong relationships with global banks. The company, arguably, has one of the strongest balance sheets in the U.S. clean energy sector today.
The attractive dividend
NextEra pays a quarterly dividend of 47 cents per share, which translates to an annual yield of 3.2%. The current payout ratio of around 60% makes its dividend relatively safe, and the company is unlikely to face any material challenges in maintaining this dividend should earnings decline in the short term before rebounding.
The company has projected stable earnings per share growth through 2026 despite the unfavorable interest rate environment, driven by the strong demand for clean energy. Favorable demographic trends in Florida, underpinned by population growth, should benefit the company's rate-regulated business as well. Robust earnings growth, in the long run, should help NextEra boost dividend distributions.
Takeaway
With the Fed lining up to put an end to its aggressive rate hike regime, market sectors that are highly sensitive to interest rates seem well-positioned to perform well this year. The utilities sector stands out as one of the biggest potential winners of rate cuts, and NextEra Energy is a top pick in this sector. At a forward price-earnings ratio of 18, the company is reasonably valued with a promising pipeline that points toward stellar earnings growth in the long run.
This article first appeared on GuruFocus.
