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NextEra Energy: Valuation Compression Risks Remain
Stock Analysis & Ideas

NextEra Energy: Valuation Compression Risks Remain

NextEra Energy (NEE) is one of North America’s biggest electric power and energy infrastructure companies, and a prominent player in the renewable energy industry. The company runs two principal businesses, FPL and NEER.

Business Breakdown

FPL is Florida’s largest electric utility and one of the largest electric utilities in the country. FPL is focused on investing in the generation, transmission, and distribution infrastructure to achieve affordable customer bills, increased reliability, and clean energy generation for more than 5.7 million customers.

On the other hand, NEER is the biggest generator of renewable energy from the wind and sun in the world. The company is also a world leader in battery storage. NEER is focused on developing and operating assets throughout the U.S. and Canada under long-term contracts. These assets primarily consist of clean energy infrastructure, including renewable generation facilities and battery storage projects.

NextEra shares’ performance has been one of the most impressive amongst its industry peers over the past decade. Following the stock’s decade-long rally, the company is valued at around $169.1 billion, making it the highest-valued utility in the country. To provide some perspective on NextEra’s dominance, the second-most valuable utility in the U.S., Duke Energy (DUK), is valued at “only” $87.8 billion.

On the one hand, NextEra is a trustworthy company that should continue rewarding its shareholders with growing capital returns going forward. On the other hand, I believe that investors have been paying an increasingly steep premium for the stock, leading to NextEra’s valuation multiples expanding substantially over the past decade. 

Accordingly, I am neutral on the stock.

Recent Developments & Growth Estimates

NextEra Energy’s Q4 results came in rather strong, with revenues growing 15% to $5.05 billion. NextEra’s profitability and future earnings projections were also quite promising.

Adjusted earnings increased to $814 million, or $0.41 per share, compared to $785 million, or $0.40 per share in last year’s comparable period. Hence, on an adjusted basis, the company’s earnings for the full year totaled $5.02 billion, or $2.55 per share, an increase of 10.4% compared to $4.55 billion, or $2.31 per share, in Fiscal 2020.

Earnings growth was primarily driven by NextEra’s continued investments. Further, under a new agreement with Florida Power & Light, NextEra now expects that its average annual growth in regulatory capital employed is going to be between 8% and 9% through 2025. Accordingly, the company raised its adjusted earnings per share expectations over the medium term.

For this year, NextEra expects adjusted EPS to land between $2.75 and $2.85. The company then forecasts adjusted EPS growth between 6% and 8% per year through 2025.

Dividend & Valuation Expansion

Utility companies have historically paid substantial dividends to shareholders because their cash flows are rather predictable compared to most other businesses.

Amid its continuous growth, NextEra has managed to grow its dividend quite rapidly as well. The company now counts 27 years of consecutive annual dividend increases, featuring a 10-year dividend per share CAGR of 10.84%. 

Dividend growth has not slowed down even a bit over the years. In fact, NextEra’s latest DPS increase in February was once again in the double-digits, equaling 10.4%, highlighting the company’s commitment to shareholder returns.

At the midpoint of management’s Fiscal 2022 adjusted EPS guidance and the current DPS run-rate of $1.70, NextEra’s payout ratio stands at a healthy 60.7%. Hence, the company is likely to sustain DPS growth in the double-digits for the next several years without its payout ratio reaching worrying levels.

However, with investors likely (over)appreciating NextEra’s growth prospects and overall qualities, the stock’s valuation has expanded to rather distressing levels. 

The midpoint of management’s adjusted EPS guidance implies a forward P/E of 30.7, which is quite rich for the industry. In fact, the company’s forward P/E has expanded from just under 20 between 2013 and 2015 to a range between 20 and 30 since then and 2020. From another point of view, NextEra’s price/book ratio has expanded from around 2.3 in 2014 to a rich 4.5 as of today.

As a result, despite the company’s double-digit dividend hikes, the stock’s yield has been on a downward trend for years. At just under 2%, NextEra’s yield is currently at the very low end of its historical range.

Therefore, current investors are subject to softer capital returns than previously, which may not be enough to counterbalance the damage of a potential valuation multiple compression.

Wall Street’s Take

Turning to Wall Street, NextEra Energy has a Strong Buy consensus rating based on nine Buys and three Holds assigned in the past three months. At $93.33, the average NextEra price target implies 8.4% upside potential, nonetheless.

Conclusion

Overall, I believe that NextEra is one of the highest quality companies in the utility sector. The company’s focus on renewables has positioned it well for the future, while its track record of consistent shareholder value creation is undoubtedly impressive.

With a clear EPS growth outlook through 2025 and adequate room for further dividend hikes ahead, NextEra is likely to keep providing dividend growth investors with rising payouts. 

However, at its current valuation levels, investors are likely overpaying for the stock. Further, the current dividend yield could hardly compensate against the cracks of a potential valuation contraction.

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