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Summary Hawaii Electric looks less likely to close by the end of the year than in our previous analysis. NextEra still doesn’t appear worth more than the mid-$90s. NextEra is doing really well in Florida and profits are higher than expected. Today, we will to take a refreshed look at NextEra Energy (NYSE: NEE ). We first looked at the company in late February and followed that with an update in June . When we started our analysis in February, we argued for some correction. We then reiterated that valuation was too rich in June. YTD, the company is now down 5% and has not shown much ability to add more value. We noted we would be interested at the 90-level. Our main thesis was that, while the company’s health and catalysts were strong, valuations were pricing in a best-case scenario of 6% revenue growth and 22% operating margins consistently moving forward. In the June update, we continued to be worried about margin compression from the Hawaii Energy (NYSE: HE ) deal. Today, we want to revisit our catalysts in the wake of the last set of earnings as well as other developments that have occurred. Additionally, we will take another look at our pricing model to update that given this analysis. 2015 Catalysts Revisited Economic Moat Strength For me, the key strength for NEE has always been its economic moat that exists from non-competitive agreements that the company has with many municipalities. Non-comp agreements exist in many of the relationships the company has where it negotiates a “fair price” deal with a town/city/county that limits competition but keeps prices in check for citizens. As we noted before, NEE is very attractive because about 80% of its business is in the regulated arena, where profitability is strongest. This image from Market Realist tells the tale: (click to enlarge) (click to enlarge) The company benefits strongly from these regulated industries as it can establish infrastructure, keep consistent revenue/earnings flowing, and doesn’t have to worry about competition. As long as the company can maintain this strong mix, it will be attractive for income, long-term investors. To me, the real catalyst, though, is the company’s ability to have success in Hawaii. Hawaii – Another Regulated Market to Add Shareholder Value In 2014, NextEra bought Hawaiian Electric ( HE ) for north of $4B. The move was a chance to come into a new market that was in need of cost savings and be able to combine a regulated market with the company’s practice of making efficient utility deliveries. Further, NEE wanted to be able to bring its ability and knowledge of scaling renewable energy in an area that is burdened by extreme energy costs. Between the company’s initiatives in solar energy and knowledge of other sources, NEE stands to be able to generate a very strong value proposition for Hawaii while also continuing to promote its economic moat. So, how have things been moving since the last time we looked at the company… The last time we looked at the HE/NEE deal, the main aspect of the deal was just to get it done and approved. In April, HE’s CEO came out saying he was confident that the deal would be completed within a year, and the Hawaiian House of Representatives put a resolution in place to complete the deal by June 2016. Given the market is regulated, it is a major decision for Hawaii, consumers, etc. In the company’s latest earnings, here was the company’s comments on the HE deal: Steven Fleishman – Wolfe Research Yes, hi good morning and congrats. The couple things that I guess you didn’t mentioned, first is any kind of thoughts on the Hawaiian deal and just, there does seem to opposition in your ability to get that done? James L. Robo – Chairman and Chief Executive Officer Steve this is Jim, obviously the state filed a testimony ten days ago saying that they opposed the deal in its current form and the Governor held a press release where he, press conference where he said he opposed the deal in its current form. I think the key, the keywords there in its current form, they also, the state also listed several conditions that would be, I think just positive for them to think about changing their view. And we are in the process of responding to that testimony and we think we have a very strong case to put forward to the Commission around the benefits to customers, the benefits to customers were actually pretty compelling and I think we’re going be able to make that case as we go forward. So, this was not necessarily a surprise to me that the state filed a kind of testimony that they did and we are going to continued to move forward on laying out our arguments and we look forward to the hearings we’re going to have in December to make our case. As we can see, things aren’t progressing as well as the company has hoped. In the last report, the company had noted that they expected the deal to be done by the end of the year. Now, the company is not quite as positive. Waiting till December to answer testimony is much different than getting approval then. The state of Hawaii published testimony in July, and the Governor came out against the deal: Gov. David Ige said Tuesday he doesn’t support the sale of Hawaiian Electric to Florida-based NextEra Energy. The sale was approved by Hawaiian Electric’s shareholders in June but still needs approval from the state Public Utilities Commission. Ige said he supports capital investment in Hawaii, but he joined critics saying he’s concerned that NextEra may not be able to fulfill Hawaii’s goal that its utilities use 100 percent renewable energy by 2045. This news was not exactly the type of “positive” news that the company had hoped for. Since that comment in July, the Governor has said the process was still very early, and that he is looking forward to the company’s responses to testimony it presented. While we all expected some snags, the process continues to move quite slow and questions the long-term prospects of being able to have this deal work well for all parties. Overall, though, we believe this deal is very important to NextEra Energy. As we noted previously: The company brings the expertise of how to apply a mix of renewable energy and create consistent returns. With the prices that Hawaii is used to paying, the company should reduce costs for Hawaiians yet also make a strong profit. The company’s mix, though, of more green energy plays has not been as profitable. The company still makes its bread and butter in Florida where it uses a majority natural gas. So, the question will be if they can return the type of 20% operating margin in Hawaii? The nice thing that is baked into the cake for them is that Hawaiians are used to paying more than most Americans, so they will be able to invest more easily. We will continue to monitor this situation, but for now, the company is starting to look like they are getting off track. Current Pricing Next, we want to update our current pricing model for NextEra. The latest earnings for NEE were pretty solid in the latest quarter. EPS came in at 1.56 versus 1.50 expectations as well as a beat for revenue as well. The company’s strength continues to be seen in Florida, where revenues/earnings continue to rise. The company’s results were helped by an improving Florida economy that led to more additions as well as a lot of strength in NextEra Energy Resources, which saw a 21% increase in revenue. The NEER division is the renewable contracted part of the business, and that type of growth shows just how in demand renewable energy is becoming. In this section, we will want to take a look at our last pricing analysis, update it, and determine what we believe is a fair value price for NEE. In order to price the company, we need to make certain assumptions. In our last two articles, we modeled revenue growth to continue at a clip of 4-5% per year, and we believe that level will maintain for the next several years. The gains we noted in our last article were not sustainable in NEER, and the results have already seen a 50% reduction QoQ. Most analysts are only modeling for 1% growth still for this year, but we are using an annualized figure. Utility revenue is fairly consistent. The key to the company is definitely margins. Operating margins are key to our DCF analysis. The coming has forecast that they will come in at the 22-23% in 2015, but I imagine this number will dip some with the onslaught of Hawaiian Electric when it is approved. In Q2, the company’s operating margins came in strong at 26% after 28% in Q1. For 2015, we believe 22-23% is a bit light, and we will increase our expectation to 25%. As for the HE deal, it should add roughly $4.5B in sales in 2016, but the company operates with a 10% operating margin. The deal is really essentially to take what is a tough market for making money, revolutionize it, and improve it. This plan, though, will take several years. Therefore, margins will drop in 2016 but gradually improve again through 2020. Taxes have averaged roughly 25% for the past five years, and it’s likely this will stay around 28%-30% over the next several years. We may see it jump even a bit more beyond 2016 when more solar credits are expected to expire. Depreciation will continue to grow at about the same rate as revenue growth. Capex should come down in 2015 to around $6B and again in 2016 to $4B.The $4B rate, though, is pretty standard for the company. Our WACC rate is 5% for discounting. When we use this math in our five-year DCF analysis, we were looking at a low-90s number. We have made some positive adjustments, and here is our projections: PROJECTIONS 1 2 3 4 5 2015 2016 2017 2018 2019 Income from Operations 4350 3654 3990 4347.2 4726.73 Income Taxes 1218 1023.1 1117.2 1217.2 1323.48 Net Op. Profit After Taxes 3132 2630.9 2872.8 3130 3403.25 Plus: Depreciation 2600 2700 2800 2900 3000 Less: Capex -3600 -3900 -4000 -4100 -4200 Less: Increase in W/C -100 -100 -100 -100 -100 Available Cash Flow 2,232 1,531 1,773 2,030 2,303 We don’t see any major change from our last model, so we are keeping our price target at $96. Margin drops in HE and getting regulations approved are key to this model. Additionally, if Florida and NEER stay very strong, the company could outperform our expectation for the current FY. Conclusion NextEra has interesting catalysts to 2015, but after a tremendous run in 2014, the company looks like its upside may be limited in the near-term. Recent issues in Hawaii Electric ( HE ) make me nervous, but the rest of the company’s business is extremely intriguing and strong, which neutralizes my fears there. Yet, we still don’t see the reason to buy when we are at sitting at 2.5+ times sales and the company has question marks outstanding. Scalper1 News
Scalper1 News