NextEra Changes Utility Paradigm By Outperforming S&P 500 Index

March 19, 2019

• NextEra Energy has consistently outperformed the S&P 500 Index over the past decade.
• NextEra is up much more than the broad market benchmark over the past six months.
• Like all utilities, NextEra is a defensive stock, but it stands out for growing earnings and free cash flow.
• NextEra has increased dividend payouts on a yearly basis.

When thinking about growth stocks, utilities are not at the top of the list. Think of the game of Monopoly, utilities are the most boring properties to own. They’re often less exciting in real life.

However, one utility, NextEra Energy (NEE), has consistently outperformed the S&P 500 Index over the past decade, and is up much more than the broad market benchmark over the past six months.

Utility companies, especially ones providing electricity and gas, generate little excitement among investors because they tend to grow slower than other industries and carry significant amounts of debt. Utilities typically experience limited revenue growth because they’re heavily regulated industries in which the government sets the price they're allowed to charge.

Limits on revenue growth typically put a big crimp in capital appreciation. However, when markets start to fall, utilities are a good defensive play because the government-set prices guarantee enough revenue to cover costs, and ensure a consistent and reasonable profit.

During the financial crisis, the stock market hit the bottom of one of the biggest bear markets in history on March 9, 2009. From that date until March 15, 2019, the S&P 500 soared 317%. Over the same period, it shouldn't surprise anyone that the Utilities Select Sector SPDR ETF (XLU), which holds most of the utility stocks in the S&P 500, underperformed the broader index with just a 156% return.

However, NextEra is turning the utility paradigm on its head because it’s growing.

Over the past decade, NextEra's stock rocketed 358%, 13% more than the S&P 500. In 2018 alone, NextEra’s stock rose 14.3%, while the S&P 500 fell 4.4%.

And since Sept. 20, when the S&P 500 began its end-of-the-year plunge and rebound, the index is down 0.04% and the XLU is up 0.09%. However, NextEra has leapt 14.3%. It's current share price is $188.54.

The government-set revenue provides utilities with reliable cash flow, which provides the basis for the stable dividends with premium yields that utility companies are famous for paying out. Typically, utilities return between 60% and 80% of their earnings to shareholders, resulting in a typical return on equity between 10% and 12%.

Because of their large dividend yields, utilities are considered bond proxies. When interest rates climb, utilities face more competition from bonds and other income vehicles.

The risk of more competition from bond yields seems minimal for now, Jim McCaughan, chief executive of Principal Global Investors, told Barron's. He said he doesn’t see much inflationary pressure on the horizon, partly because of the impact of technology. With lower inflation, there’s less pressure on yields to move higher. Another potential lid on yields is the growing number of retiring baby boomers, McCaughan told Barron's.

On Friday (March 15), Federal Reserve Chair Jerome Powell said he does "not feel any hurry" to change rates. The Fed is expected to raise interest rates once more this year, in the third quarter. U.S. Treasury prices rallied on the news, pushing yields lower.

The benchmark 10-year Treasury note closed Friday with a yield of 2.594%, its lowest level since Jan. 3, according to Dow Jones Market Data. As of Friday, the S&P 500’s yield was 1.83%.

The XLU ETF hit a 52-week high Thursday (March 14) and broke out of a saucer-with-handle technical formation. It currently yields 3.09%, way above government securities.

I think foreign investors seeking income are buying U.S. utilities as the U.S. economy remains in expansion and utilities are able to increase their dividends.

The strength in utilities reflects the attitude of investors who “don’t really buy the rally,” Jim Paulsen, chief investment strategist of the Leuthold Group, said in this week’s Barron’s. While they’re skittish, they still want to participate in the stock market rally, but opt for its most conservative sector, he added.

Like most utilities, NextEra has a nice dividend. The payout increases yearly and its current yield is 2.62%. Like all utilities, NextEra is a defensive stock, because people will pay their utility bill in a recession. Utilities are also immune to the global economy and considered a safe haven if a trade war or Brexit heats up. However, what makes the Juno Beach, Fla., electric company unique is that it's a growth stock. It's hard to find a stock with all those qualities.

NextEra operates Florida Power & Light (FPL), a large regulated utility in the Sunshine State, providing the parent company with stability. "FPL is benefiting from rate increases and the healthy economy in its service area," according to Value Line. "FPL will get additional rate relief when a 1,750 megawatt gas-fired plant is completed in mid-2019."

"Whatever happens to the economy, NextEra has a balanced portfolio," Bobby Edemeka, a portfolio manager of the Prudential Jennison Utility fund (PRUAX), told Barron's. "Its Florida Power & Light unit, which chips in close to 70% of operating revenue, is benefiting from population growth in the Sunshine State."

In addition to the population growth, FPL also benefits from somewhat favorable regulatory oversight, giving it good sales growth potential. NextEra's latest Florida rate case lets the company raise rates by $811 million over the next three years, supporting its ability to maintain a pace of utility earnings expansion that exceeds peers.

Edemeka also told Barron's that NextEra could expand its profits at an 8% annual clip through 2020, which bodes well for growing the dividend.

NextEra started 2019 completing the acquisition of assets from The Southern Company (SO). These include Gulf Power Company and Florida City Gas, two non-regulated, gas-fired generating assets in the Sunshine State. These unregulated growth opportunities should help drive performance

"NextEra paid $5.1 billion and assumed $1.4 billion of Gulf Power debt. It financed the deal with $4.5 billion of debt," according to Value Line.

The company expects that the transaction will boost net income by 15 cents a share in 2020 and 20 cents in 2021.

In addition, NextEra has become the largest producer of wind and solar power, and is expanding its portfolio. It's built the largest solar storage plant in the U.S. on 440 acres in central Florida. It sells this power to utilities and other customers.

"As one of the largest owners of renewable energy, it's taking steps to be in the same position in the energy storage market," said Value Line. These are batteries storing solar power connected to the grid.

For NextEra and others in the wind space, “there are relatively high barriers to entry,” said Stephen Byrd, an equity analyst at Morgan Stanley, in Barron's. Byrd added NextEra is also supported by long-term contracts to distribute renewable power, and technological breakthroughs in wind power have helped a lot, too. “As these blades get longer, the output goes up exponentially,” said Byrd.

“As the renewable business has grown, it’s become more efficient, reducing production costs,” said Barron’s. “Adding to the business’s allure is that wholesale customers often sign 20- to 30-year contracts, ensuring relatively reliable cash flows for decades.”

I believe NextEra is both a dividend and capital appreciation play. It’s a good investment to put you in a position to benefit from the shift away from fossil fuels and into renewable energy, because it's going to keep adding capacity.

Cash on the cash flow statement grew 165% year over year to $5.3 billion. I expect cash to increase because of tax breaks, lower production costs, the higher prices they can charge, and a customer base growing 1.5% each year. These will all increase dividend payouts.

The stock will be a better investment than Treasurys because its dividends have been increasing between 10% and 15% every year. In 2015, the annual dividend was $3.08. In 2016, it grew 13% to $3.48. It jumped another 13% in 2017 to $3.93. Last year saw another 13% advance to $4.44. The dividend is projected to advance another 13% in 2019. These are consistently big increases which would be a projected total of 62% increase in payouts over four years.

I also expect earnings per share to experience long-term growth of 6% to 8%, which should support its premium price-to-earnings multiple of 25.

NextEra is also a good investment for people who follow environmental, social and governance (ESG) criteria. It was recently recognized as one of the World's Most Ethical Companies by Ethisphere Institute, a global leader in defining and advancing the standards of ethical business practices. And Forbes placed NextEra on its list of America's Best Employers for Diversity for the second consecutive year.

In January, Fortune's list of the "World's Most Admired Companies," ranked NextEra first in the electric and gas utilities industry for the 12th time in 13 years. Fortune also placed it among the top 25 companies worldwide, across all industries, for innovation, use of corporate assets, social responsibility and long-term investment value.

For 2018, the company reported total operating revenues fell 0.6% to $16.7 billion. Net income jumped 18% to $6.64 billion, or $13.88 a share, on a GAAP basis. Adjusted earnings jumped 15% to $7.70 a share.

In January, NextEra reiterated its guidance for the next three years. The company still expects adjusted earnings of $8 to $8.50 a share in 2019. For 2020, it backed expectations for adjusted earnings of $8.70 to $9.20 a share and for 2021 adjusted earnings of $9.40 to $9.95 a share.