At one point, NextEra Energy Partners (NEP -0.89%) was a hot master limited partnership (MLP) in the hot renewable-power sector. And then clean-energy investments fell out of favor on Wall Street, and NextEra Energy Partners' math changed in a big way. With a huge 12% distribution yield, is the risk of a different future worth taking on, or should investors avoid the MLP?
What does NextEra Energy Partners do, exactly?
If you look at NextEra Energy Partners as a business, you'll see that the MLP owns and operates renewable-power assets, such as solar and wind farms, among other things. But that's not really the purpose of the partnership. NextEra Energy Partners was created by utility giant NextEra Energy (NEE -1.36%) as a funding source. This isn't uncommon, but it is important to understand the relationship between parent NextEra Energy and its controlled MLP.
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Basically, NextEra Energy builds renewable-power assets and then sells them, or drops them down, to NextEra Energy Partners. That helps NextEra Energy Partners grow its cash flows and allows parent NextEra Energy to raise capital to support its own growth plans. The key is that NextEra Energy Partners has to sell MLP units to raise the capital it needs to buy assets from NextEra Energy. When clean-energy stocks were a hot commodity on Wall Street, drop-down transactions were a no-brainer. At that point, investors were clamoring to buy NextEra Energy Partners' units.
Now that Wall Street has soured on the clean-energy industry, however, the math isn't nearly as attractive. That's why NextEra Energy has cut the guidance for distribution growth at NextEra Energy Partners in half, taking it from roughly 12% a year down to around 6%. That's a huge change, and it suggests that NextEra Energy Partners isn't nearly as desirable as many investors once believed it to be.
Buy NextEra Energy Partners
NextEra Energy is a very strong parent, as it's one of the largest and fastest-growing utilities in the United States. In fact, despite cutting the outlook for NextEra Energy Partners, NextEra Energy itself didn't change its financial outlook at all. The big change is that it doesn't expect to use NextEra Energy Partners as a funding source to the same degree, which is bad for NextEra Energy Partners' future.
However, NextEra Energy isn't at this point completely abandoning its offspring. The plan is to muddle through the near term as best as can be done while continuing to reward MLP unitholders with more modest distribution growth. And on that score, 6% distribution growth is hard to complain about. Given the contract nature of the assets NextEra Energy Partners owns, it has reliable cash flows. So for more aggressive investors, there are reasons to believe that the distribution will hold, if not continue to grow. At some point, if Mr. Market becomes more accommodating, growth could pick up again if NextEra Energy begins to drop down assets to the MLP again. If you have a glass-half-full view, it might be worth buying NextEra Energy Partners for its lofty yield.
Sell NextEra Energy Partners
There is one caveat here that can't be ignored. In the first nine months of 2023, NextEra Energy Partners paid out $554 million in distribution to unitholders. It generated cash available for distribution of $603 million. That means it paid out nearly 92% of the cash available for distribution, which doesn't leave a huge amount left over in case of adversity. Nor is there much money left behind to put toward business growth.
That last point is important, because, basically, NextEra Energy Partners really needs to tap the capital markets if it wants to keep growing its business. That's materially harder today than it used to be. A much quicker way to raise growth capital would be to cut the distribution and use the freed-up cash to fund its capital investment plans. That's a glass-half-empty view, but not an unreasonable take on the situation. If you're a conservative income investor, you might want to move on to a better-positioned high-yield investment.
Hold NextEra Energy Partners
The logic for buying and holding here is basically the same. However, there's a slight nuance for those worried about the distribution. A lot of bad news has been priced into the stock, which is now down nearly 70% from its 2021 highs. At this point, a distribution cut may not actually result in a material unit price drop, since a cut appears to have been priced in.
With the mood so negative, you might want to give NextEra Energy and NextEra Energy Partners some time to figure out the future in more detail before making a final sell call, which might lock in material paper losses. And if NextEra Energy Partners manages to keep growing the distribution and its business despite the changed outlook, well, at least you get to keep the income stream while you wait for a possible unit price rebound. Sometimes the best thing to do is nothing. If you do go down this path, however, you'll want to make sure to keep watching the MLP's business progress to ensure that it doesn't take a turn for the worse.
No easy decisions
NextEra Energy Partners is not the same MLP it was just a few years ago. That's been made clear by both parent NextEra Energy and investors. Where things go from here remains a bit up in the air, but the risk of a distribution cut can't be ignored even if it appears to be priced into the unit price. Those with a positive view might want to buy, or keep holding, NextEra Energy Partners. For those with a negative view, well, it might be better to take your lumps and move on.
