The global economy is in the midst of transitioning its power source from fossil fuels to renewable energy. It will take decades and trillions of dollars to make that switch. That makes it a mega-trend that investors won't want to miss because it has the potential to produce powerful returns.
One of the early leaders in this transition is utility Xcel Energy (XEL 1.04%). While the company currently has a carbon-heavy business, it was the first utility to pledge to be carbon-free by 2050. That strategy has the potential to produce attractive total returns in the coming years. Add that upside to its relative underperformance last year, and it stands out as one of the best renewable energy stocks for 2021 and beyond.
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A renewable-powered growth plan
Xcel Energy is a utility holding company that operates electric and natural gas utilities across eight western and Midwestern states. At the end of 2019, the company got 26% of its power from coal, 33% from natural gas, 13% from nuclear, and 24% from renewables.
However, Xcel has a bold plan to reduce its carbon emissions by 80% in ten years and eliminate them by 2050. The company aims to achieve that first pledge by retiring its current coal power plant fleet and replacing them with cleaner power sources like natural gas and renewables. Xcel expects to invest $24 billion through 2025 toward this ambitious goal.
Thanks to falling costs, the returns it earns on these investments should help it grow its earnings per share at a 5% to 7% annual rate over the next few years. That should support a similar growth rate in its 2.7%-yielding dividend. Add it up, and the company could produce 8% to 10% total annualized returns from here, assuming no change in its valuation multiple.
A relatively attractive valuation
Xcel Energy's earnings and dividend growth are only part of the draw. The other is its additional upside potential if the market rewards it with a higher valuation. That's possible given its increasing focus on renewables. That has helped power rival utility NextEra Energy (NEE +0.08%) to new heights over the past year because the market has rewarded it with a higher valuation multiple as a result of its leadership in renewables:
XEL Total Return Level data by YCharts
With Xcel Energy's stock price declining last year while NextEra's zoomed more than 30%, it trades at a much cheaper relative valuation of about 21 times its forward earnings compared to 32 times for NextEra. While NextEra does expect a bit faster earnings growth at 6% to 8% per year through 2023 -- powered by its industry-leading renewable business -- Xcel is growing faster than the average utility. Meanwhile, it shares many of NextEra's other attractive qualities, including a relatively low dividend payout ratio of 60% to 70% of its earnings and an investment-grade balance sheet. It thus has the financial flexibility to deliver on its bold plan.
Long-term optionality
Another longer-term catalyst for Xcel is its investments in emerging technologies that could prove to be the key to achieving its bold plan to be emissions-free by 2050. For example, it's investing in the transportation sector's electrification by building charging stations and other infrastructure. These investments will also benefit its core electric operations because they'll help increase the adoption of electric vehicles, powering more electricity demand.
Meanwhile, Xcel Energy is following NextEra's footsteps by investing in early stage projects to produce green hydrogen, which could be the emissions-free fuel needed to replace natural gas in generating electricity and in homes and businesses. The company is working on a pilot project to use nuclear energy to generate hydrogen, which could enable the company to commercialize this fuel. It's a potentially massive market opportunity, implying it could help power significant growth for Xcel in the coming years if it's successful.
The potential for strong renewable-powered returns in 2021 and beyond
Xcel Energy is still in the early days of its bold transition plan to become emissions-free by 2050. The company plans to invest billions of dollars in this strategy over the next few years, which should power steady earnings and dividend growth. Add in its relatively cheaper valuation, and Xcel Energy looks like one of the best-positioned renewable energy stocks for 2021 and beyond.
