NextEra Energy Partners: Bet On Renewables With This High-Potential YieldCo (NYSE:NEP)

NextEra Energy Partners, LP (NEP) is a master limited partnership that was set up by NextEra Energy (NEE) to purchase and manage renewable energy projects. In some regards then, the company is similar to Brookfield Renewable Partners (BEP) except that NextEra Energy Partners is affiliated with an electrical utility that is specifically focused on renewable sources of energy. As has been the case with many other companies in the renewable sector, NextEra Energy Partners has seen its unit price surge so far this year. This is partly due to the increasing popularity of the renewable industry following the steep decline in crude oil prices following the outbreak of the COVID-19 pandemic. This strength in the market has pushed down the distribution yield and thus NextEra Energy Partners does not have nearly as high of a yield as most master limited partnership investors like to see. With that said though, the company could offer a way for investors in traditional energy partnerships to gain exposure to renewables and still receive a reasonably appealing yield in today’s low-interest rate world.

About NextEra Energy Partners

As mentioned in the introduction, NextEra Energy Partners is a partnership that was set up by NextEra Energy to purchase and operate renewable energy projects that are under long-term power purchasing agreements that provide reasonably stable cash flows. The partnership has the majority of its assets in the central and western parts of the country, although it also has some assets in Pennsylvania:

Source: NextEra Energy Partners

The majority of the partnership’s assets are wind and solar generation facilities. This is unlikely to be a surprise to anyone that follows the renewable energy sector since this is what the majority of new renewable projects have been over the past several years. Perhaps surprisingly, the partnership also has 727 miles of pipeline assets in Texas and Pennsylvania. This may seem to go against the overall business model that focuses on renewable energy projects. While it is true that pipelines are used to transport traditional fossil fuels, the pipelines owned by NextEra Energy Partners are natural gas pipelines. As I have pointed out in many previous articles, natural gas burns much cleaner than either coal or crude oil so converting power plants and vehicles from coal and crude oil to natural gas should have the effect of reducing carbon emissions. Thus, these pipelines still qualify as clean energy assets even if they are not strictly renewable assets.

In order to truly function effectively, a master limited partnership needs to have a reasonably consistent source of cash flow. In the renewable energy sector, the way that we accomplish this is the use of power purchasing agreements. As I discussed in a previous article, a power purchasing agreement is an agreement between a producer and a purchaser of electricity over an extended period. Due to their relatively long terms (often many years), these agreements allow for a relatively stable and consistent source of income for the owner of the electricity generation assets. This is something that we very much like to see in a master limited partnership because the consistent cash flows provide a great deal of support for the distribution. NextEra Energy Partners has an average remaining contract life of fifteen years so we can clearly see that NextEra Energy Partners should be able to maintain relative stability over the long-term.

In addition to its stable cash flows, NextEra Energy Partners possesses a considerable amount of growth potential. This comes largely from its affiliation with NextEra Energy Resources, which is an electricity wholesaler that constructs wind and solar projects throughout the United States. NextEra Energy Resources owns 24 gigawatts of energy generation facilities in operation with another thirteen gigawatts in its development pipeline:

Source: NextEra Energy

NextEra Energy Partners’ primary source of growth is to purchase assets from NextEra Energy Resources that manage to obtain long-term power purchasing agreements from creditworthy customers. This frees up money for NextEra Energy Resources to construct more clean-energy facilities while still allowing the parent company to retain some of the cash flows from these assets due to its stake in NextEra Energy Partners. It also naturally results in growth for NextEra Energy Partners because each new asset that it purchases produces revenues and cash flows. This has provided the partnership with growth over the past few yeas. As we can see here, NextEra Energy Partners has purchased eight renewable energy facilities from NextEra Energy Resources since 2019:

Source: NextEra Energy Partners

There is much more potential for forward growth from this method. As already noted, NextEra Energy Resources still has a relatively substantial project backlog that is being driven by the growing demand for renewable energy, which we will discuss in just a bit. This is simply a continuation of the growth that we have already seen. Back when NextEra Energy Partners conducted its initial public offering in 2014, NextEra Energy Resources had a clean energy generation capacity of ten gigawatts. As we have already seen, it is substantially larger than that today. When we consider the current size of its portfolio and the project backlog, NextEra Energy Partners is positioned to grow at a 12%-15% compound annual growth rate until 2024:

Source: NextEra Energy Partners

NextEra Energy Partners is not limited to generating growth by purchasing assets from NextEra Energy Resources, although that is the primary driver. The company does have the option of generating growth by purchasing clean energy assets from other companies. Naturally though, the assets that NextEra Energy Partners acquires from another company must still meet its requirements. In particular, the asset must have long-term power purchasing agreements with creditworthy customers. This ensures that any facility that the company purchases will be accretive to revenues and cash flows immediately and removes any risk of it not obtaining a power purchasing agreement after the acquisition.

Renewable Energy Fundamentals

As I mentioned in a few previous articles, the long-term fundamentals for renewable energy are quite strong. This is at least partly due to fears of climate change. These fears have led governments and other authorities throughout the world to advance a variety of mandates and incentives meant to reduce the carbon emissions of their respective nations. The easiest way to do this is to convert from fossil fuels to renewable energy. In addition to this, many consumers of electricity are trying to reduce their own carbon footprint due to these fears, which also prompts companies to develop renewable generation technologies and facilities in order to meet this demand. This is a trend that is expected to continue due to the fact that climate change fears are unlikely to go anywhere and the simple fact that the global supply of fossil fuels is ultimately finite. According to the International Energy Agency, the global demand for renewably-generated electricity is expected to increase by 83% over the next twenty years, far outstripping any other source of energy:

Source: International Energy Agency, Kinder Morgan (KMI)

The same trend is true inside the United States. In fact, right now the renewables market in the United States has been growing at a 15% rate. This resulted in about twenty gigawatts of wind and solar generation capacity becoming operational annually over the 2019-2022 period and is expected to increase to nearly 35 gigawatts annually over the 2023-2030 period:

Source: NextEra Energy

We can expect these capacity addition numbers to be fairly accurate over the medium-term. This is because that due to the development and construction time of these facilities, pretty much all of the generation capacity that will be coming online by 2022 is already under development in various stages. Thus, we can be pretty sure what will be coming online over the period.

It makes little sense for the nation’s utilities to construct these new facilities if the demand from consumers of electricity is not there. Fortunately though, the demand for renewable electricity can be manufactured. While there are certainly some consumers and businesses that directly seek to purchase renewably-sourced electricity to expand their own green credentials, there are also many that simply do not care. These people could still wind up using this source of energy though if the electric utilities retire old fossil fuel (especially coal) power plants and replace them with renewable facilities. If the price of electricity produced by these new facilities is relatively in-line with the price of electricity produced by fossil fuel plants, it is unlikely that even ambivalent people will care. The Energy Information Administration expects that this will be the case as the percentage of oil- and coal-fired electricity declines and natural gas- and renewable-fired generation capacity increases over the next thirty years:

Source: Energy Information Administration

This transition will be driven by electric utilities retiring their old coal- and oil-fired power plants. I discussed this in a previous article. There are many types of renewables, however. Thus, an investor in this sector should ensure that they are buying into a company that is developing the correct type of renewables. Fortunately for our purposes here, it is solar and wind power that are expected to see the largest growth:

Source: Energy Information Administration

This is not especially surprising. This is because many types of renewable energy, such as hydroelectric, are extremely location-specific. Solar and wind power are not as much since they only need to be placed in sunny or windy areas, respectively, which are reasonably common. Fortunately for us, these are the two types of renewable power focused on by NextEra Energy Resources and by extension NextEra Energy Partners. Thus, the company is focused specifically on the correct areas in order to see a significant amount of growth going forward. This is something that investors should find appealing.

Financial Considerations

One thing that we always want to consider when analyzing a company is the way it finances itself. This is because debt is a riskier way to finance a company than equity is due to the simple fact that debt must be repaid at maturity. In addition, a company must make regular payments on debt if it wishes to remain solvent. Thus, should some event occur that causes its cash flows to decline then these regular payments could strain the company or push it into insolvency. We do not have these problems when financing with equity. Thus, we want to look at the company’s net debt-to-equity ratio. As of September 30, 2020, NextEra Energy Partners had a net debt of $3.808 billion compared to $6.723 billion in equity, which gives the company a net debt-to-equity ratio of 0.57 . This is below the 1.0 maximum that we usually want to see, which tells us that NextEra Energy Partners primarily finances itself with equity. This is the kind of thing that we like to see in a conservative income play.

NextEra Energy Partners’ long history of growth has allowed it to steadily increase the distribution that it pays out to its investors. As we can see here, the partnership has generally increased its distribution in every quarter over the past five years:

Source: Seeking Alpha

As is always the case though, we need to make sure that the company can actually afford the distribution that it pays out. This is because we do not want to be the victims of a sudden distribution cut. The easiest way to do this is to look at a measure known as the cash available for distribution, which is a non-GAAP measure that tells us the amount of cash that was generated by a company’s ordinary operations that is theoretically available for distribution to the limited partners. In the third quarter of 2020, this figure was $162 million, an increase over the $147 million that the company had in the prior year quarter:

Source: NextEra Energy Partners

As of September 30, 2020, NextEra Energy Partners had approximately 65.5 million common units outstanding. Thus, the current distribution of $0.595 per common unit costs the company approximately $38.9725 million. This gives it a coverage ratio of 4.16, which is quite obviously well above the 1.20x that analysts usually consider to be sustainable and above the 1.30x that I generally like to see in order to add a certain margin of safety to the distribution. Thus, NextEra Energy Partners’ 3.70% yield does appear to be quite safe, even if the yield is lower than what many income-focused investors really want to see.

Conclusion

In conclusion, it can be a smart idea to add some degree to exposure to renewables in an energy portfolio in order to take advantage of the growth potential in this sector. Unfortunately, most companies in this sector have essentially no yield, which can be a problem for retirees or others that need income. A company like NextEra Energy Partners allows one to have the best of both worlds as its long-term power purchasing agreements allow it to produce a relatively consistent source of cash flow to support a distribution and it retains the growth potential of its parent company. Overall, this company may be worth considering, although the yield is fairly low compared to other partnerships.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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