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Solar-power stocks and master limited partnerships (MLP) have captured the market’s imagination of late, with the World Solar Energy Index and the Alerian MLP Index handily outperforming the S&P 500 thus far in 2014.
Against this backdrop, it’s no surprise that NextEra Energy Partners LP (NYSE: NEP)–a publicly traded partnership that specializes in renewable energy–has been a slam dunk since its initial public offering (IPO) on June 26.
In fact, the stock has rallied by 40 percent since debuting on the New York Stock Exchange, propelling it to second place among the energy-related MLPs that completed their IPOs this year.
Only GasLog Partners LP (NYSE: GLOP), which went public in early May and owns tankers that transport liquefied natural gas (LNG), has outperformed high-flying NextEra Energy Partners.
Over the past decade, NextEra Energy Partners’ sponsor and general partner, NextEra Energy (NYSE: NEE), has quadrupled its wind- and solar-power capacity to more than 10,000 megawatts (MW).
After this building spree, the utility accounts for 17 percent of the nation’s capacity to generate power from the wind and 14 percent of its solar-power capacity.The company also plans to add 2,500 MW over the next three years.
NextEra Energy has contracted all its current and future renewable-energy output to regulated utilities, investment-grade corporations and government entities under agreements with an average duration of more than 20 years.
This conservative strategy provides a high degree of visibility to the utility’s future cash flow by limiting speculative building and insulating the firm’s revenue against fluctuations in the wholesale power market. These qualities make NextEra Energy’s renewable-energy assets a perfect candidate for a MLP.
With NextEra Energy Partners’ well-received IPO, the parent company raked in about $467 million in proceeds that can be plowed into growth projects.
Equally important, the creation of the MLP gives NextEra Energy a vehicle to monetize its renewable-energy assets at a higher valuation than they receive internally. (We discuss this phenomenon at length in MLPs Remain Popular Way to Monetize Energy-Related Assets.)
Because NextEra Energy owns the general-partner interest in NextEra Energy Partners and 83 percent of the newly listed MLP’s float, the utility enjoys ample exposure to further upside in the partnership’s unit price and quarterly distribution.
And NextEra Energy won’t pay US state or federal income taxes on the earnings generated by the 10 wind- and solar-power plants that the utility conveyed to the MLP prior to its IPO.
As for NextEra Energy Partners, the MLP’s initial asset base comprises 989.6 MW of generating capacity, all of which operates under contract until at least 2029, when 22.5 MW comes up for renewal.
Parent NextEra Energy has designated an additional 1,549 MW of generating capacity for potential drop-down transactions, effectively giving the MLP the right of first refusal to acquire these assets at accretive terms. The contracts on the aforementioned renewable-energy assets expire between 2030 and 2041.
On June 2, 2014, the Environmental Protection Agency proposed dramatic cuts in carbon dioxide emissions from US power plants. (See EPA’s Crackdown on CO2 Emissions: An Indecent Proposal?.)
“The Cost of Cutting Carbon” outlines the dozen states that face the largest emission reductions.
Wind- and solar-power installations only produce electricity when the wind blows or the sun shines; the intermittent nature of these renewable energies currently require backup sources of power, though advances in energy storage hold promise.
And these technologies remain more expensive than natural gas, the price of which has declined precipitously in the US because of surging production. The economics of wind and solar power depend on subsidies and state mandates that may not survive the next presidential election cycle.
For at least the next few years, however, demand for new wind- and solar-power capacity appears solid.
And by requiring long-term contracts with high-quality counterparties as a prerequisite to future capacity additions, NextEra Energy and NextEra Energy Partners should be able to sustain their growing payouts even if these technologies lose favor.
The Bottom Line: Despite the cyclical nature of the renewable energy business, NextEra Energy Partners’ conservative business model is built to last.
Next Era Energy Partners’ prospectus calls for the firm to pay an initial distribution of $0.1875 per unit, implying a 2.1 percent yield at the stock’s current quote.
Assuming that the MLP meets the high end of management’s guidance for annual distribution growth of 12 percent to 15 percent through 2016, the stock’s implied yield increases to 2.4 percent for year No. 1 and 2.8 percent for year No. 2.
By comparison, NRG Yield (NYSE: NYLD)–a recent spinoff of NRG Energy (NYSE: NRG)–boasts a dividend yield of 2.7 percent. That’s after the stock surged by 138 percent since its IPO in July 2013. And the Alerian MLP Index, a basket of 50 popular MLPs, sports a distribution yield of 5.2 percent.
At these levels, NextEra Energy Partners’ stock trades at roughly three times its book value–more than twice the multiple commanded by Brookfield Renewable Energy Partners LP (TSX: BEP-U, NYSE: BEP), a pure play on renewable energy (wind and hydropower) that boasts a longer track record and yields 5.4 percent.
Brookfield Energy Partners continues to grow its cash flow and distribution via asset acquisitions and expansion projects.
In late June, for example, the Canada-based company completed the purchase of a 321 MW of wind-power capacity in Ireland.
But solar power has panache in a market bedazzled by the likes of SolarCity (NSDQ: SCTY), an upstart company whose losses accelerate with every uptick in revenue. The steady cash flow generated by low-cost hydropower doesn’t measure up in this regard.
NextEra Energy wisely cashed in on the solar-power craze with the IPO of NextEra Energy Partners.
However, savvy investors should wait for the stock to pull back–a secondary offering in advance of a drop-down transaction would create a good opportunity–before establishing a position.
Icarus learned the hard way about flying too close to the sun. So have countless investors who bought into solar power’s hype when valuations in the industry were approaching their zenith.
Solar power is here to stay as part of the global energy mix. But we prefer value to momentum at this juncture.
Elliott and Roger on Oct. 29, 2018
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