U.S. utility NRG Energy (NYSE:NRG) offers investors a generous dividend and is promising a fairly bright future. It makes sense that dividend-focused investors would be interested, particularly given the generally conservative view most people have of the utility sector.
But there's a little history lesson that's needed before you jump aboard -- NRG Energy is not your typical utility.
A good story
Dividend investors will be attracted to NRG Energy's 4.1% dividend yield. While there are other utilities with similarly high yields, 4.1% is fairly generous, and well above the yield of the broader market; the S&P 500 Index yields just 1.9% or so. Meanwhile, the average utility, using Vanguard Utilities Index ETF as a proxy, yields around 3.4%. NRG Energy is projecting that it will grow its dividend by 7% to 9% over the near term. That's very generous for a utility, and is two to three times the historical growth rate of inflation.
The foundation supporting the dividend and its continued growth is a mixture of two businesses: generation assets, and a direct-to-customer retail model. A utility with assets that generate electricity isn't really a differentiating factor on its own. And like most peers, NRG is looking to get more environmentally friendly over time. But that's pretty much table stakes in the utility space today, so it's not where NRG Energy really stands out.
What really sets the company apart is its approach to selling, which involves reaching out to customers via a number of different brands to sell electricity and natural gas. It competes directly for this business, offering a variety of pricing options and contract lengths in markets that have been opened up to third-party sellers. Generally speaking, the regulated utilities in such areas control the power lines, but the power that moves through the system can be sold by another firm, like NRG Energy. Although most of its business is in Texas, NRG Energy has a notable footprint in the Northeast as well. And it recently agreed to purchase privately held Direct Energy, which will expand its reach and brand offerings.
All in all, NRG Energy is not exactly the type of company that would come to mind if you think of utilities as conservative "widows and orphans" stocks. That doesn't make it a bad company, but it doesn't have the government-granted monopoly that most people associate with utilities. Its customers have choices, and they can jump ship for lower-cost providers if they want.
We've tried new before
Assuming that NRG Energy can live up to its growth projections, most investors probably wouldn't even notice that difference. However, this isn't the first time that NRG Energy has charted its own course. And that should worry conservative investors.
Here's the quick and dirty story: NRG Energy declared bankruptcy in 2003. Clearly, whatever it was doing back then wasn't successful. After working through the bankruptcy process, it regrouped and bought a merchant power business in 2013. It also began to build a renewable power operation. But these two businesses didn't work out quite as well as hoped, either.
In 2017 the company's merchant power business declared bankruptcy, and the division's creditors took control of it. And then, in 2018, the company sold its stake in the renewable power business it had created. The current incarnation of NRG Energy is basically the third try at finding a business model that works. And notably, it's only about two years into the current reset. This is clearly a simplification of a process that transpired over decades, but it doesn't instill confidence if what you are looking for is a boring utility that will pay you a steady and reliable dividend.
The large dividend increase at the beginning of 2020 and the heady dividend growth promise are basically meant to signal that NRG Energy has turned the corner. That may be true, but given the uneven past here and the direct-to-customer model, a little caution is probably in order. To buy NRG Energy today, you have to believe that the company's current incarnation is the one that's -- finally -- going to work.
Wait and see
NRG Energy could end up being a great investment opportunity, or it could flounder again -- it's still too early to tell. Thus, for most investors, the stock is probably best left on the watch list. After it's proven that the current business model is worthwhile for a few years, it may be worth revisiting. However, for conservative types seeking out a regulated utility, it's probably never going to be a good fit.