Three weeks ago, I outlined my plans to create a portfolio of 10 companies that all have one thing in common: They provide a basic need or deliver life's necessities. It's my contention that basic-needs companies can offer investors stability and growth throughout any market environment thanks to consistent demand, incredible pricing power, and delectable dividends. This portfolio, which I have dubbed the Basic Needs Portfolio, will be pitted against the S&P 500 over a period of three years with the expectations of outperformance for all 10 stocks. I'll be rolling out a new selection to this portfolio every week for the next seven weeks.
You can review my previous two selections here:
Today, I plan to introduce the third of 10 selections to the Basic Needs Portfolio: NextEra Energy (NEE -1.36%).
How it fits with our theme
Of all the companies I will profile in this series on basic-needs stocks, perhaps none fits the bill more perfectly than NextEra Energy, which engages in the generation, transmission, and sale of electric energy in the United States. Unless you plan on living your life in the woods, chances are that electricity has become a basic necessity of your life. We need it for our homes to power our lights, stove, refrigerator and central air, just as enterprises and government agencies need it to power their vast infrastructure. With the demand for electricity consistent in almost any economic environment (both booming and recessionary), electricity price remain inelastic -- a telltale sign of a necessity product.
In spite of having a product that tends to only go up in price and demand over time, there is no such thing as a riskless investment.
The first risk NextEra faces is its extraordinarily high levels of debt. It's true that cash flow from electricity generation is steady, but so is the interest it pays on the $28.2 billion in debt the company carries on its balance sheet. Electric utilities don't have much choice when it comes to upgrading or expanding their operations in order to reduce their long-term operating costs other than to take on debt to fund projects. The danger is that sometimes this debt can even put previous darlings out of business. U.S. electric utility Calpine (NYSE: CPN), for example, was forced to declare bankruptcy in 2005, weighed down by $17 billion in debt at the time. Calpine's collapse had a lot to do with the weakness in the energy market generated by Enron's collapse a few years prior, but it has also failed to regain its luster since reemerging from bankruptcy.
Another risk factor that can often be overlooked is that electricity price increases aren't a guarantee. In fact, power price increase rulings are often determined by state regulatory energy commissions which have a duty to look out not for these companies, but also for the best interests of consumers. Last summer, for instance, Xcel Energy (XEL -0.40%) was denied a $100 million rate increase (about $2 each month per customer) by the Colorado Public Utilities Commission after failing to sufficiently demonstrate how not raising these rates would adversely impact the company.
Why NextEra Energy?
Now that you better understand the risks, let's look at why NextEra Energy stands out among my favorite basic-needs electric utility plays.
The primary allure of electric utility providers is their asset diversity. Duke Energy (DUK -1.04%) and Exelon (EXC -0.12%), two of the nation's largest electric generators, have been investing heavily in alternative energies to help allay the high costs of coal-fired plants and, in Exelon's case, the high cost of nuclear energy generation. Duke is required by the North Carolina energy commission to meet a minimum of 12.5% electric generation from renewable energies by 2021, while Exelon owns 44 wind projects located in 10 states throughout the U.S. that's capable of producing nearly 1,300 MW of electricity.
While impressive, no company can hold a candle to NextEra Energy's renewable energy capacity, which is second-to-none. The company is an industry giant with nearly 43,000 MW in electrical capacity and recently commissioned a 400 MW project in Colorado that'll put it over the 10,000 MW generation mark in wind capacity! NextEra also has undertaken numerous solar energy products with the help of First Solar and even China's Yingli Green Energy.
NextEra's robust renewable energy portfolio has a few notably positive impacts. First, it's a green source of power, which doesn't harm the environment. Second, renewable energy costs are falling, meaning that consumers are likely to benefit with lower electric costs over the long run. Finally, the Obama administration has made it quite clear that one of its primary focuses is to reduce America's dependence on foreign oil. One way of achieving that is by better utilizing renewable energies such as what NextEra has devoted the majority of its portfolio too. If subsidies continue for renewable energy projects, then NextEra is going to be sitting in better shape than many of its peers.
Another very important factor that makes NextEra attractive is its dividend, which has been raised for 18 consecutive years. NextEra hasn't been shy about its plans to pursue a targeted payout ratio of 55% which has led to big gains for shareholders, as the following chart shows.
All told, NextEra shareholders have witnessed their payouts jump by an average of 6.3% over the previous 18 years and currently are receiving a steady yield of 3.4%. While a bit lower than some of its peers, this is still considerably higher than the S&P 500 average yield which is closer to 2%.
Stay tuned next week, when I'll unveil the fourth selection to the Basic Needs Portfolio.