Shares of NextEra Energy Partners (NEP -0.89%) soared 16% this week, according to data from S&P Global Market Intelligence.
This yield company, whose model is to buy renewable-energy projects and pay out virtually all cash flow as distributions to unitholders, had fallen on hard times this year. Due to its need to consistently raise or refinance its capital, NextEra Partners is extremely sensitive to interest rates, so the summer's sharp rise in long-term rates caused the stock to crash.
But on Wednesday of this week, the Federal Reserve appeared to pivot its posture from a focus on how high to raise rates and toward when to cut them. That led to a relief rally in rate-sensitive stocks, including NextEra.
The Fed sees a pivot next year, with or without a recession
At this week's Fed meeting, the Fed left the federal funds rate unchanged. Following that meeting and Fed Chair Jerome Powell's press conference, 10-year Treasury bond yields fell sharply, reaching 3.93% by the end of trading Friday. That's in comparison to 4.27% to start the week and a recent multiyear peak of 4.99% in October.
Perhaps the most consequential part of the meeting was the Fed's "dot plot" for rate expectations going forward, showing three rate cuts in 2024 and another four in 2025. That's more cuts than the Fed had previously projected, thereby giving investors incremental confidence that the Fed would ease off its restrictive position soon without needing a recession and job losses to do so.
Thus, investors gained more confidence in the "soft-landing" scenario.
Lower interest rates would definitely be a boon to NextEra Energy Partners, which has to raise capital in order to fund the acquisition of new renewable-energy projects. The stock traded as high as $77 per share early in the year but has since cratered to just $30 despite this week's gains. This has largely been due to the rapid change in interest rates, which rocketed higher throughout the summer before peaking in October.
Because NextEra either has to raise money from the debt markets or sell some of its stock to fund projects, a downward spiral in its stock price could be self-fulfilling. If the price goes low enough, the stock can become too cheap for the company to reasonably sell in order to buy more renewable wind- or solar-energy projects. And without any growth on the horizon, investors will have to take its current run-rate yield as their return.
As higher interest rates and a lower stock price emerged this year, management lowered the growth outlook for shareholder distributions in September from 12% to 6% going forward due to tighter financial conditions. But even though management was being honest with shareholders, that appeared to backfire, as NextEra's stock crashed even further, perhaps hampering the company's ability to buy projects at all. Even with this week's gains, shares are still far lower than they were prior to that announcement.
However, with the Fed easing off the brakes, the prospect of that rate-headwind trend reversing pushed NextEra's stock higher this week.
Image source: Getty Images.
Can NextEra grow from here?
With the stock around $30, NextEra is well off its recent low of $20 but still well below its 52-week highs and even well below the $48 price right before its September announcement. Thus, it remains to be seen if NextEra will be able to increase its dividend growth going forward.
On its recent quarterly-earnings report, management did announce a 6% dividend increase, in line with its new target given in September. New capital for projects will come from the recent sale of its natural gas pipeline assets, as well as some lower-cost repowering of existing wind projects, which will increase their efficiency. But there are only so many of these alternative financing or lower-capex options the company can pursue outside of selling more debt or stock.
At its current run rate of about $775 million in cash available for distribution (CAFD), NextEra's stock only trades around 3.6 times CAFD, which is cheap. But keep in mind, NextEra's enterprise value (EV), including debt, is much higher at around $9 billion, putting its EV-to-CAFD ratio at a more normal-looking 11.6.
That 9% or so CAFD yield is still attractive, although not screamingly cheap for a company that might have a hard time growing those payouts without a higher stock price. Thus, NextEra investors are really left with either the current 11% dividend payout or the hope its share price will climb in the future to more palatable levels where management can once again sell stock to fund growth. It's uncertain if and when that time will come, making NextEra shares still a risky proposition.
