Shares of U.S. utility NextEra Energy (NYSE:NEE) are on quite a run so far in 2020, up nearly 30%. For comparison, the average utility, using Vanguard Utilities ETF as a proxy, is down about 6%. What's behind NextEra's big run, and is it worth buying at current prices?
Hitting on all cylinders
When NextEra reported second-quarter earnings, they continued what has been a long line of good results. Adjusted earnings in the three-month span came in at $2.61 per share, up 11% from the prior year's $2.35. CEO Jim Robo noted that, "Despite the challenges created by the COVID-19 pandemic, all of our businesses continue to perform well and maintain their excellent prospects for growth going forward." In other words, he sees no reason to expect the good news to end.
That includes both the company's regulated utility operations, which are the foundation of its business (roughly 70% of 2019 revenue and 60% of adjusted earnings, ), and its contracted power segment (roughly 30% and 40%, respectively), which is a more growth-oriented business.
NextEra's Florida utility operations make it one of the largest utilities in the country. The state has benefited from a growing population, a trend that is expected to continue in the years ahead. This is an important piece of the puzzle, since more customers means more opportunity for revenue growth in what is generally considered a pretty boring sector.
Notably, regulated utilities need to get the rates they charge approved by the government. Ensuring reliable and affordable power is one piece of that puzzle, but making certain that there is enough generation is also important. Essentially, every new customer gives NextEra another reason to support its rate requests.
The other side of the business doesn't face the same level of government control, but it is benefiting from regulator mandates just the same. NextEra is one of the largest providers of contracted solar and wind power in the world. It is benefiting from increasing demand as regulators, and customers, require utilities to increase the amount of green energy they use. At this point, NextEra has roughly 14 gigawatts of renewable power construction projects in its backlog, the largest number in its history. So growth here looks set to continue as well.
All of this has led to impressive earnings growth and, notably in the utility space, robust dividend growth. NextEra has increased its dividend for more than a quarter of a century, with the dividend increasing by more than 10% a year over that span. Dividend growth is projected to be at least 10% a year through 2022, which should easily put NextEra at the high end of the utility sector on this metric.
What's not to like?
So far there are a lot of reasons for utility investors to buy NextEra Energy shares, particularly if you are focused on dividend growth stocks. There's only one problem: The stock has done so well that its yield is a miserly 2% or so. The average utility yields around 3.3%. So investors looking to maximize the income they generate won't be pleased with this stock.
However, there's another issue to consider along with that yield: valuation. That 2% is near the lowest levels in the company's history, which, using yield as a rough valuation tool, suggests that NextEra is far from cheap today. In fact, the stock's price to earnings ratio is nearly 40 times -- a number you might expect from a technology stock, but not from a utility.
Essentially, NextEra is doing very well, but investors are fully aware of that fact, and have priced the shares accordingly. If you step in to buy NextEra at current prices, you are likely paying a premium. Investors looking for dividend growth stocks might be OK with that, but anyone with even the slightest value bias will probably be better off waiting for a pullback.
It's not for everyone
If you are looking at NextEra Energy and wondering if it's worth buying, there are some pretty clear answers. First, you will probably want to look elsewhere if you are a value investor or trying to maximize the dividend income you generate today. However, if you are a dividend growth investor, NextEra might look fairly enticing. That said, you need to go in understanding that you are paying a potentially high price for that growth.