NextEra Energy (NEE -1.36%) has been a wonderful investment. Whether you've been a shareholder for only a few years or for a decade or more, the utility giant has delivered market-beating returns for investors with the same regularity that it provides energy to its customers. That's unsurprising, considering the demographic trends helping grow its regulated business in Florida, along with the megatrends driving growth in renewable energy, where NextEra has become a huge player as an independent power producer.
Yet investors have also benefited from some trends that might not continue in their favor going forward, weighing on NextEra's advantages, and making it harder to deliver the growth that's helped it be a market-beating investment. Trying to decide whether the future is bullish or bearish for NextEra? Keep reading to get some insight from two investors with expertise on the company and the sector.
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Offering something for everyone
Howard Smith (Bull): The interesting thing about NextEra Energy stock is that investors can look at adding it to a portfolio from two different angles. Conservative investors more interested in income can look at NextEra as a utility-like investment. But it also has its fast-growing renewable energy subsidiary in NextEra Energy Resources that might appeal more to investors looking for growth.
The utility segment comes from its ownership of Florida Power & Light and Gulf Power. Combined, the two electric utilities contributed 64% of total adjusted earnings per share (EPS) to NextEra in 2021. But growth investors may focus more on NextEra's growing renewable energy and battery storage assets. Overall adjusted EPS grew more than 10% in 2021, and has averaged about 9% annual growth over the past decade. That has helped NextEra shares trounce the S&P 500 index in total returns over that time.
NEE Total Return Level data by YCharts
After reporting fourth-quarter and full-year 2021 results last month, NextEra increased its expectations for 2022 earnings, and it extended guidance for 6% to 8% annual growth in adjusted EPS through 2025 off of the revised 2022 estimate.
Management has also conveyed it intends to increase the annual dividend payment by 10%, which it accomplished with a new payout announced earlier in February. An updated dividend policy provided at that time said the company intends to continue to increase the dividend annually by 10% off of this year's level through at least 2024.
An investment in NextEra Energy brings benefits for different types of investors. That's partially why it has performed as well as it has, and why it is valued highly. With the balance between the slow-growing utilities and additional potential from a fast-growing renewable energy sector, it is an investment that anyone can feel good having in a portfolio.
Starting its "next era" at a premium valuation, with rising capital costs
Jason Hall (Bear): Let me start by saying that I am not bearish on NextEra as a company. It is incredibly well run, has strong demographics in its favor in its core regulated market, and is positioned as a winner in renewables, after years of making this a priority. I am an investor in NextEra Energy Partners, its independent power-producing subsidiary.
But that's far from a guarantee that it will be a market-beating investment from here. To the contrary, there are some very real risks I don't think investors are giving enough credence: valuation and cost of capital. Simply put, it's going to be harder for management to generate earnings growth at the same rate we have seen in the past going forward, while today's valuation says investors may not have adjusted their expectations lower enough for that reality.
Let me explain the risks. Utilities spend billions of dollars to build power assets, and the bulk of those investments are funded with debt. Low interest rates have been great for NextEra for years; falling rates -- along with lower costs for wind and solar assets -- have helped it race to the renewables lead. But that trend is about to reverse, with rates set to start climbing again, while NextEra's capital appetite will remain very high. Debt is already over $50 billion, up 190% since 2010.
Rising interest rates will weigh on future returns, both for new debt issued and for refinances. Ironically, NextEra's returns were already trending lower:
NEE Total Long Term Debt (Quarterly) data by YCharts
Yet the stock trades for a sharp premium to its historical valuation, whether earnings or cash flow:
NEE PE Ratio data by YCharts
As much as I admire the company and its management, this creates major headwinds for future returns that many investors may not be considering fully. And that could result in poor long-term returns for shareholders.
This is what makes a market
There's no denying that NextEra Energy is a wonderful, well-run company. It's also financially strong, and its business will benefit from both demographic trends in its home markets and secular trends driving renewables growth. But there are also headwinds it must navigate, including rising interest rates that will weigh on future cash flows and per-share returns. Will its strong profile and fast-growing dividend be enough to offset the risks of a premium valuation and rising rates? Whichever side you fall on, investors with a diversified portfolio and a willingness to hold for many years will have the best chance at making money.
