Reliable dividend stocks with the potential for long-term payout growth can be solid choices for investors looking to generate cash and even beat the market overall. When a company delivers those dividend hikes, a low-yielding stock can turn into a high-yield stock before you know it.
NextEra Energy Partners' (NEP -2.04%), with its 4% dividend yield, may not qualify as a high-yield stock among yieldcos now, but there's good reason to expect big payout growth ahead, which I think makes it one of the top dividend stocks for investors to buy today.
The value of a growing dividend
NextEra Energy Partners' dividend today sits at $1.68 per share. But management expects to grow the dividend 12% to 15% annually through 2023, which at the high end of the range would more than double its payout between the end of year 2017 dividend of $1.62 per share and end of year 2023's projected dividend.
|Dividend at 12% Growth
|Dividend at 15% Growth
The implied yield in 2023, then, based on today's stock price, could be nearly 9%.
NextEra Energy Partners is in a good position to make such forecasts because its cash flows are predictable. Its 3,700 MW of renewable energy assets and seven pipelines have an average of 18 years left on their contracts with customers, primarily through power purchase agreements with utilities. And its parent company, NextEra Energy, has lots of projects it can drop down to the yieldco to provide revenue growth.
How yieldcos can grow their dividends indefinitely
What separates top-tier yieldcos from the rest of the crowd is the strength and dedication of their sponsors. NextEra Energy is NextEra Energy Partners' sponsor, and it not only runs the company, it provides some of the projects for the company to acquire that will ultimately grow the dividend.
NextEra's Energy Resources business develops and builds wind, solar, and energy storage facilities that can be sold, or dropped down, to NextEra Energy Partners over time. It currently has 20,000 MW of renewable energy generating capacity with a 28,000 MW pipeline of future developments.
NextEra Energy Partners can acquire new projects -- whether from its sponsor or from third parties -- either by using the cash on its balance sheet, or by issuing new shares and debt. But even when it uses its own cash, the company funds some of the drop down with cash and some with project debt. Right now, the ratio is about 50/50 between cash and debt financing.
Acquisitions completed using stock involve buying projects that will have a higher rate of return than the stock's rate of return, for which we can use the dividend yield plus incentive distribution rights (IDR) of 25% as a proxy. For example, if a dividend yields 4% we add the 25% IDR to get about a hurdle rate of at least 5% to acquire projects. If a project that has an 8% rate or return is acquired, we can assume the project will be accretive to the dividend long-term. Traditionally, this is how yieldcos have funded most of their growth. However, this requires the stock to maintain a low dividend yield to work properly, which doesn't always work in a yieldco's favor.
NextEra Energy Partners has used both strategies in the past, but the great thing about the company today is that it has the balance sheet and expected cash flow to fund its planned growth through 2020 from its balance sheet. That means it won't be dependent on the stock maintaining a certain price to drive dividend growth, which in turn reduces the risk that dividend growth won't come to fruition.
A dividend you can count on
NextEra Energy Partners is one of the most stable energy stocks on the market, and it has a bright future. The company has renewable energy assets and a few pipelines with an average of 18 years of contracted cash flow that assure long-term stability. On top of that, it will generate enough cash from the business to keep acquiring projectsand growing the dividend at least through 2020. Unless something unforeseen happens, it has visibility for 12% to 15% annual dividend growth through 2023.
A yieldco with a yield of 4% may not seem impressive on the surface, but given the opportunity for long-term dividend growth from a stable business, this is the one dividend stock I would buy today, and hold for many years to come.