Deep Dive: NextEra Energy Partners

In this episode of Industry Focus: Energy, host Nick Sciple and Fool.com contributor Matt DiLallo dive into the business of NextEra Energy Partners (NEP -0.89%). Tune in to learn what this company does, how it's different from NextEra Energy (NEE -1.36%) and NextEra Energy Resources, what the relationship is between NextEra Energy Partners and its parent, why NEP's dividend is so massive and growing so fast, some risks that investors definitely want to be aware of before diving in, and more. And, if you missed it, be sure to go back to last week's show for part one of the NextEra investment extravaganza. 

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This video was recorded on Nov. 7, 2019.

Nick Sciple: This episode was pre-recorded on November 7th. Be aware that some facts may have changed by the time you hear this. 

Welcome Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, and this is part two of our discussion of the NextEra Energy family of companies. I'm your host, Nick Sciple. Today I'm joined by Motley Fool contributor Matt Dilallo via Skype. How's it going, Matt?

Matt Dilallo: It's going pretty well! How are you?

Sciple: I am doing fantastic! As I mentioned at the top of the show, this is part two of our discussion of the NextEra Energy family of companies. If you didn't catch part one where we discussed NextEra Energy, ticker NEE, go back in your podcast queue, wherever you find your podcasts, and we'll have that waiting for you. 

Today, we're going to be talking about another member of this family of companies, which is NextEra Energy Partners, ticker in NEP. First off the top of the show Matt, what does NextEra Energy Partners do, and how is it different from NextEra Energy that we talked about on the first show?

Dilallo: Whereas NextEra Energy itself owns utilities and a competitive energy business, which owns wind farms and solar plants and it sells the power to third parties, NextEra Energy Partners focuses entirely on that competitive energy business. They own a large portfolio of wind farms and solar projects. They sell the power to third parties. Other utilities, for example, they don't want to build a wind farm themselves, so they'll buy the power from NextEra Energy Partners. It's structured almost like an MLP in that its focus is to generate cash flow that it returns to unitholders. However, it does not issue a schedule K-1, which a lot of MLPs do. It gives you a 1099, so investors can hold it in their retirement accounts. It also owns natural gas pipelines. That might differentiate it a little bit. So, their focus isn't entirely renewables, but it's clean energy. In their mind, they view natural gas pipelines as being a good fit, too. 

Sciple: It fits into that yieldco bucket that we've talked about on this show. Primarily focused in North America. When it comes to the dividend that this company pays, and its primary relationship is with NextEra Energy or NextEra Energy Resources, like we discussed on the previous episode of the show, what are the advantages to owning a NextEra Energy Partners vs. owning a NextEra Energy parent company? Can I accomplish a different goal owning NextEra Energy Partners than I would with a NextEra Energy?

Dilallo: Their main focus is to grow their dividend, which has almost double the yield of NextEra Energy's, and at a faster rate, 12% to 15% per year. Their whole goal is to buy clean energy assets, then return most of that cash flow to investors through the dividend. That's one of the differences. And then, as we mentioned in the last show, NextEra Energy has heavy exposure to Florida. If investors didn't want that hurricane risk that you might get in Florida, or the utility risk that you get from owning the utilities, that's another draw to NextEra Energy Partners. It kind of gives investors an opportunity to purely focus on clean energy, as long as you're OK with natural gas pipelines. You get a lot of income growth. That's their big appeal.

Sciple: OK, Matt, I want to dive a little bit more into NextEra Energy Partners' business. I teased it a little bit on the first half of the show, but would like to dive into it a little bit more, that relationship between NextEra Energy Partners and NextEra Energy Resources. The predominant customer when it comes to acquiring these renewable energy assets is NextEra Energy Resources. Matt, can you pick apart that relationship, and how the parties interact with one another there?

Dilallo: NextEra Energy will work with the other utilities that want to build a wind farm or solar panels, or something like that. They'll build it. They're like the renewable energy developer. And they'll hold those assets and generate cash flow that they'll use to fund their dividend and to build other ones. However, given the amount of growth that they have, they need extra capital. One way they do that is, instead of selling these really great cash flowing wind farms to third parties, they'll sell it down to NextEra Energy Partners. They kind of formed it so that they could still control them, but cash in. So, they're targeting different investors. Like we mentioned, dividend growth investors. It gives them a way to leverage what's out there in the market. Investors that are interested in renewables and income, it gives them this outlet for these assets. So, they sell them, get the cash, and build more renewable energy assets.

Sciple: It sounds kind of like we've talked about with Brookfield Asset Management in the past, where they recycle their capital through. Sounds like NextEra Energy Partners helps that take place. We talked about before the show, you had mentioned some intricacies when it comes to how they finance these deals and how that's important for investors in NextEra Energy Partners to understand. Can you walk us through that a little bit, Matt?

Dilallo: Yeah. Typically, what a company like NextEra Energy or an MLP or a yieldco, what they would have done is, they would have sold stock or units to public market investors. Back a couple of years ago, when interest rates were really low, investors were just gobbling these up. And they would use that cash to make acquisitions. However, the market has changed. A lot of these yieldcos struggled. Some went out of business, and there were bankruptcies. The energy market's been in terrible shape the past couple of years. It's made it really hard for NextEra Energy to be willing and wanting to sell equity to fund these deals. So, they've turned to private equity and alternative asset managers is like their go-to capital source. They've done three deals in the past year. One with KKR and the other two with BlackRock. What they're doing is, they're getting equity, but not selling stock right away. They're called convertible equity portfolio financing. Sounds really complex, but what it is, it's basically almost an IOU, where they can sell stock later on. The hope is that their stock will gain value in the four or five years before these convertible things are convertible. Let's say NextEra's stock doubles in five years. Well, then they don't need to sell as much to pay these off. So, it's a unique way that they're basically funding their business now, but paying for it later.

Sciple: Are there any risks in that business model that investors should be aware of relative to that traditional model you described, of selling units into the open market?

Dilallo: Yeah. Eventually, someday, they're going to have to buy these back. It's part of the structure. It's between four to six years, depending on which one. And there's the opportunity to actually exchange it for units. As long the units have gained in value, it works out. But let's say there's a market crash or interest rates rising -- when interest rates rise, yields on stocks tend to rise, too, so that would drop their stock market value. If something like that happens, it might be worse, and they'll dilute their investors a lot more than they were expecting. It is something to watch. It's a longer-term thing, four to five years.

Sciple: Yeah, something to be aware of, and part of the thesis that you need to bake into this company. I wanted to talk about one of their recent deals. We mentioned that they've moved into some more pipeline investments. That's one area where there may be a little bit less of a pure play on renewable than maybe the NextEra Energy headline company. They recently acquired Meade Pipeline Co. Management said it really checked off all the boxes they were looking for when it came to an investment. When you take a look at this recent acquisition, what does that tell us about how NextEra Energy Partners approaches acquisitions? And what does it mean for the business?

Dilallo: This is really a one-off. They're always open to making third-party acquisitions. This almost proves to the market that they can make third-party deals, they're not 100% reliant on NextEra to fund growth. It checked those boxes. It's a natural gas pipeline, that's clean energy. The big draw, though, is the value. They're getting it for like a 14X cash flow multiple, which is really, really a good multiple that they're getting it for. Because they're getting such a great deal, and it's so accretive to their cash flow, they don't need to make any more deals until 2021 to fund their dividend growth. The pipeline itself, it's up in the Marcellus Shale, backed by long-term contracts. It's very steady cash flow that it's getting. It really fits in well with this idea of, "We're owning clean energy assets that generate very predictable cash flows." It makes the dividend very safe.

Sciple: Yeah. The real moneymaker there is what you said there on the dividend. They don't expect to need to do any further acquisitions until 2021 to achieve their targeted distribution growth expectations, which are pretty ambitious. They want to grow their distributions 12% to 15% each year, at least through 2021. When you take a look at that dividend, the opportunity that this company gives to you relative to other yieldcos, how attractive is this business on aspect?

Dilallo: I'm going to run through two more names that a lot of investors who might be familiar with yieldcos might have heard of -- TerraForm Power and Brookfield Renewable Power. They're both part of the Brookfield family of companies that we talked about on the show before. TerraForm yields 4.8%. A little bit higher yield. They expect to grow their dividend 5% to 8% per year through 2022 while maintaining an 80% payout ratio. You're getting a little bit lower growth rate, a little bit higher payout ratio. However, it's fully funded. They don't need to make any acquisitions. They're doing this growth slowly through previous acquisitions they made. Then they're doing some stuff to cut costs. And then they're doing some wind repowering projects. What that means is, they're taking older wind turbines and replacing them with bigger and more powerful ones, and they can generate more power, more cash flow. That's TerraForm. Slower growth, but it's all baked in.

Brookfield Renewable on the other hand, 4.6% yield. Expects to grow that 5% to 9% per year through 2024. They're targeting a lower payout ratio, 70%. Again, similar power sources for this growth. Margin enhancement, they're working to cut costs, organic expansions, they're building more wind farms, hydro plants, those sort of things. The kicker with Brookfield, though, is they also expect another 3% to 5% per year of growth funded by asset sales. They actually expect to grow their earnings by double-digits going forward. So, faster growth with Brookfield. 

Again, both of these dividends, there's really no financing risk. They don't need acquisitions to fund their growth. That's a big difference between those two. Investors have to weigh the higher risk vs. the higher return.

Sciple: Just to clarify, you would say that there's higher risk when it comes to the NextEra business because there needs to be continued investment in order to justify that dividend; whereas the other folks, lower yield, but that's for good reason, they're a little bit safer when it comes to their payout and that sort of thing?

Dilallo: Yeah, yeah. Definitely. You get a slower growth rate. However, they don't need the acquisitions that are juicing the growth. Like we mentioned earlier, if the market tumbles and NextEra Energy can't buy assets from its parent, then it won't be able to grow its dividend. Whereas the other two, nothing's without risk, but there's less risk of something like that impacting their growth.

Sciple: Sure. So, definitely a more aggressive investor maybe should look to the NextEra Energy family of companies. But again, relative to the overall market, all of these companies are going to have a lower risk profile. Would that be fair to say? 

Dilallo: Yeah, definitely. 

Sciple: For sure. OK, Matt, zooming out a little bit. We discussed NextEra Energy last week. This week, we're talking about NextEra Renewable and Partners. When you zoom out and take a look at the renewable sector more broadly, what should folks be paying attention to in renewables going forward? Where should folks be looking for these big opportunities in renewables, in addition to the NextEra Energy family of companies?

Dilallo: The big thing to keep an eye on is the falling costs. We mentioned earlier that NextEra sees these costs for, especially solar storage, energy storage, coming down. If that doesn't happen like they thought, it could impact growth going forward. And then, you also have to keep in mind with fossil fuels, part of the big thing with these is that fossil fuels aren't going to tank in price, but if natural gas prices keep going down as they are, that might tilt the balance a little bit. There's risk involved in renewable growth. However, the big tailwind here is climate change. There's a lot more being talked about with that. Even if the financial numbers aren't there, you'll still have a lot of investment in renewables just because those concerns are getting more real.

Sciple: Yeah. It's one of those, if the people want it, they will buy it, no matter what the price is. We've seen interest really ramp up the past several years. I don't expect that to turn back anytime soon. If the economics come along for the ride, there's a really big opportunity here.

Matt, thank you as always for coming on the show and for sharing all your knowledge when it comes to this sector of the market!

Dilallo: Thanks for having me!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Matt Dilallo, I'm Nick Sciple. Thanks for listening and Fool on!