There's no question that the world is pushing hard to increase the amount of clean energy produced. It is likely to be a multi-decade trend. But no trend on Wall Street goes in a straight line. This is why investors looking at NextEra Energy Partners (NEP -0.89%) and its huge 11.1% distribution yield might want to pause before jumping aboard.
There's a lot to digest here.
NextEra Energy Partners is a funding source
NextEra Energy Partners describes itself as a "growth-oriented" limited partnership (LP). In this case, the word growth has been more of a reference to distribution growth. Over the past five years, the LP's distribution increased a huge 90% or so. That's way better than Pepsico and Fastenal, which increased their dividends by 37% and 75%, respectively. The beverage giant and industrial fastener maker are both well known for their impressive dividend growth rates.
NEP Dividend data by YCharts
But notice that the chart above also includes NextEra Energy (NEE -1.36%). The similarity between the two names is not a mistake, because NextEra Energy Partners was created by NextEra Energy. It is, basically, a funding vehicle for NextEra Energy, which is one of the largest U.S. utilities. But here's the interesting thing, NextEra Energy owns a large regulated utility business and has a huge renewable power operation. NextEra Energy Partners is focused on owning renewable power.
In what is generally called a drop-down transaction, NextEra Energy sells some of its renewable power projects to NextEra Energy Partners. That gives the LP more cash flow to grow its distribution and provides NextEra Energy with cash to build new clean energy assets. On the surface, you could call that a win/win deal. But there's a dark side here that has become increasingly more clear.
What happens when the math changes?
For many years investors were gung-ho about renewable power and afforded companies in the sector with a premium valuation. Add in the rapid distribution growth at NextEra Energy Partners and the units often traded at lofty levels. That made it very attractive for parent NextEra Energy to drop down assets to the LP and for the LP to buy those assets. But competition has been heating up in the clean energy sector, reducing returns in the space. And now inflation has increased, further limiting returns. NextEra Energy Partners' unit price has been falling since roughly the start of 2022.
The more units NextEra Energy Partners has to issue to buy clean energy assets from NextEra Energy the less attractive the transaction is for everyone involved. Now focus on the steep decline in the price at the end of the chart above. That happened when NextEra Energy announced that it was cutting the distribution growth projections for NextEra Energy Partners in half, going from 12% a year to 6%. While 6% is hardly a bad growth rate for a distribution, it is a far cry from what investors had grown accustomed to.
But the backstory here is that NextEra Energy has chosen not to drop assets down to NextEra Energy Partners. The unitholder dilution that it would cause would likely have irked investors, leading many to wonder why the transaction was undertaken at all. But with the unit price still falling, there's no clear indication when NextEra Energy will resume selling assets to the LP. It could be a long time if the renewable power sector, and NextEra Energy Partners specifically, doesn't quickly recover.
Let the dust settle on NextEra Energy Partners
If you are an aggressive income investor, you might be willing to take on the risks here. NextEra Energy is a strong parent company and has a long history of rewarding investors well. There's good reason to believe it will attempt to ensure that NextEra Energy Partners does the same thing. But there have been a number of examples where a similar setup didn't end well, for example when a falling unit price led Dominion Energy to buy its controlled LP that operated in the pipeline space.
Indeed, for most investors, there is a huge amount of uncertainty right now. The clean energy sector is in a state of flux and so is the relationship between NextEra Energy Partners and its parent. Until there's a bit more clarity, erring on the side of caution is probably the best choice.
