2023 was a banner year for many stocks. The tech-heavy Nasdaq Composite index soared more than 40% and even the broader S&P 500 index returned over 25%. But there were still some sectors that missed out on the party.
The stocks of renewable energy company NextEra Energy Partners (NEP 2.83%) and its parent company, utility NextEra Energy (NEE +1.21%), both got crushed, dropping 56.6% and 27.3%, respectively, according to data provided by S&P Global Market Intelligence. It was also telling that retail real estate investment trust (REIT) Realty Income (O 0.95%) lost 9.5% in 2023. The reasons behind those drops, and why those stocks could reverse course in 2024, are what investors should be focusing on now.
NYSE: NEP
Key Data Points
Much ado about interest rates
Companies that use debt to help fund their operations have had a difficult economic environment the past two years. As benchmark interest rates quickly rose from around zero to over 5%, costs associated with this extra capital suddenly became a big variable. That's been challenging for these companies -- and unappealing to investors.
NextEra Energy Partners is a partnership that acquires and controls renewable energy projects for its parent company, NextEra Energy. Similar to a stock dividend, it pays out the earnings it collects from operations -- known as funds from operations or FFO -- as a distribution to shareholders. Both NextEra entities need to tap the debt and equity markets for investment capital to sustain growth. The terms on NextEra Partners' latest capital raise shows how expense debt is for the partnership in this environment. Just last month it issued debt to raise $750 million at a rate of 7.25%.
Those high interest terms are what helped drive investors out of these types of stocks last year. NextEra needs to maintain financial flexibility to purchase energy projects that include contracted solar and wind projects. That upfront capital allocation provides long-term cash flows. To keep that flexibility, in September, NextEra Partners lowered its expected distribution growth rate from a range of 12% to 15% to an annual growth rate of just 6% through at least 2026.
NYSE: O
Key Data Points
REITs like Realty Income have the same higher expense challenges. That company needs to fund acquisitions or investments in new properties to continue generating growth. In addition to its retail-focused portfolio, Realty Income invested $950 million in a Las Vegas casino and agreed to acquire fellow REIT Spirit Realty Capital for about $9.3 billion in 2023. Though the latter was an all-stock transaction, it highlights the continued investments management is making.
Buy when others are fearful
So there is a reasonable explanation for the drops in these stocks in 2023. But the business fundamentals were not at fault. Realty Income added property diversity last year and maintains a stable retail tenant base provides the cash flow it needs to distribute to shareholders. And NextEra's contracted energy generation provides long-term value and stable cash flows.
At its December meeting, the Federal Reserve's rate-setting Federal Open Market Committee decided to keep interest rates steady. In the minutes from that meeting, investors saw that most Fed officials now believe that rates will in fact be cut at some point in 2024.
That's good news for companies like NextEra and Realty Income that will need to continue to borrow. It also means that the dividends and distributions from these names will be more competitive with savings account and bond yields. For example, Realty Income recently yielded about 5.1%. That's near what many treasury bills and certificates of deposit (CDs) are currently paying.
Interest rates beginning to drop should entice income seekers to buy these higher-yielding stocks. Those who own shares now could see capital appreciation on top of the dividend income. That's why it makes sense to take advantage of these stocks' lower prices today.
