ET - NextEra Energy Partners: Investors Are Too Fearful Of This 15% Yield

2023-11-29 20:37:36 ET

Summary

• NextEra Energy Partners has a sustainable 15% dividend yield despite concerns of a potential distribution cut.
• The company focuses on alternative energy projects and is well-positioned to benefit from the ongoing drive to decarbonize the US industry.
• Financials show a healthy uptrend, with strong EBITDA and cash flow growth, indicating a low payout ratio and solid distribution coverage.

The 15% yield of energy company NextEra Energy Partners ( NEP ) looks, at first glance, to be a high-risk yield where the payer might be forced to institute a pay-out cut, possibly due to insufficient dividend coverage or weak business fundamentals.

On the contrary, NextEra Energy Partners is a well-managed energy company that produced more than enough cash flow to finance its dividend and grow its distribution, albeit at a lower rate.

NextEra Energy Partners’ unit price crashed after the company said that it would slow its rate of distribution growth in September and the unit price has not substantially recovered from this shock.

Though there are risks with NextEra Energy Partners, the distribution is set to grow and the high 15% dividend yield should be sustainable.

What Happened To Units Of NextEra Energy Partners?

The unit price of NextEra Energy Partners crashed in September after the company issued a press release saying that it expects to grow its distribution at a rate only between 5-8% moving forward.

The ensuing selloff occurred over fears of a potential distribution cut as well as the prevalence of high interest rates which the company itself cited as a reason for scaling back its growth ambitions.

Taking into account that NextEra Energy Partners still covers its distribution with cash flow and has considerable excess dividend coverage, I think that passive income investors have an opportunity here, two months after the selloff, to still buy NEP’s attractive 15% yield.

Business Profile And Growth Opportunity

NextEra Energy Partners is focused on the development of alternative energy projects, particularly in the wind and solar sectors. The company acquires, manages, and owns clean energy projects that generate long-term, predictable cash flows and its assets span the United States.

The key driver for the investment thesis is an ongoing drive to de-carbonize the U.S. industry, meaning clean energy sources such as wind and solar are going to produce a higher share of U.S. energy production.

NextEra Energy Partners seeks to replace high-carbon energy sources with low-carbon energy sources like wind and solar, which is the company’s core focus already. NextEra Energy pegs the decarbonization revenue opportunity at $4 trillion, with wind and solar playing a particularly dominant role in driving the energy transition.

By 2030, electricity generated through power and solar is expected to double to a 32% energy share and companies like NextEra Energy Partners are set to profit from these trends.

Financials Show A Healthy Uptrend, Outlook For 2023 Implies A Low Pay-Out Ratio

The energy transition means big bucks for companies that invest in such alternative energy sources, in large part because the U.S. government is heavily supporting investments. As a consequence, NextEra Energy Partners’ EBITDA and cash flow are rapidly growing and the company’s adjusted EBITDA rose 29% YoY to $488 million in the third quarter.

Cash available for distribution, which quantifies the cash flow that theoretically could be distributed to unit holders, was up 34% YoY to $247 million, with new investment projects making incremental earnings and cash flow contributions.

The outlook for the full financial year indicates that the company will generate more than enough EBITDA and cash flow to finance its distribution (which should continue to grow as well).

NextEra Energy Partners presently expects $1.9-2.1 billion in adjusted EBITDA and a minimum of $730 million in cash available for distribution which implies that the distribution is well-covered. Cash available for distribution reconciles from EBITDA and accounts for debt service, non-cash items, tax credits, and maintenance capital. The present distribution rate for NEP is $0.8675 per unit per quarter and the energy company raised its distribution in November by 1.6%.

The outlook and the present distribution rate mean that NextEra Energy Partners is set to pay out 44% of its cash flow, on a run-rate basis, at the end of the year. At $820 million in cash flow, the pay-out ratio drops to 40%. The pay-out ratios strongly suggest that the present distribution is solidly covered by cash flow and that a pay cut is not on the cards.

Since the pay-out ratio is below 50%, even in the minimum CAFD case, the distribution should be sustainable even in the event of new asset divestitures as well. In November, NEP announced the divestiture of its Texas natural gas pipeline portfolio and more asset sales may follow.

In the long term, I think NEP will move towards a 50% payout ratio as the company will continue to invest in capital-intensive new energy projects.

NEP’s 15% Yield Implies Undervaluation

NextEra Energy Partners is priced at a 14.7% yield though other energy companies with midstream-like assets sell for much lower yields, indicating that passive income investors have been carried away by their fears over slowing distribution growth.

Large energy companies with mid-stream focused energy portfolios generate stable cash flows from which disbursements are made. Enterprise Products Partners L.P. ( EPD ) and Energy Transfer LP ( ET ) are two such companies and their units sell for yields between 7-9% which is a reasonable yield range for mid-stream companies that pay high distributions to their investors.

This is also a yield range to which I would ultimately expect NextEra Energy Partners’ units to sell, considering that NEP similarly relies on long-term contracts with its customer base that translate into stable and predictable cash flows.

Headwinds To The Investment Thesis

NextEra Energy Partners does not appear to be headed for a distribution cut, based on the implied distribution pay-out ratio for 2023. The company also reaffirmed that it plans to grow its distribution moving forward, which to me is a signal that passive income investors have become too risk-averse with respect to NEP.

Future asset sales may result in a deterioration of NEP’s distribution coverage, but from a business performance point of view, the energy company is seeing growing EBITDA and cash flow. If those trends reversed, and NEP’s distribution coverage suffered, I would reconsider my buy rating.

My Conclusion

Passive income investors might want to take a closer look at NextEra Energy Partners as the company seems to have fallen out of favor after pointing at slower distribution growth in the future.

The present distribution appears to be well-covered by distributable cash flow and I don’t think that the company has an immediate incentive to force a distribution cut.

With considerable excess distribution coverage reflected in NextEra Energy Partners’ full-year forecast, I think that passive income investors still have an opportunity here to load up the truck with NextEra Energy Partners’ healthy 15% yield.

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