NextEra Power Companions (NYSE:NEP), as soon as a high-flying dividend inventory, has seen its inventory value languish amidst increased rates of interest. With the inventory yielding practically 7%, dividend traders could also be questioning if it’s time to “again the truck up” so to talk. Buyers might be having hassle adjusting to the fact of the upper rate of interest setting, as NEP might face nice issue in driving development in such an setting. I focus on how the upcoming debt maturities might additional strain development charges, making the 7% yield look costlier than low-cost. Previous outcomes don’t predict future efficiency – I’m uncertain that the corporate can obtain its aggressive 12% to fifteen% distribution development steering with out compromising its already extremely leveraged steadiness sheet.
NEP Inventory Value
Heading into 2022, NEP was one of many largest winners within the dividend area, providing a uncommon mix of yield and development. The inventory has crashed closely from latest highs as a result of increased rate of interest setting.
I see that my colleagues have a really bullish view of the inventory.
With the inventory providing its most tasty valuation ever (when it comes to dividend yield), I searched arduous for causes to affix the bandwagon – however sadly got here to the conclusion that draw back or at the very least underperformance appeared extra probably right here.
NEP Inventory Key Metrics
I do not intend to rehash the enterprise story right here – my colleagues have written excellent reports on this already. However here’s a fast refresher on the corporate and up to date monetary outcomes. NEP is an power firm primarily targeted on renewable power technology. The corporate does have some pipeline publicity, however it’s engaged on promoting off these property to grow to be a pure-play renewable power funding.
The thought is that its prospects signal long-term contracts, agreeing to pay for a base quantity of power technology at a sure value. NEP sometimes acquires these property from its guardian firm NextEra Power (NEE). In some sense, NEP may be regarded as being fairly just like web lease REITs (‘NNN REITs’) as a result of long-term contracts and similarity to sale and leaseback transactions. NEP’s counterparties have a median BBB+ credit standing and the corporate has elevated its buyer roster quickly over the previous a number of years.
In its most up-to-date quarter, NEP noticed each adjusted EBITDA and money accessible for distribution (‘CAFD’) decline YOY as development from new initiatives was unable to offset declines at present initiatives.
Administration expects development to choose up within the second half of the yr, with as much as $860 million in projected CAFD for the complete yr. Administration has reiterated expectations for 12% to fifteen% common distribution development by means of 2026, however on the conference call famous that it could be extra on the low finish of that vary.
I believe that the dedication to the distribution development steering is what’s serving to many traders preserve their conviction regardless of the rising warning indicators from the macro setting.
Is NEP Inventory A Purchase, Promote, or Maintain?
At first look, NEP appears like an outright steal, buying and selling at its highest distribution yield ever at round 7% whereas administration is guiding for at the very least 12% ahead development.
However that’s not the precise manner to have a look at it. As an alternative, traders needs to be asking how plausible the steering is. Think about that primarily all of the money stream development in 2022 got here from new initiatives. With NEP seeing declines at present initiatives this yr, it’s clear that we shouldn’t be anticipating development, if in any respect, from present initiatives, at the very least not on a constantly recurring foundation. That is a technique wherein NEP differs from NNN REITs which usually have annual lease escalators (and thus can publish some development even with out exterior acquisitions).
The inventory presently yields simply shy of seven%. Based mostly on the excessive finish of CAFD steering, NEP will generate round $4.52 in CAFD per share in 2023 (for these checking the mathematics, I notice that the market cap generally reported isn’t together with the models owned by NEE). The inventory is buying and selling at a roughly 9% CAFD yield. Property, plant, and tools elevated by $3.5 billion from 2021 to 2022, implying round an 8.5% yield on new acquisitions. The acquisition yield is even decrease if we evaluate 2022 outcomes with these from 2019 at round 6.8%.
That calculation means that funding new acquisitions by means of retained money stream is not going to create extra shareholder worth. One other option to put it, if NEP solely used retained money stream to fund new acquisitions, then one of the best that shareholders might hope for is round 2% development. Issuing inventory to fund acquisitions could also be dilutive or solely mildly accretive, at finest.
However with administration nonetheless committing to their 12% distribution development steering, that suggests that they might be seeking to challenge debt to fund acquisitions. I notice that NEP has $6.3 billion in long-term debt and administration expects to be close to the excessive finish of S&P’s metrics by the top of the yr. In different phrases, I do not see a lot capability right here from a debt perspective to fund accelerated acquisitions.
What’s extra, the typical yield for BB-rated issuers hovers round 7%.
In contrast to in previous years the place NEP may need loved increased funding spreads in addition to the flexibility to ramp up leverage, the trail ahead appears more difficult. Between NEP’s excessive leverage load and the excessive price of capital, I wrestle to see how NEP will come remotely near producing 12% money stream development on a sustainable foundation. Sure, NEP might in concept maintain strong distribution development within the close to time period by elevating its payout ratio, however that can’t be sustained over the long run.
There’s one more challenge. NEP is ready to see round $3.4 billion of debt mature by means of 2027. These debt securities had been initially issued with very low rates of interest.
Assuming a 7% rate of interest is used on new debt to refinance these maturities, that may result in roughly $150 million in additional curiosity expense, which might make up over 17% of full-year CAFD steering. Averaged out over 4 years, that suggests round 4% of annual drag which will maintain down development charges. I would not be stunned if curiosity expense headwinds alone are capable of hold CAFD development charges very near zero (not to mention distant from 12%).
The place does that depart us? NEP appears like a 6.7% yielding inventory with poor development prospects. Sure, a 6.7% yield is increased than the inventory has yielded traditionally, however ahead development charges aren’t prone to resemble these of the previous. If something, this can be a identify which can current additional draw back to round 8%, as that may be extra in step with anticipated returns from the broader market (and lots of different excessive yielders are hovering round that degree). Maybe one would possibly need to purchase NEP because of views that rates of interest would possibly fall. Nevertheless, there are arguably extra compelling methods to precise such a view, and one mustn’t rule out the likelihood that NEP continues to commerce at a reduction because of traders now realizing that the corporate is so uncovered to rising rates of interest. Is that this a brief? At these valuations, I see a larger case for underperformance reasonably than an outright implosion. It’s attainable that many traders are OK with a flat 6.7% yield, at the very least lengthy sufficient to make financing a brief unreasonable. With the draw back at round 14% (excluding the dividend), the risk-reward doesn’t look favorable for brief positions. I charge NEP with a impartial ranking because the excessive yield is greater than offset by poor development prospects.