NextEra Energy: a high-end company with a premium valuation (NYSE:NEE)
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Florida, the sunshine state, is home to several icons, the heat of Miami and Disneyworld, but also one of the best performing utility stocks in the S&P 500, NextEra Energy Inc (NYSE:NEE).
Data by YCharts
NextEra Energy is unique within the utility industry, with a growing regulated power distribution network (Florida Power & Light) as well as a significant stake in a power generation and transmission business. growing electricity via NextEra Energy Resources (NEP). Owning and controlling regulated utility companies provides predictable cash flow that the company can opportunistically deploy into higher growth investments such as solar farms through NEP.
In addition to a strong business model, NextEra also benefits from superior demographics in the Sunbelt state of Florida, one of the fastest growing states in the nation.
In this article, I will explore NextEra’s business performance from a strategic and financial perspective and provide my commentary on the direction I think the stock could take from there.
Increased demand = higher income
Let’s start with the basics. Regulated utilities provide energy (gas and electricity) to their customers at rates regulated by the local governments where they serve. Utility companies accept a lower price in exchange for what amounts to a state-sanctioned monopoly.
With this arrangement comes advantages and disadvantages. On the pro side, you have very stable earnings in almost all market cycles. On the other hand, growth can be hard to come by. Steady incomes and little or no growth are why the industry is so attractive to many retirees looking for bond-like predictability.
But not all utility companies are devoid of growth, one company that has successfully reversed this trend is NextEra. For the year 2022, NextEra increased its EPS from $2.55 to $2.90, or more than 13.7%! Considering how painful the past year has been for so many companies, 13.7% stands out as particularly remarkable.
But how did they do it? My opinion? Two reasons: An excellent regulated company NextEra Energy Resources.
FP&L is the state’s largest utility provider, controlling nearly all of Florida’s east coast, as well as a significant portion of southwest Florida.
Since the turn of the 21st century, Florida’s population has grown like a weed, growing from 16 million to over 22 million less than 25 years later. Florida’s population has grown so rapidly that in 2022 it took the top spot for population growth in the United States for the first time.
Florida’s low taxes and warm climate appeal to businesses and retirees alike. According to this author, this trend can be expected to continue as Americans flee from highly taxed states such as California and New York or colder regions more broadly, such as the Northeast and Midwest. As more wealthy people move to low-tax states like Florida, it can further strain high-tax states, resulting in even higher taxes that will only exacerbate the problem.
Such population growth provides a kind of rising tide, allowing NextEra to earn more and more every year, driven by ever-increasing demand for electricity from consumers and businesses moving in from other states.
NextEra Energy Resources initiatives also support NextEra’s growth. Although not the subject of this article, it should be noted that this subsidiary offers a substantial growth opportunity to the parent company through its various green energy projects.
NEP invests in wind, gas, nuclear, solar, storage, pipeline and transmission projects nationwide, not just in Florida, allowing them to build where the environmental and financial conditions are best.
These projects are often launched alongside an electricity supply agreement where customers pay a predictable price for a set amount of electricity over a long period of time. This provides financial predictability to the business and makes financing these large projects much more feasible. Its focus on green power can enable them to sell its power at a premium to companies and localities with a mandate to switch to green power, giving investors an added advantage.
Speaking of benefits, let’s take a look at how NextEra performs against some of its other peers. For this article, I want to effectively highlight that these companies were able to grow (both revenue and profit), returns on invested capital, and dividend growth.
Revenue and EPS
Data by YCharts
Right off the bat, we start to see why NextEra is so popular as it has significantly outperformed its peers. NextEra has grown its revenue by around 48% over the past decade, although that may not sound like much, in the world of utilities, it’s pretty fast. This 48% increase in revenue was enough to allow NextEra to double its earnings per share over the same period thanks to its operating leverage. Peers like Dominion (D) and ConEd (ED) were only able to generate 30% growth in their EPS over the same period, underscoring NextEra’s relative strength.
Data by YCharts
Shifting our focus to ROI, we can see that these 4 companies score relatively low on this metric. This is due to heavy price regulation and the huge amount of capital needed to invest in maintenance and new projects. Although lower overall, NextEra still has the highest return on investment of this peer group, around 4%, compared to its peers which are closer to 3%.
Data by YCharts
As a utility company, investors practically demand a dividend. In the utilities sector, high dividends are common, but what is often rare is rapid dividend growth.
NextEra is one of those rare exceptions that meets this metric, having nearly tripled its payout over the past decade! While this is impressive, I expect dividend growth to moderate going forward, as over the long term dividend growth should follow earnings growth, which appears to be closer to 10% on the based on its long-term history.
No investment is without risk, and yes, that includes regular producers like NextEra. For me, the biggest risk NextEra faces is tighter financial conditions that make debt and equities more expensive to issue. As the Fed raised rates, banks began to slow lending, and investors demanded higher yields, pushing yields higher. Higher interest rates lead to lower asset prices, which also makes equity financing more expensive.
After last weekend’s bank failures, one would expect lending activity to remain below pre-covid levels, although this may be at least partially offset by lower interest rates that have recently priced in as investors doubt the Fed’s ability to continue raising rates. given the extreme pressure on several regional banks (KRE).
It’s hard to say what impact, if any, all of this will have on NextEra, but if capital markets shut down, growth opportunities are likely to slow and should likely be funded with a greater mix of internal capital.
Evaluation and conclusion
In conclusion, NextEra Energy is a well-managed company that has experienced truly impressive growth over the past decade. The company benefits from a strong regulated business through its subsidiary Florida Power & Light and a significant stake in the growing power generation and transmission business through NextEra Energy Resources.
Additionally, Florida’s rapid population growth is driving an increasing demand for electricity, which is beneficial to NextEra’s growth. In terms of financial performance, NextEra has significantly outperformed its peers, delivered strong returns on invested capital and has best-in-class dividend growth.
These are all reasons NextEra is a popular utility stock among investors, and the company’s growth trajectory suggests it could continue to be a solid investment…
Data by YCharts
But looking at NextEra’s valuation against its peers, it looks like the market has identified its superior business model by placing a premium multiple on its forward earnings at ~25x versus its peers trading between 14 and 20x long-term profits.
This puts investors in a difficult position, how much is it worth paying for a great company versus a good company?
Given the heightened uncertainty in the market and the fact that 2-year Treasuries are yielding more than 4%, I’m not convinced that a 4% double-digit growth earnings yield is a good enough investment. attractive for me to consider doing at this point. . If earnings fell to 20 times forward earnings, I would become much more interested in initiating a long position. For now, this company remains on my watch list.
I rate NextEra Energy at Hold.
I hope you enjoyed reading my article! If you enjoyed this or would like to discuss anything mentioned, please let me know in the comment section. Cheers!