Regulated utilities have long been a staple of dividend portfolios, and a handful of them are included in our list of the best high dividend stocks for good reason.
Their highly stable business models generally make for attractive and safe current yields, with slow but steadily-growing payouts.
Best of all, utilities generally have very low stock price volatility, making them ideal core holdings for low risk income portfolios and investors living off dividends in retirement.
However, there are a few fast-growing utilities that manage to provide most of the benefits of this industry, along with impressive payout growth and long-term total returns.
Such is the case with NextEra Energy (NEE), which has proven to be one of America’s best regulated utilities over the past few decades with an annualized return in excess of 12% since 1995.
Let’s take a closer look at what has made NextEra Energy such a remarkable success story and if this utility is likely to continue generating industry-leading growth over the coming years to make it a “buy and hold forever” dividend growth stock.
Founded in 1984 as Florida Power & Light (FPL), NextEra Energy changed its name in 2010 to better represent its aggressive push into renewable solar and wind power (the company is the world’s number one generator of wind and solar energy).
Today the company provides electric utility services to 9.5 million Floridians via its 4.8 million FPL accounts; however the business has evolved into so much more.
For example, the company is one of America’s largest electric utilities with 46.4 GW of capacity in 27 states and Canada. Close to 40% of that capacity comes from the company’s widely diversified solar and wind generation (part of its NextEra Energy Resources subsidiary), which makes it America’s largest renewable energy supplier.
NextEra Energy appears to be well positioned for a low carbon future, thanks to one of the least carbon intensive generator fleets in the industry.
To help supply cheap gas to its power plants, as well as serve as an additional way of diversifying into stable cash flow sources, NextEra Energy also has a fast-growing midstream gas pipeline business (also part of its NextEra Energy Resources subsidiary).
In addition, the recent $18.4 billion acquisition of Oncor Electric, the largest electricity distributor in Texas, will likely provide a strong long-term earnings boost to NextEra, courtesy of synergies provided when it combines Oncor’s 119,000 miles of transmission lines with its own fast-growing wind and pipeline assets in the state.
Source: NextEra Energy-Oncor Electric Merger Presentation
As you can see, currently NextEra’s rate-regulated utility Florida Power & Light remains its largest business. However, NextEra Energy Resources, the company’s diversified clean energy company, is the key growth catalyst that makes this such an interesting long-term dividend growth investment.
|Business Segment||% Of Revenue||% Of Net Income|
|Florida Power & Light||67%||60%|
|NextEra Energy Resources||31%||38%|
Source: Q4 2016 Earnings Release
Don’t let the apparent variability of NextEra Energy’s sales and earnings growth fool you. That variability is largely a result of the company’s wind assets, which make for moderate amounts of revenue volatility.
However, as you can see, the company’s returns on shareholder capital are far more stable, and its operating margins have been quickly and steadily growing over time.
The reason for that is the very low (and declining) marginal cost of its wind and solar assets. Specifically, once a utility-scale wind or solar project is complete and a long-term (20-30 year) power purchase agreement, or PPA, signed with another utility, those operations become very profitable. After all, wind turbines and solar panels are generally low maintenance assets and their fuel is free.
Meanwhile, the utility’s large gas-powered production fleet takes advantage of very low cost natural gas, courtesy of America’s shale gas boom (especially in Texas, Pennsylvania, and Ohio).
Combined with the highly favorable regulatory environment in Florida, NextEra Energy generates some of the best profitability in the electric utility industry.
|Utility||Operating Margin||Net Margin||Return On Equity|
Specifically, regulators have been highly amenable to steady base rate increases (including another $1.3 billion increase expected between 2017 and 2020, according to Morningstar) for FPL.
This has been driven in part by the need to incentive infrastructure investments in the areas that NextEra Energy’s regulated utility operations serve, which are characterized by relatively fast-growing populations (for a utility). You can see that Florida’s economic growth remains in good shape, for example:
As a result, FPL enjoys strong opportunities to increase its regulated asset base.
This creates a steadily growing and predictable cash flow stream that has allowed NextEra Energy to consistently generate some of the industry’s best long-term earnings and dividend growth.
This kind of fast growth is likely to continue now that NextEra will be adding the sales, earnings, and cash flow from Oncor.
Better yet, because Texas (another highly favorable regulatory environment) and Florida are expected to experience strong population growth in the coming decades, NextEra is ideally situated to take advantage of growth in both its regulated utility business, as well as the coming boom in renewable energy.
|State||Pop 2010||Pop 2030||Pop 2050||Pop 2100|
|Texas||24.6 million||33.1 million||45.6 million||99.3 million|
|Florida||19.3 million||28.7 million||42.2 million||111.9 million|
Source: US Census Bureau Projections
In fact, as much as 5.4 GW of additional wind and solar projects are expected to be constructed in the next two years.
To help pay for all of this additional renewable energy capacity, the utility has set up a YieldCo called NextEra Energy Partners (NEP). This is a Limited Partnership similar to a Master Limited Partnership, or MLP.
NextEra Energy serves as the manager, sponsor, and general partner of NEP, owning 34.8% of its limited units, as well as its lucrative incentive distribution rights.
The way it works is that once NextEra completes a solar or wind project and obtains a long-term PPA for it, it will sell or “drop down” the project to NEP, who pays for it via raising debt and equity capital from investors.
NextEra Energy Partners gains a stable, long-term source of cash flow which then funds its very generous and fast-growing distribution (management targets 12% to 15% annual distribution growth).
And because NextEra Energy owns so much of the YieldCo, most of that cash flow ends up coming back to it. This creates a high margin cash flow stream that only further strengthens the security and growth prospects of the parent company’s dividend.
The utility industry is extremely capital intensive, which means that, like most electric utilities, NextEra Energy has a large amount of debt on its balance sheet.
And thanks to the Oncor acquisition, that figure will soon grow to $40.3 billion. While that isn’t a dangerous level of debt relative to the size of its cash flow (more on this in a moment), rising interest rates could increase the company’s interest expense and cost of capital. That could decrease the amount of potentially profitable new projects the company can invest in.
Another risk to keep in mind is that because both NextEra Energy and NextEra Energy Partners rely on periodic equity issuances to raise growth capital, they are somewhat at the mercy of fickle investor sentiment.
That’s especially true if interest rates rise high enough to decrease investor demand for high-yield investments such as utilities. While the dividend and distribution for NextEra Energy and its YieldCo are highly secure, if income investors can eventually obtain 4%, 5%, or 6% from risk-free Treasury bonds, then demand for shares and units of NextEra and NEP could fall.
Low share and unit prices for NEE and NEP, respectively, may further slow the rate at which the company can grow.
Finally, we can’t forget that as a regulated utility much of NextEra Energy’s future growth is in the hands of Texas and Florida regulators. While up until now the need for aggressive electric infrastructure expansion has meant friendly regulatory environments, a prolonged recession in either state could create political pressure to cap rising electricity rates.
Renewable energy is another risk to consider, given its dependence on tax credits. U.S. Federal tax incentives for completed renewables projects have been extended into the next decade, but this is generally a murky area to keep track of.
These risks could slow NextEra’s impressive earnings growth, as well as that of its dividend.
NextEra Energy’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.
NextEra Energy has a Dividend Safety Score of 96, which indicates that its dividend is extremely very safe and dependable. This is largely due to two factors.
First, management has been very conservative with how quickly it grows the dividend, preferring to maintain a relatively low EPS payout ratio of around 50% over time. That’s compared to many electric utilities that payout 75% to 85% of earnings.
Combined with the largely recession-proof nature of its business model, this low payout ratio creates a large buffer protecting NextEra’s dividend. It also allows management to be very consistent and generous with its payout growth, even during severe economic downturns such as the Great Financial Crash of 2008-2009.
In fact, NextEra Energy, with 22 straight years of dividend increases, is just three years away from becoming a dividend aristocrat.
The second protective factor is the utility’s strong balance sheet. While its leverage ratio (Debt / EBITDA) is slightly above the industry average and its current ratio slightly below, the strong and consistent cash flow it generates from its regulated business (as well as highly profitable renewable energy segment and midstream pipeline business) still grants it an excellent credit rating and keeps its borrowing costs low.
|Utility||Debt / EBITDA||Debt / Capital||Current Ratio||S&P Credit Rating|
Source: Fastgraphs, Morningstar
NextEra has plenty of liquidity available to grow, either through its large backlog of growth projects or through accretive acquisitions such as Oncor, without threatening its ability to sustain or grow the dividend.
NextEra Energy’s Dividend Growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
NextEra Energy has a Dividend Growth Score of 57, which suggests that the company’s dividend growth potential is above average. As you can see, NextEra Energy has one of the most impressive dividend growth track records of any regulated electric utility.
With a low payout ratio, as well as three major growth markets (Florida, Texas, and U.S. wind and solar power) to drive its future revenue, earnings, and free cash flow growth, NextEra investors can likely expect around 6% to 8% dividend growth to continue for the foreseeable future.
NEE shares trade at a forward P/E multiple of 20.3 and offer a dividend yield of 2.9%, which is somewhat lower than the stock’s long-term historical median yield of 3.2%.
While NextEra Energy’s long-term future is very appealing, it’s hard to make a compelling valuation case for the stock today.
Given the quality of the company, including its impressive growth runway and dividend growth record, you’d expect to pay a premium.
However, NEE would be more appealing to me at a price closer to $120 (currently trading at $135), which would represent a forward P/E multiple more in line with the broader market’s multiple and a yield of 3.3%.
When combined with the company’s expected 6-8% long-term annual earnings growth rate, NEE would offer annual total return potential of around 10% at that price (3.3% yield plus 6-8% annual earnings growth).
Closing Thoughts on NextEra Energy
Dividend investors have learned to think of utilities as boring, high-yield income generators. However, as we’ve seen today, NextEra Energy is one of the fastest-growing utilities in America and appears to have a bright future ahead of it.
With strong profitability, a generous dividend that is likely to continue generating strong payout growth for the foreseeable future, and NextEra Energy Partners providing a nice high margin growth kicker with meaningful exposure to renewable energy markets, NextEra Energy is a standout utility stock.
I am adding the stock to my watch list and will be hoping for a pullback to give the stock stronger consideration for our Top 20 Dividend Stocks portfolio.