FLNC - NextEra Energy: A Long-Term Hold Until It Fully Commits To Renewables

2023-06-06 21:33:54 ET

Summary

• NextEra Energy's transition to renewable energy is incomplete, and the company has supported fossil fuel projects for personal gain.
• The company's financials are not encouraging for investors, as NextEra's spending may spiral out of control if it isn't careful.
• NextEra's two-faced approach to the energy transition will likely bleed the company of many supporters and investors as renewable generation expectations are raised for energy companies in the future.

Thesis

NextEra Energy ( NEE ) ( NEP ) is a regional American power company that, as its name suggests, is attempting to usher in a renewables-based transformation of its energy generation and distribution. While I agree with its transition, and give the firm credit where it’s due, I don’t think the clean energy hype surrounding the company is justified despite the company’s sizable renewable generation capacity. NextEra’s transition to renewable energy is incomplete; it has undercut renewables proliferation in its region; and it has supported fossil fuel projects for personal gain. Until that all changes, I think long term energy investors might want to remain on the sidelines for a while. Renewables are the future, and NextEra hasn’t demonstrated the necessary commitment to it for me to recommend it as an investment.

Financials

The financials for NextEra are stranger than those of other companies I have covered. Revenue for the consecutive fiscal years 2018-2022, ending December, are as follows: $16.7 billion, $19 billion, $18 billion, $17 billion, and $21 billion. Net income during this period was $6.6 billion, $3.7 billion, $3 billion, $3.5 billion, and $4 billion. This tells me that for whatever reason, during the two high-revenue years 2019 and 2022, NextEra’s business was unable to capitalize on its high top line and had to settle for lower than expected profit margins. 2022’s tepid margin result was particularly surprising, given the severe upward pressure on energy prices after the West’s cutback on Russian energy sources (following Russia’s invasion of Ukraine) roiled energy markets.

Moving on, cash from operations, or operational cash flow, was $6.5 billion, $8.1 billion, $8 billion, $7.5 billion, and $8.2 billion for the consecutive years in the 2018-2022 period. This more closely matches the rises seen in the total revenues, so NextEra’s core energy generation and sales business seems to be doing fairly well, and is self-sustaining.

Delving deeper, NextEra appears to have high costs from non-business obligations and driving capital to other ventures. Its cash flow from investing has been consistently negative, resulting in losses of $11 billion, $16 billion, $13.7 billion, $13.6 billion, and $18.3 billion from FY2018-22.

Looking at its debts in the FY2018-22 period, the company seems to take out, and pay back, good amounts of debt to run its operations. Debt repaid was $3.5 billion, $10.5 billion, $9 billion, $10 billion, and $5.6 billion for each consecutive year in the period. On the other hand, debt taken out was $11 billion, $14 billion, $14.5 billion, $17 billion, and $16 billion for each consecutive year. Lastly, NextEra’s costs for its dividends on common and preferred shares were $2.1 billion, $2.4 billion, $2.7 billion, $3 billion, and $3.5 billion in the FY2018-22 period.

These financials, to me are not the mark of an optimally run company. NextEra is taking out larger and larger amounts of (mostly long-term) debt that will in time come due. Yet the company is already forced to pay off significant amounts of debt every year, in what looks to me like a vicious cycle; this occurs while the core energy business is already generating its own cash flow. I am therefore uncertain why NextEra is still leaning on debt for running its business.

Regardless of whether or not it is justified, if NextEra is going to issue debt, it certainly should not be issuing a dividend or offering preferred shares, in my opinion. The funds from these dividends and preferreds could be used to go toward debt repayment or expansion of the core energy business, yet these funds are being wasted on paying back investors.

Overall, NextEra’s financials are not encouraging for me as an investor, as NextEra’s spending may well spiral out of control if it isn’t careful.

Valuation

NEE/NEP are generally fairly overvalued compared to utility sector peers, with some variation between the two stocks.

NEE is overvalued across the board. On P/E, whether trailing, forward, GAAP or non-GAAP NEE’s metrics are all above sector, trading at a ratio of ~22 while the sector trades at ~18; NEE’s Price to Sales, or P/S, trades at a ratio of 6, compared to ~2 for the sector; NEE’s Price to Book or P/B trades at about 3, compared to less than 2 for the sector; and NEE’s Price to Cash flow trades at 15-16, compared to ~8 for the sector. NEE is thus in no way a bargain.

However, NEP is less frothy in some regards. Its average P/E trades at about 22 like NEE, but its GAAP P/E is undervalued at a ratio of 16 compared to the sector’s 19; NEP’s P/S is about 4 compared to 2 for the sector, so pricey, but still better than NEE; NEP’s P/B is about 1.5 averaging forward and trailing, with sector at about 1.7, indicating undervaluation. Finally, NEP Price to Cash flow is either undervalued or overvalued, with trailing ratios being ~7 for NEP and 10 for the sector, and with forward ratios being 16 for NEP and 7 for the sector.

Overall, NEE and NEP are not very good value picks. For an energy business in transition and not in the best financial shape, I think even undervaluation on paper would represent fair valuation or a value trap. For the overvalued NEP and NEE, I think value investors would want to avoid both based on the financials and premium alone.

NextEra Pursues Greater Clean Energy Generation

NextEra energy began as Florida Power and Light Company in the early 20 ^th century, and eventually reformed into NextEra Energy in 2010.

I must give credit where it’s due: NextEra Energy is setting itself up to become one of the largest clean energy providers in the world. With 34 gigawatt hours (‘GWh’) of generation in 2020 alone, NextEra expects to add 30 GWh of renewable energy between 2021 and 2024, doubling its total renewable output in just 4 years.

This is a very promising development for the company, as it raises the company’s status as a clean energy producer and provider, since clean energy is increasingly in demand in the energy market .

However, NextEra’s other ambitions are decidedly less in line with its purported clean energy goals.

NextEra’s Support of Fossil Fuels

NextEra has supported at least one major fossil fuel project in recent years, and used a subsidiary to actively campaign against renewables in Florida. Considering that NextEra is heavily invested in fossil fuel projects (41% in fossil fuel energy according to a 2020 SEC document ), this is not actually very surprising at all.

In fact, in regions where its fossil fuel energy generation is threatened, such as in Maine in 2021, NextEra can be counted on to sabotage attempts to introduce renewable energy to the area. This is likely because its management knows from experience with renewables generation that its fossil fuel facilities will be unable to compete with new clean energy plants, and NextEra's fossil fuel plants will have to be written off for much more at the end of their life due to reduced use and productivity.

Assuming this rationale for NextEra’s actions is correct, I would argue the better course would be to sell off these dirty fuel sources now and cut its losses, not double down on carbon-intensive energy in the hope of breaking even. The proceeds from the sale could then be plowed into investing in new clean energy projects, which would likely be more lucrative in the long run than running old fossil fuel plants.

Another possibility is that NextEra is not actually a true believer in renewables as a standalone energy source, and believes fossil fuels will always be needed in a region’s power mix. I have an article in the pipeline with a section more thoroughly dispelling that notion, but for now, I will only say that NextEra is deeply misguided if this is the case. For example, the entire country of Portugal could run on renewables alone as far back as 2016.

In any case, renewable energy is the future, yet the company is unable to fully commit to ushering it in. It’s ironic that this “renewable energy company” named NextEra still has assets and generation capacity firmly planted in the previous era of fossil fuel-based energy. This reveals a greater likelihood that the company will fall behind other companies such as Tesla, Inc ( TSLA ), Fluence ( FLNC ), and a host of other energy industry firms that are going all in on the coming transition to renewable energy, and which will be handsomely rewarded as renewables are quickly adopted.

NextEra’s half-in-half-out approach will pale in comparison, as will its growth, since it will be forced to juggle management of dirty fuel sources as well as grow its clean energy production, incurring unnecessary business costs and bad publicity from supporting fossil fuels.

Lastly, given what is publicly reported and disclosed about the company's activities, NextEra’s stock will likely face additional overhang due to savvy investors staying away from a Janus-like energy company. NextEra’s approach will turn off many potential investors who consider renewables a fad, and also investors who consider renewables the future. Thus, NextEra stands to miss out on investor support on both ends of the spectrum, leading to even more middling performance for its stock in the long run.

Risks to Thesis

A couple of risks to my thesis should be pointed out here. First, if there is no renewable energy transition, then there is no harm from NextEra obstructing renewables and supporting fossil fuels; however, in this scenario, NextEra’s buildout of increased renewable generation would pose more of a liability, so this risk to the thesis would be a double-edged sword for NextEra.

Second, I could be incorrect that NextEra's continued operations of fossil fuel energy projects will drag more on the business and drain investor interest compared to selling them off. In this case, NextEra’s current approach would represent a forced slow phase-out of its remaining fossil fuel facilities, with the company getting more revenue over years of keeping them in operation and defending their use than it would get from selling them. If true, it is maximizing the value of these assets while increasing its company’s value by building out renewable capacity, engaging in a best-of-both-worlds approach to transitioning to renewable energy and setting the company up to outperform.

While I acknowledge the possibility of both of these risks being born out, neither, especially not the first, seems all that likely to occur. I consequently have a good deal of confidence in my thesis.

Conclusion

NextEra Energy portrays itself as a renewable energy company, but at the end of the day, this is not the whole truth. Its loyalties are split between expanding into the growing world of renewables and defending its fossil fuel assets at the expense of renewables. This two-faced approach to the energy transition will likely bleed NextEra of many supporters and investors as renewable generation expectations are raised for energy companies in the future.

Still, NextEra is making some genuine progress on renewable energy buildout, and despite its attacks on renewables in recent years, it’s still progressing toward increasing renewables generation itself, which means the company won’t be completely left behind as the energy transition gets underway.

As such, for long term, buy-and-hold energy investors looking for companies that will prosper during the green energy transition, I rate NextEra Energy a hold.

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