What happened
Shares of NextEra Energy Partners (NEP -0.89%) fell again this week, plunging 29.3% through Thursday trading, according to data from S&P Global Market Intelligence. This week marked an ugly snowball effect on top of last week's roughly 35% decline, which was set off when the yieldco announced it was lowering its dividend growth model.
NEP is the yieldco partner to utility NextEra Energy (NEE -1.36%). It's designed to acquire projects from NextEra Energy, then pay out growing distributions to shareholders. The thing is, when you have a captive yieldco or master limited partnership (MLP) that depends on issuing debt and equity to fund more repurchases, the model can be disrupted if there's either an increase in rates or a loss of confidence in the yieldco.
These two things usually go hand in hand. Over the last two weeks, NEP has seen both.
So what
Yields on the 10-year Treasury bond hit 4.8% this week, up from the low 4% range just a month ago and the low 3% range in just six months. That's a rapid move and the highest that long-term bond yields have been in roughly 17 years.
The rapid rise in the cost of capital prompted NextEra to announce last week that NEP would reduce its dividend growth outlook from a range of 12% to 15% per year to 5% to 8% per year. The company cited higher debt prices and lower equity prices for NEP as the reason to slow acquisitions.
Unfortunately, that announcement set off a chain reaction. NEP's share price fell, which would have made share issuance dilutive. NextEra Energy then decided to cancel a sale of a "drop-down" project to the yieldco. While potentially the correct thing to do, it caused a further crisis of confidence in the model.
This week, more analyst downgrades came, escalating the sell-off. Wells Fargo analyst Neil Kalton downgraded NextEra Partners on Monday, lowering his price target from $80 to $33 on news of the canceled drop-down. And two more analysts downgraded NEP's parent NextEra Energy later in the week, as well. That increased the downbeat mood for NEP even further.
It also didn't help matters when NextEra Partners dipped into its revolving credit line to purchase a partner's 25% stake in a natural gas pipeline business called South Texas Midstream, which NextEra Partners co-owns with a private equity firm. While NextEra is lining up to sell this asset in order to solely focus on solar and wind projects, using debt to purchase more of the pipeline probably also made investors incrementally nervous, until a sale is finalized.
Image source: Getty Images.
Now what
NextEra Partners has been cut in more than half in two weeks and is now down almost 70% year to date. Its dividend yield has risen to 15.7% as the result of the stock's implosion, and the stock trades at just over half its book value.
That may seem like a bargain, but it's also hard to see how the situation will play out. The yieldco model is predicated on the ability to finance the purchase of new projects, which necessitates a reasonable stock price and cost of debt. When the cost of capital changes rapidly, the model can become "stuck," requiring management to seek alternative tactics or just wait for interest rates to cooperate.
Kalton, the analyst for Wells Fargo, suggested NEE may have been better off going forward with the asset drop-down to NEP at a lower price in order to keep up the model, even if NEE wouldn't receive as much in return. When it didn't, it led to a crisis of confidence.
If you're looking for bargains, take a deeper dive into how the company is looking to resolve the conundrum. Management may just wait and hope conditions improve. But investors may need more than hope for the stock price to recover. So it's a catch-22.
