If you're searching for income-producing stocks, NextEra Energy Partners (NYSE: NEP) and its 11% dividend yield is an alluring choice. The renewable energy company provides visibility into future growth, but that can be a drawback when expectations suddenly shift, as they did in September last year.
The company is feeling the impact of higher interest rates and has taken steps to bolster its financial position. With the stock down 45% from its 52-week high, NextEra Energy Partners presents an intriguing opportunity for patient investors today.
NextEra Energy Partners' revised growth projections
NextEra Energy Partners is a limited partnership formed by its parent company, NextEra Energy (NYSE: NEE), in 2014. NextEra Energy is one of the world's largest producers of wind and solar energy, and it created a master limited partnership (MLP) in the form of NextEra Energy Partners to give investors a way to invest directly in renewables.
A benefit to investing in NextEra Energy Partners is that you have visibility into the company's future cash flows. That's because its projects are under long-term contracts and generally pay a fixed payment over the contractual period. Although investors have visibility into NextEra Energy Partners' future cash flows, this can open the stock up to significant volatility when growth expectations change, as they did last year.
In September, the MLP announced lower expected dividend growth, reducing its expected growth to 5% to 8% annually, down from previously guided growth of 12% to 15% annually. The stock plummeted 56% in the days following that announcement.
NextEra Energy Partners is addressing some of its debt obligations
NextEra Energy Partners funds its acquisitions using financial instruments like debt, convertible equity, or other credit facilities. It then uses cash flow from these assets to pay distributions to shareholders, which has increased yearly since going public. This business model can thrive during times of low interest rates, as the lower cost of financing can help it fund more projects thanks to a lower cost of capital.
Since going public, NextEra Energy Partners has made a steady stream of acquisitions thanks to funding from convertible equity portfolio financings (CEPFs). These financing options are similar to loans in that an investor provides capital, but that loan can be converted to equity at a later time.
As long as a company's share price keeps rising, this can be attractive because it allows investors to participate in its stock price appreciation. For the company, it means it has to issue fewer shares to satisfy the conversion. However, if a company's share price falls, it must issue more shares to satisfy this equity conversion option, further diluting its existing shareholders.
As interest rates have risen in recent years, financing costs have increased, weighing on NextEra Energy Partners' acquisitions. That, combined with its falling share price, has put the company between a rock and a hard place.
Image source: Getty Images.
NextEra Energy Partners is retiring some of these outstanding obligations and rebuilding its capital to alleviate these pressures. Last year, the partnership sold its Texas natural gas pipeline portfolio to Kinder Morgan for $1.8 billion. It used those proceeds to extinguish project-related debt and had $1.4 billion left over to buy out other CEPFs.
Its high payout ratio could make the dividend vulnerable to cuts
NextEra Energy Partners paid investors a distribution of around $0.88 per share in Q1, and management expects its payout ratio to be in the mid-90% range through 2026. This means it has a narrow margin for error, and failure to execute on improving its balance sheet while maintaining growth could lead to an eventual cut in its payout.
The high cost of debt could continue to weigh on the partnership. Coming into this year, many market participants expected interest rates to fall along with inflation. However, inflation, as measured by the year-over-year change in the Consumer Price Index, has remained stubbornly higher than the Federal Reserve's stated target of 2%.
After pricing in up to six interest rate cuts this year in January, market participants now expect three interest rate cuts through April of next year, according to CME's FedWatch Tool.
Is NextEra Energy Partners stock right for you?
Falling interest rates could be a tailwind for the business, but for now, higher financing costs will continue to weigh on it, and its distribution is vulnerable if it fails to execute its plans. If you're looking for a steady income you can trust, NextEra Energy Partners may not be appropriate for you.
However, a potential infusion of financing from private equity could help fund buyouts of other CEPFs and shore its balance sheet further. That, coupled with it juicy 11% dividend yield, could make it an intriguing pick for investors willing to tolerate these risks.
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Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Kinder Morgan and NextEra Energy. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
