The first half of 2020 has been pretty chaotic for investors. The stock market entered March valued at a historic premium, plunged on fears of the potential economic impact of the coronavirus pandemic, and then reclaimed most of its lost ground by early June as unprecedented action from the Federal Reserve offset Wall Street's concerns about the health crisis (for now). Due to the pandemic's negative impact on earnings, the stock market is even more expensive now than three months ago.
The fact that stocks are trading at a premium might make investors tread carefully, but those with a long-term mindset might not hesitate to buy great businesses. For those interested in adding to or opening new positions, NextEra Energy Partners (XIFR 1.50%) and Enphase Energy (ENPH 0.21%) are among the top growth stocks in the energy sector. There are risks for each business, but both have long-term growth prospects that will survive any economic downturn.
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A solid play for the energy transition
NextEra Energy Partners is a clean-energy company that benefits from both asset and geographic diversification. The business sells electricity from 5,330 megawatts of onshore wind and utility-scale solar power assets, collects fees from 3.5 billion cubic feet per day of contracted natural gas pipeline capacity, and operates in 17 states.
The existing portfolio has been built through a series of acquisitions that have fueled growth in recent years. In 2019, the partnership generated $855 million in revenue and 16.7 terawatt-hours of electricity. That compares to full-year 2015 revenue of $501 million and electricity generation of 7.3 terawatt-hours.
Investors can expect acquisitions to continue powering growth. NextEra Energy Partners has committed to growing the annual distribution per common unit 12% to 15% per year from 2019 through 2024. The year-end 2020 annualized payout of $2.43 per unit would be equivalent to a payout ratio of roughly 70% -- a level that's both sustainable and rewarding. In fact, thanks to the company's financial flexibility, distribution growth targets can be met into 2022 without an additional acquisition.
That flexibility could offset some of the uncertainty created by the coronavirus pandemic, but there are a few reasons investors might not have to wait for 2022 for the company's next acquisition.
First, NextEra Energy Partners acquired its current 5,330 megawatts of power assets through multiple transactions with NextEra Energy Resources (NEER), the power-generation subsidiary of NextEra Energy. NEER owns and operates about 13,000 megawatts of renewable energy power capacity today, and could place an additional 19,000 megawatts into service from 2019 to 2022. Therefore, investors can expect some of that capacity to end up in the partnership's portfolio.
Second, the United States is expected to achieve a record year of renewable-energy expansion, placing into service over 33,000 megawatts of onshore wind and utility-scale solar power capacity in 2020. That provides plenty of opportunities for NextEra Energy Partners to acquire renewable-energy assets outside of its relationship with NEER.
Third, the United States is expected to achieve an impressive decade of renewable-energy expansion. At the beginning of 2020, the nation had roughly 140,000 megawatts of onshore wind and utility-scale solar power capacity in operation. By 2020, that could swell to 500,000 megawatts.
Investors with a long-term mindset will see the opportunity for NextEra Energy Partners to continue along its growth trajectory for the next decade, at least. It all comes down to execution and managing the financial arrangements required to complete acquisitions. Debt-ridden balance sheets have tanked plans at some of the partnership's peers, so that concern can't be dismissed. Considering that units have delivered a total return (share performance plus dividends) of 107% since their initial public offering (IPO) in 2014, easily better than the 85% total return of the S&P 500, the business might deserve the benefit of the doubt.
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A successful lobbying effort could lift this solar stock
Shares of Enphase Energy are certainly on the expensive side. The solar stock trades at 52 times sales and 48 times future earnings, and has a market valuation of $6.6 billion. Investors who want to wait for a better entry point would have a solid argument, although in the long run it might not matter too much.
The company sells some of the leading microinverters on the market for solar hardware, is developing a next-generation microinverter that's both smaller and more powerful than current designs, and plans to launch a revamped portfolio of energy-storage products in 2020. Given the rapid growth of small-scale solar installations (residential and commercial markets comprise the majority of customers) in recent years -- estimated electricity output in the first quarter of 2020 jumped over 20% compared to the year-ago period -- investors might expect healthy demand for Enphase Energy's products.
There will be some headwinds for the business in the near term. After generating $205 million of revenue in the first quarter of 2020, Enphase Energy expects second-quarter revenue of only $115 million to $130 million, due to the stay-at-home orders issued during the early stages of the coronavirus pandemic. It's possible the slowdown will be deep but short, especially given that many U.S. states have already begun reopening. Judging from the stock's recent ascension, Wall Street seems comfortable with the company's growth trajectory either way.
Investors should consider other potential pitfalls. For instance, Enphase Energy's board of directors recently authorized a $200 million share repurchase program to offset equity issuances to employees. That could be a less than ideal use of cash with shares trading near all-time highs. Additionally, the company's much hyped energy-storage product lineup has now been delayed multiple times, which could signal other issues for the technology portfolio.
Those are important concerns, but they might be countered by an under-the-radar advantage: an extension of the investment tax credit (ITC) for small-scale solar installations, which might be more likely in a post-pandemic world.
The solar ITC provides a tax subsidy equivalent to a certain percentage of the project's investment value, based on the year significant construction begins. Many project owners meet the legal criteria by purchasing microinverters, placing their projects in safe harbor. That's been a great boost for Enphase Energy, but it's coming to an end.
The tax credit was valued at 30% -- the maximum -- in 2019, but its value decays starting this year. More importantly for Enphase Energy and its shareholders, the ITC treats utility-scale, commercial, and residential solar energy systems differently. A utility-scale project that begins construction after 2021 can earn a 22% credit, whereas a commercial project can earn only 10%, and residential projects become ineligible.
In recent years, the solar industry has lobbied (unsuccessfully) to extend the ITC or make small-scale solar installations eligible in perpetuity. Similar legislation was included in the initial drafts of recent stimulus bills aimed at reducing the impact from the coronavirus pandemic, but were ultimately removed.
Despite the last-minute setback of recent lobbying efforts, the odds of an ITC extension seem higher now than in recent years. If political pressure builds to make renewable energy part of the post-pandemic economic recovery, then the solar industry -- and Enphase Energy -- could achieve higher near-term growth than currently expected. That alone isn't a reason to purchase shares of the solar stock, but it's something that investors need to factor into the company's premium valuation. An ITC extension for small-scale solar systems might make shares much more attractive.
