NextEra Energy Partners: Strong Yieldco With Considerable Upside
Summary Solid base of long-term, stable cash flow-producing electricity generation assets. Strong partnership sponsor willing to step up with equity contributions when required to grow the dividend. Currently priced at an attractive level due to the market’s over-reaction to acquisition and financing of natural gas pipeline assets. NextEra Energy Partners (NYSE: NEP ) is a limited partnership formed and sponsored by NextEra Energy (NYSE: NEE ), with the sponsor maintaining approximately three quarters interest in the underlying operating company. NextEra Energy Partners focuses on the acquisition of energy projects, primarily in the renewable space, with long-term stable cash flows. These stable cash flows are then levered in order to generate a high rate of return in a sustainable long-term dividend. The company’s primary focus is a collection of renewable energy assets currently under long-term power purchase arrangements in eight states and one Canadian province. These assets currently have capacity to generate 1,923.2 megawatts of energy, approximately 84 percent from wind generation. This will be further expanded by 149 megawatts of wind generation from the Jericho assets being purchased from its sponsor, which will be discussed later along with the partnership’s recent developments. Also in terms of recent developments for further discussion, the company has recently acquired substantial natural gas transmission pipeline assets. In terms of forward guidance, NextEra Energy Partners has indicated that it expects to generate $400-440 million in adjusted EBITDA for 2015, increasing to $580-620 million of adjusted EBITDA in 2016, primarily on the back of the NET Midstream acquisition, which we’ll cover along with some other recent developments. This should leave the company with approximately $170-190 million in cash available for distribution in 2016. The partnership has currently set its target distribution to $1.23 per share annualized at the end of year, reflecting an increase to approximately $0.3075 per share quarterly or a dividend yield, based on the September 10 closing price, of 4.7 percent. From a long-term perspective, the company expects to continue to grow this dividend at an average annual growth rate of 12-15 percent. As a note to investors, the partnership expects its distributions to be treated as though they are dividends received from a corporation for U.S. federal income tax purposes. This income will be reported on a 1099-DIV form. While we’re not in the position to offer expert tax advice, and readers should consult their tax advisors, we believe this is certainly an easier-to-understand tax structure than many partnerships out there, albeit perhaps trading off some of the benefits. Recent Developments In NextEra Energy Partners’ second-quarter release, the partnership announced that they had entered an agreement to acquire NET Midstream, an owner and operator of natural gas pipelines located in Texas. This operation maintains 3.0 billion cubic feet per day in ship or pay contracts, with an average life of 16 years, and, according to NextEra Energy Partners, an average investment-grade counterparty credit. Current growth and expansion projects are expected to grow this contract volume by an additional 1 billion cubic feet per day upon completion. The pipelines, in particular, look to be a relatively high-quality asset, with a current capacity of 4 billion cubic feet per day, which could later be expanded to 5 billion cubic feet per day. The primary shipment of gas on these pipelines is from the Eagle Ford shale gas region into Mexico. Additional volumes served include volumes from the ENSTOR Katy Hub to residential consumers and industrial users in the Houston area, and additional volumes supplied to the city of Corpus Christi, Texas. The acquisition of NET Midstream is expected to provide $145-155 million in 2016 adjusted EBITDA, and by 2018, following the completion of the expansion projects, up to $190-210 million in EBITDA. On a whole, this isn’t really an exciting acquistion from a purely cash flow accretion standpoint, but it does offer some diversification to the partnership’s energy infrastructure business at little dilutive cost. Overall, we’re pretty neutral to the acquisition, but the impact the financing has had on the stock price has driven our current short-term excitement about the stock. One further smaller acquisition announced by the company is the Jericho wind assets being purchased from the partnership sponsor NextEra Energy. The Jericho wind project is a 149 megawatt installation in Ontario, Canada. This transaction is expected to close in the fourth quarter due to Canadian tax rules. Both of these acquisitions have created substantial financing needs for the company. In order to raise the money required to complete these acquisitions, NextEra Energy Partners has put in place the following as announced in the August 31 conference call: Raising $600 million of non-amortizing 2-5 year NextEra Energy Partner debt. Issuing $200 million of NextEra Energy Partnership units to the public. NextEra Energy slowing its rate of ownership dilution by investing $700 million in NextEra Energy Partners on the same terms as the public unit issuance. In beginning the execution of this financing plan, on September 10, NextEra Energy Partners confirmed the issuance of 8,000,000 common units at a price of $26 per unit to the public in an underwritten deal. On the same terms, NextEra Energy has agreed to purchase $702 million in common units at the same price via a private placement. This would complete the equity issuance portion of the capitalization plan, setting up the company to complete the transactions. Raising $900 million in equity for the partnership on September 10 certainly puts the firm in a relatively healthy position in terms of financing these new acquisitions. In fact, management suggested in the August 31 conference call that they are affirming their 2015 through 2018 guidance based on this financing plan, with the difficult piece now squared away in the equity financing. Positives Opportunity to get in at an attractive price: Although the current financing was telegraphed by the company in late August, the market responded negatively to the deal yet again, with the partnership falling 7.65 percent in Thursday’s trading following the announcement. The company is down 40 percent over the last three months from its highs in early June, and is now priced extremely attractively, with a high but easily sustainable, and even growing, dividend. We believe that the recent price moves have been partially macro-driven and do not reflect a material change in the future prospects of the firm. Also, it’s worth keeping in mind that the partnership’s sponsor had no concerns about stepping up in a big way to buy additional units at this price. This should be comforting that those closest to the operational realities of this firm are putting their dollars on the line. While not exactly comparable to insider buying from executives or directors, this is, in our books, a vote of confidence in the assets being purchased and the ongoing dividend sustainability of the firm. Multiple Jurisdiction Exposure: One of the risks facing independent power producers is regulatory and political change in specific jurisdictions. While, on balance, the push towards greener or renewable energy sources has been strong in most North American and European jurisdictions, the costs of these green energy programs are beginning to mount. By having assets in eight different states and an additional 516 megawatts of capacity (following the Jericho acquisition) in Canada, the partnership has effectively hedged exposure to political change in any one jurisdiction. Long-term Stable Cash Flows: According to the partnership’s 2015 European investor presentation , the firm is sitting on an average capacity-weighted remaining contract life of 20 years. Given that the majority of counterparties are investment-grade rated or better, these long-term, stable cash flow projects provide the underlying support to the partnership’s dividend. Strong Sponsor in NextEra Energy: The partnership’s sponsor in NextEra Energy is certainly one with many advantages. Through maintaining a majority ownership stake in the partnership, NextEra Energy is certainly engaged in the success of the venture. Further, the company’s expertise is directly applied to the operations and management of the partnership through its controlling interest in the general partner. The other advantage of the partnership’s relationship with the parent is the potential future stream of cash flow-generating assets that it could acquire from a trusted developer. NextEra Energy has 1,766 megawatts of contracted wind development coming onstream over the next few years, and another 1,417 of contracted solar development. These offer potential assets for the partnership to purchase for the purposes of expanding its cash flow available for distribution at potentially attractive rates. NextEra Energy also announced a new dividend policy in its second-quarter presentation, reflecting a more aggressive stance. Without management’s confidence in the underlying performance of NextEra Energy Partners, this new dividend strategy by the parent would be risky and ill-advised. We believe that this shows confidence in the ability of NextEra Energy Partners to distribute the required cash to sustain its sponsor’s own dividend policy. Risks Access to Capital Markets: Continued access to capital markets at attractive rates is more or less required to sustain growth in any “yieldco” type of company. With the firm paying out much of its free cash flow to investors, any incremental acquisitions are generally financed with a mix of equity and debt. In the event that capital markets are unwilling to provide additional financing due to macro conditions or particular developments within the firm, the growth trajectory can be severely impacted. In the case of NextEra Energy Partners, its sponsor does seem willing to put up additional capital when required, as illustrated by its over $700 million commitment to additional equity for the NET Midstream acquisition. Pipeline acquisition could fail to achieve EBITDA projections: With the current commodity price collapse, natural gas shipments on these assets could potential fall, or the company could fail to obtain contracts to fill the addition 2 billion cubic feet per day of capacity coming onstream with the NET Midstream assets. Failure to reach its EBITDA projections on this acquisition could make this deal look extremely dilutive in the future. However, we believe even with this factored in, there isn’t considerable further downside to the share price, as the market seems to have already taken a very skeptical view of this transaction. In context, the pipeline assets will comprise approximately a quarter of the firm’s 2016 EBITDA. Valuation We approach the valuation of NextEra Energy from a few angles, but we’re primarily focused on that cash flow available to equityholders. We’re comfortable with the mid-range of the company’s projection following the closing of its equity financing, with $180 million in cash available for distribution in 2016. The expected growth rate, potentially fueled by a pipeline of currently in development project acquisitions from the sponsor, of 12-15 percent per year put forward by management also seems reasonable. At the current share price of $26.18 (as at September 10), and assuming a 12 percent growth rate in cash flow available to equity interests, this would suggest an equity cost of 24 percent, which is far in excess of what would be reasonable for a company with this kind of stable, long-term cash flow. This is determined on a basic FCFE calculation using the cash available for distributions and adjusted on a per share basis, based on the share count, giving consideration to the September 10th announcement. By comparison, Brookfield Renewable Energy Partners LP (NYSE: BEP ) is currently priced at a roughly 16 percent equity cost on a lower 9 percent growth target (per the company’s materials ), and targets a 15 percent return on equity on its investments. If NextEra Energy Partners was priced at an 18 percent return on equity (to give effect to a smaller, less diversified portfolio), with a 12 percent growth rate, we’d be looking at a share price of approximately $50 per share. This would be our one-year target on this stock, and we believe this is a still a conservative valuation providing a great return to equity investors. This isn’t entirely unfounded in past performance either, as the company traded at these levels earlier in the year on the same basic cash flow fundamentals. This further reflects our thesis that the current market price is not driven by cash flow realities, but by market sentiment and overreaction to this recent acquisition and financing. And all of our valuation is priced without any substantial upside to the NET Midstream acquisition, which the company indicates could be another $45-55 million in incremental EBITDA beyond the initial 12-15 percent growth target included in our valuation. Summary Overall, we believe that NextEra Energy Partners currently offers a very compelling valuation for a portfolio of long-term cash flow-generating energy infrastructure assets. The current market reaction to the financing arrangement for its NET Midstream and Jericho acquisitions seems to be considerably overdone, and the stock is current available at a substantial discount to other players in the space. With a solid and competent sponsor in NextEra Energy, this “yieldco” would fit nicely in a portfolio of dividend-paying stocks, providing a solid, growing dividend into the future. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.
