Investors searching for high dividend yields may find NextEra Energy Partners' (NEP 0.88%) 12% payout alluring. However, the renewable energy provider has faced a significant setback in the past year as management cut the company's growth forecast as a result of higher interest rates.
NextEra has since taken steps to bolster its financial position and continue offering investors an appealing dividend. But the stock remains down 54% from a year ago. Could it now provide an attractive upside for patient investors? Let's see.
A utility provider with an appealing payout
NextEra Energy Partners acquires, manages, and owns clean energy assets focused on renewable energy, including wind, solar, battery storage, and natural gas pipelines. The limited partnership was formed in 2014 by NextEra Energy (NEE 2.45%), one of the world's largest producers of solar and wind energy. It spun off NextEra Energy Partners to create a master limited partnership (MLP), creating an investment vehicle for those focused on renewable energy.
This MLP structure helps NextEra Energy raise capital for future projects by "dropping down" assets to NextEra Energy Partners. NextEra Energy Partners funds these asset purchases by issuing debt or new units, which introduces added risk for investors. In return for this risk, NextEra Energy Partners offers investors higher dividend yields than its parent company, which is why MLPs may appeal to income-focused investors. Over the past decade, NextEra Partners' average dividend yield has hovered around 4%.
NEP Dividend data by YCharts
Rising cost of capital has weighed on the utility provider
One positive aspect of investing in the partnership is that investors can see future cash flows. That's because the projects in its portfolio are held under long-term contracts with generally fixed payments. Still, things can turn south quickly if those projections are scaled back.
That happened last September when the partnership announced lower expectations for future dividend growth. Last year, management reduced its guidance for dividend growth to between 5% and 8% annually, with a target of 6%. This was well below its previous guidance of 12% to 15% dividend growth, and the stock plunged 56% following the announcement.
Interest rates have risen rapidly over the past few years, increasing the cost of capital. One structure NextEra Energy Partners uses to acquire assets from its parent company is convertible equity portfolio financings (CEPFs). These are like debt, and the partnership has the right to buy out this financing in the future at a fixed rate of return using either cash or common units. However, when the unit price falls like it has, buying out this financing becomes more expensive, diluting shareholders, so paying cash is preferable.
Management has taken steps to rebuild capital and retire some of its outstanding arrangements. For one, it's selling non-core assets, like its gas pipelines, making it a pure-play renewable energy producer. Last year, it sold its Texas pipeline portfolio to Kinder Morgan for $1.8 billion. After extinguishing project-related debt, the partnership had $1.4 billion in proceeds that it plans on using to buy out other (CEPFs).
Image source: Getty Images.
Keep an eye on its dividend payout ratio
Given the slowing growth of the partnership's assets, many wonder if its dividend is safe. The company continues to maintain and grow its dividend payment. It paid investors $0.88 per share in the first quarter, up 8% from last year. However, the company's dividend payout ratio is relatively high, and management expects this ratio to be in the mid-90s through 2026.
A high dividend payout ratio means NextEra's margin for error is small, and the dividend could be at risk of getting cut if it fails to execute its plan. Therefore, investors should approach the stock cautiously and be aware that its high dividend yield could be at risk.
What to watch for
NextEra Energy Partners has long-term advantages as one of the largest renewable energy providers in the U.S. Renewables will likely continue expanding to meet growing electricity demand. According to the U.S. Energy Information Administration, global electric power generating capacity is expected to increase 55% to 108% by 2050 and electricity generated from renewables and nuclear energy could increase by 54% to 67%.
However, NextEra will face near-term headwinds. The high cost of debt could continue to weigh on the business. Many expected interest rates to fall in 2024. However, inflation remains stubbornly above the Federal Reserve's 2% target. The most recent core Consumer Price Index (CPI) increased 3.8% over the last year. After pricing in up to six interest rate cuts this year, markets now expect only one rate cut, according to CME Group's FedWatch Tool.
Is it a buy?
NextEra has made progress in raising capital and reducing some debt facilities, and that should alleviate some pressures on the business. And, no doubt, the stock offers a very attractive yield -- as long as the dividend doesn't get cut. But the bottom line is that investing in NextEra Energy Partners comes with risks and may not be suitable for risk-averse investors looking for a reliable dividend income stream.
