NextEra Energy (NEE -0.86%) is one of the largest utilities in the United States. The stock has risen about 26% so far in 2019, easily besting the 18% advance of the broader utility group, as measured by Vanguard Utilities ETF. There are good reasons for that outperformance, but such a strong showing comes with a downside. Here's what you need to know before you buy NextEra Energy.
1. A long run
NextEra's 2019 performance isn't out of the ordinary. The utility's stock has outdistanced the broader utility peer group over the 1-, 3-, 5-, and 10-year periods as well -- and in a big way, with a massive 300% or so gain over the past decade, easily trouncing Vanguard Utilities ETF's advance of just under 130%.
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But here's the interesting thing: The numbers are roughly similar when you switch the comparison to the S&P 500 Index. NextEra's year-to-date gain beats the S&P's 19%. It also beats the S&P over the trailing 1-, 3-, 5-, and 10-year spans. Over the past decade, the S&P's nearly 190% advance easily lags behind NexEra's impressive gain. There's no doubt that NextEra has been a great stock to own.
2. And you get dividends!
Adding to the allure here is the company's impressive dividend growth. The company has increased its dividend every single year for 25 consecutive years. That puts it in Dividend Aristocrat territory. That's no small feat; only a couple dozen S&P 500 companies can lay claim to 25 or more years of annual dividend hikes.
But it's not just the length of the streak that's notable here. NextEra's dividend growth rate is also pretty incredible, with a nearly 10% annualized increase over the past 10 years. The average for companies with at least 25 years of annual hikes is closer to 8%. Two percentage points might not sound like a lot, but it adds up over time. And more recent dividend increases have been even larger, with the trailing 3-year annualized increase coming in at 13%.
3. A solid business
A company doesn't put up numbers like these without having a very strong business behind it. And that's definitely true when it comes to NextEra. It's the largest utility in Florida, a state that has been growing and is expected to continue growing as people move toward warmer climates. A growing population means more customers to charge. The utility also charges some of the lowest rates in the country and provides better-than-average reliability, leading to a generally positive relationship with the regulators that ultimately control NextEra's customer rates.
That, however, is just the foundation at NextEra, which is also one of the largest renewable solar- and wind-power producers in the world. This operation sells power to third parties under long-term contracts and provides a reliable stream of income. While not a regulated operation, it is a relatively safe complement to the company's utility core.
4. More to come...
Perhaps the most exciting thing about NextEra is that there's a lot of growth on the horizon. For starters, management has capital spending plans of up to $55 billion between 2019 and 2022. Roughly 45% of that will go to the regulated side of the business, which should lead to solid rate increases. The remaining cash will go to NextEra's renewable power segment, which will likely make more money as it gains in size.
All in all, NextEra expects to see earnings growth of 6% to 8% a year over the span. That's not huge, but for a utility, it's pretty good. It gets even better on the dividend front, where management is projecting annualized growth of between 12% and 15%. That's an impressive number for any company, let alone a utility. The reason it can grow dividends faster than earnings is because the company's roughly 60% payout ratio is notably below the industry average of around 70%. If you are into dividend growth stocks, NextEra should be on your short list.
5. But everyone knows
The problem with NextEra, which the impressive stock price advance hints at, is that Wall Street knows just how great a company it is. The yield, for example, is a miserly 2.3% or so compared to the utility average of roughly 2.8%. Clearly investors have rewarded the stock for its success and are pricing in continued strong performance.
Looking past the yield, the utility's trailing price-to-earnings ratio is currently over 30 versus a five-year average of 18. Rich valuation is also the case for its price to sales, price to cash flow, and price to book value, which are also above their five-year averages. And using forward earnings doesn't dramatically improve the situation, with the forward PE ratio sitting at around 24 versus a five-year average of 20.
NextEra is not cheap. That's the fly in the ointment here. And it's something that investors need to consider carefully before jumping aboard. Yes, NextEra is a great company, but great companies can be bad investments if you pay too much for them, to paraphrase Benjamin Graham, the man who helped teach Warren Buffett how to invest. That said, if you balance the company's earnings and dividend growth outlook, you could argue that it is fairly valued in today's market (which is itself on the expensive side). Still, what is clear is that NextEra is not on sale, at best you are paying full rate for a good company.
Now what?
Summing it all up, the decision to buy NextEra is not an easy one. If you are looking for a good value, this isn't it. If you are looking for a utility with an impressive growth outlook, it may be worth considering. And if you are a dividend growth investor, well, it would be hard to find a utility with better dividend growth prospects. You just need to go in knowing that NextEra's stock is expensive today. That's hardly a ringing endorsement for buying NextEra.
