NextEra Energy Partners (NEP -0.89%) has increased its distribution annually for nine consecutive years. That puts it on the cusp of achieving the key milestone of a decade. At this point, management seems pretty confident that it will hit that target, projecting annual distribution growth of around 6% through 2026. So why is NextEra Energy Partners' yield 12.7%?
What is NextEra Energy Partners?
NextEra Energy Partners is a master limited partnership (MLP) controlled by parent NextEra Energy (NEE -1.36%). NextEra Energy Partners owns a large collection of renewable power assets, many of which it bought from its parent. This is an important relationship, as NextEra Energy Partners is really a funding vehicle for NextEra Energy.
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NextEra Energy builds clean energy assets and then sells them, in whole or in part, to NextEra Energy Partners. This is often called a dropdown transaction. NextEra Energy Partners funds the purchase via the sale of MLP units and debt. The big reason investors buy NextEra Energy Partners units is the distribution, which has historically grown along with its portfolio of assets.
The problem today is that the relationship between these two entities has changed. First, Wall Street has soured on renewable power stocks, putting downward pressure on NextEra Energy Partners' units. Then interest rates rose, making it more expensive to issue debt. All told, NextEra Energy Partners' ability to raise cash for dropdown transactions isn't great today. And that has resulted in parent NextEra Energy hitting the pause button on new dropdowns, effectively halving the growth of the MLP's distribution.
So what should an investor do now?
Buy NextEra Energy Partners
If you don't own NextEra Energy Partners, the huge 12.7% yield is clearly the reason to buy it. It would be icing on the cake if the distribution can continue to grow at around 6% a year. And given the relationship with NextEra Energy, one of the largest and fastest-growing utilities in the United States, NextEra Energy Partners has strong support behind it.
However, you have to go in with the understanding that NextEra Energy Partners' story has changed for the worse. And it isn't yet clear that the MLP is on a sustainable path. Utilities used the same funding approach in the midstream space not too long ago only to close the MLPs they created when unit-price declines ended the funding usefulness of the MLPs. This is basically what is happening right now with NextEra Energy Partners. That said, there is still a long growth runway ahead for renewable power, so the analogy isn't perfect. To buy NextEra Energy Partners, you need to believe that the outlook for clean energy is still strong.
Sell NextEra Energy Partners
The simple reason to sell NextEra Energy Partners is that the MLP's condition has weakened. If you bought it because of the potential for double-digit distribution growth, you won't be getting that now. This could be a temporary slowdown, or it could be permanent; there's really no way to tell at this point. And, as noted above, NextEra Energy Partners could cease to exist if it no longer provides an attractive funding source for parent NextEra Energy. If NextEra Energy buys the MLP, there might be a slight premium offered to unitholders, but it probably won't be massive. It would be understandable if dividend growth investors wanted to cut their losses and move on to opportunities that seem more attractive.
If you have owned NextEra Energy Partners for long enough, you are probably sitting on material capital losses. You could capture those losses to offset gains elsewhere in your portfolio. That, however, is complicated by the MLP structure, which makes use of return of capital distributions (such distributions reduce your cost basis in the MLP over time). You might want to consult a tax advisor if you are thinking about selling for tax reasons.
Hold NextEra Energy Partners
Even if you are sitting on material losses, you're still collecting the distribution. And it would likely be hard for an investor to replace the cash that NextEra Energy generates with the proceeds from selling the units because of the unit-price decline. Unless you believe that the story has changed irreversibly for the worse, sitting tight and giving parent NextEra Energy some time to muddle through the current headwinds wouldn't be the worst decision. It's worth pointing out the lowered distribution growth plan is still fairly attractive. Just realize that you are betting on parent NextEra Energy's ability to execute in a difficult environment. It has a strong history of doing so, but that doesn't mean it will always be able to achieve its targets.
No easy answers
Wall Street is clearly telling investors that they should be worried about NextEra Energy Partners' future. Given the shifting dynamics, driven by both the clean energy sector and interest rates, this is a high-risk investment today. With a strong parent, there's reason to believe that NextEra Energy Partners will successfully navigate this difficult period and continue to reward unitholders with big distributions.
But the history of MLPs acting as funding sources for utility parents highlights that there is a very real chance NextEra Energy Partners will cease to exist if it stops being useful. If that comes to pass, investors probably won't be left with nothing, but the distribution will go away and likely be replaced by a much lower dividend stream. If you decide to buy or hold NextEra Energy Partners, you will want to monitor it very closely.
