If you're looking to invest in renewable power stocks, you can always pick out pure plays that take advantage of the huge demand for clean energy -- and with utility customers inking long-term power contracts as they switch from dirty carbon-based fuels, that might be a winning strategy. However, what if the growth story behind renewables doesn't live up to today's hype?
That uncertainty is why a diversified company like NextEra Energy, Inc. (NEE 0.45%), with utility and renewable power operations, might make more sense for conservative investors.
Focusing on renewables
There's no question that a company like Brookfield Renewable Partners L.P. (BEP 0.92%) is a great direct play on renewable power. Roughly 80% of the company's power is hydroelectric, with the rest made up largely of wind and solar. Moreover, it has exposure to Brazil (20% of generation) and Columbia (15%), in addition to the United States (60%). Much of the company's growth has come from acquisitions, and long-term contracts back up the bulk of its revenues. It's a perfectly fine renewable power investment.
Image source: Getty Images
However, the hydro exposure creates risks related to rainfall, but that's just one of the concerns you need to think about. Brookfield generally sells its clean power under long-term contracts. It has contracts in place for 92% of its power generation today, but only 65% in 2022. Demand for renewable power is strong today, but it may not be as strong in the future as more clean energy options are brought into service. That means there's recontracting risk for Brookfield as the renewable energy industry matures. The risk, meanwhile, could be as little as a four years away.
With all of its eggs in the renewable power business, Brookfield is a pure play in a fast-developing market that's far from mature. It's an interesting way to gain exposure to the space that has seen material success so far. But supply and demand are tricky to balance and extrapolating previous results into the indefinite future could be a mistake if Brookfield is forced to sign power contracts at lower rates in the future. There's really no telling what might happen, which is why conservative investors may want a more diversified option.
Regulated and renewable
That's where a company like NextEra comes into play. Roughly 60% of the company's 2017 earnings came from its regulated utility business in Florida. This is the foundation upon which the company's renewable power operations have been built. The Sunshine State has benefited from long-term population growth, which means more customers for NextEra to serve. This is important, because it means there's demand backing the company's spending on the utility side of the business.
As a regulated utility, NextEra's Florida Power & Light business has to get rate hikes approved by the government; it continuously invests in its infrastructure to try to ensure rate approval. A strong demand for power, in addition to upgrades to existing assets (storm hardening, for example), provides a solid floor for NextEra's long-term growth plans on the utility side. NextEra expects to spend as much as $19 billion in this division between 2017 and 2020. Slow and steady growth is the norm here, which is boring but safe.
A quick overview of Florida Power & Light's business. Image source: NextEra Energy
The rest of NextEra's business (approximately 40% of 2017 earnings) is its Energy Resources unit, which is a renewable power company. Roughly 70% of its generation is wind power, with nuclear (14%) and solar (11%) the next largest contributors. It has roughly 28 gigawatts worth of wind and solar projects in the pipeline that should keep this unit growing well into the future. This is the exciting part of the business that makes it a renewable power play equal to any of the pure plays -- in fact, NextEra is one of the largest wind power companies in the world.
The combination of slow and steady growth at Florida Power & Light and renewable power expansion on the Energy Resources side is expected to help push NextEra's earnings up around 6% to 8% a year through 2021. That, in turn, will support dividend growth of as much as 14% through 2020, as the company's low payout ratio and strong balance sheet allow it to aggressively up the shareholder payout.
Energy Resources' project pipeline. Image source: NextEra Energy
But here's the key question: What happens if growth on the renewable power side stalls or fails to live up to expectations? The answer is that NextEra's regulated Florida Power & Light business is there as a backstop. As a regulated utility notably operating in a state with a growing population, this division should continue to reward shareholders with slow and steady growth even as residential solar absorbs some of that demand. Investors in NextEra get the benefit of a solid foundation and the exciting growth opportunity offered by renewable power today, all in one investment. That's a nice balance just in case renewable power doesn't live up to the hype.
A deeper dive
With an attractive 2.8% yield, NextEra Energy's projected earnings and dividend growth are pretty enticing for a utility. That's driven, of course, by the mixture of a boring old regulated utility with a renewable power company. Investors interested in renewable power would do well to consider this balanced approach to the energy space as a way to hedge against the risk that renewable power isn't the solution to the world's energy concerns. Unlike many of the pure-plays, NextEra has something to fall back on.
