NextEra Energy: Much Better Dividend Picks Are Available Among Utility Companies (NYSE:NEE)

We have become bearish NextEra Energy, Inc. (New York stock market :BORN) at the beginning of the year. A strong rebound from the lows was behind us, profits The estimates were optimistic and the valuation was high. The stock price had room to fall and the valuation would always remain in unreasonable territory. Using historical data, metrics such as EV/EBITDA and Price/Earnings ratio favored a price decline of nearly 30% from this point. The conclusion of this article highlighted the crux of the problem.

The NEE was the perfect example of the zero interest rate bubble. This unwinding will take much longer and there are many downside risks. Of course, a key point here is that we believe interest rates will rise over the long term. Those using the The Fed rate cuts to justify their position should know that long term rates 2% higher than short term rates are about as normal as you can get when looking at long term history. So even if you accept the 6 rate cuts, know that the average situation would require 10 year yields of 5.5% in that case.

Source: NextEra Energy’s Next Step

The price has risen nearly 16% and, with dividends, the stock has returned 17.5% to its investors since then.

Of course, it’s horrible. There’s nothing worse than missing out on a rise because you’re being pessimistic at the wrong time. We’ll take this opportunity to explain why we’re holding our position and believe the stock price will eventually fall much further.

Q1-2024

The first quarter of 2024 was a disappointment for the NEE bull community. The giant lowered its earnings guidance after beating adjusted earnings numbers. While the company stuck to its earnings range for 2025 and 2026, it was starting from a slightly lower base. The consensus numbers were also at the high end of the range that NEE had outlined. The good news is that the company affirmed its rapid dividend growth. NEE promised 10% increases in 2025 and 2026.

The macro

NEE trades at around 20 times earnings.

The growth rate is expected to be around 6% per year. The NEE range is 6-8%, and we think the lower end of the range is more likely in the next 3 years. Neither of these numbers look bad relative to where the stock was trading as recently as 2021. In December 2021, the stock was near $95 per share and was posting an astonishing 37.5X earnings (for 2021). It’s pretty easy to say that we’re done now and the stock can resume its long-term trajectory. We think there will be two hurdles here. The first is that financial markets tend to create excess in one direction followed by excess in the other. So that 37.5X multiple will likely be followed at some point by significant undervaluation. Some might argue that the 17X multiple we saw near its October 2023 level was good enough. We don’t think so, as utilities as an asset class typically trade near the 12X-14X mark. This is certainly true when interest rates are not anchored to zero. So a 17X multiple is far from a fair valuation and is certainly not a sign of undervaluation.

The second aspect is that the free capital flow environment is very supportive of the global multiple. We do not believe this will last forever and that in the next recession, NEE’s growth and regulatory approvals will be challenged.

Verdict

Price and valuation matter. We have even suggested betting on NEE as we approach the 2023 bottom. We are flexible in our approach and if NEE starts to look like it has at least partially corrected the excesses, we would take a more constructive stance. As it stands, NEE remains quite expensive. This is something even income-oriented investors will recognize. You can see how NEE stacks up against comparable high-quality utilities like Consolidated Edison, Inc. (ED), American Electric Power Corporation, Inc. (AEP), Duke Energy Corp. (DUK) and Pinnacle West Capital Corp. (PNW).

PNW is by far the best comparator here. It yields nearly 2% more than NEE. It trades at a multiple of 16X. We can expect similar growth rates for both.

So why would you want to pay more for NEE? We continue to rate this product as a sale.

NextEra Energy, Inc. UNIT 01/09/25 (NEE.PR.R)

Even though no one is going to chase NEE for its dividend yield, they might chase NEE.PR.R. We can hear their thought process.

“8.5% Dividend Yield from NEE, Sign Me Up!”

If this sounds like a lack of due diligence, then that’s how the standard income investor works. We saw it in the case of Algonquin Power & Utilities Corp., (AQN) and its mandatory convertible units, whose symbol was AQNU. The two prices followed each other closely, and many analysts were surprised because they missed the first two words of our description.

Mandatory convertible.

Although NEE doesn’t use the term, it’s obvious that you’re going to have to make this exchange within 14 months:

The stock purchase agreement requires the holder to purchase a variable number of shares of NextEra Energy, Inc. common stock for $50 on or before September 1, 2025 and pay a contractual adjustment rate of 2.326% per annum. The stock purchase settlement rate will be 0.4500 shares per unit if the current market price is equal to or greater than $111.10 and 0.5626 shares per unit if the market price is equal to or less than $88.88. For market prices in between, the settlement rate will be $50 divided by the market value. Prior to the initial public offering of this security, the last reported sale price of the common stock on September 14, 2022 was $88.88 per share. The stock purchase agreement may be settled at any time at the holder’s option and the Company will deliver 0.4500 common shares for each purchase agreement.

Source: Quantum Online

In essence, you get common stock, but you have to adjust for the higher dividend in the interim. Using the 0.5626 shares of NEE, we get a fair value of about $40 for NEE. Of course, this doesn’t take into account the higher payouts up to that date. At the current price of $42.50, NEE.PR.R is slightly overvalued, even considering the large yield differential. Since we rate NEE at Sell, we will also rate NEE.PR.R at Sell.