For our first release of our Mates Rates Capital Research Snippets, we decided to focus on the energy sector. To best suit a range of investors with different risk tolerance levels, we will typically share research on one company with a large market cap and another with a small market cap, so that we can cover both ends of the spectrum.

In this months Mates Rates Capital Research Snippets, we settled on Next Era Energy ($NEE) and Flux Power ($FLUX).

We’ll split the analysis on these companies into two parts – one article for each company.

In Part 1 of our Mates Rates Capital Research Snippets from the Energy Sector, we’ll focus on NextEra Energy ($NEE).

Short Summary on NextEra Energy ($NEE)

NextEra Energy (NEE) is the largest regulated utilities electricity company in the U.S. by market cap, weighing in at $155.3B USD. By contrast, Duke Energy is the second largest regulated utilities electricity company in the U.S., which has a market cap of $72.4B USD, less than half the size of NEE.

NEE’s operating performance is driven primarily by the operations of its two principal businesses, Florida Power and Light (FPL), one of the largest electric utilities in the US, and NextEra Energy Resources (NEER), which together with affiliated entities is the world’s largest generator of renewable energy from wind and solar.

From NextEra Energy Annual Report 2021. https://www.investor.nexteraenergy.com/reports-and-filings/annual-reports

FPL is primarily engaged in the generation, transmission, distribution and sale of electricity to retail customers, while NEER is predominantly focused on long term energy contracts (typically lasting longer than 20 years) in the commercial space.

Pros

  • Large presence in regulated energy markets provides opportunity for stable revenues during market downturns.
  • Income from regulated energy markets provides capital efficiency for growing their renewable energies portfolio.
  • Decent dividend (2.15%)
  • Largest generator of renewable energy from wind and solar. Plans to continue investing aggressively in clean energy, with the aim to expand wind, solar, and battery holdings by 150% by 2024.

Cons

  • Volatile commodity power markets, weather, and reliance on government subsidies to fund clean energy projects present some uncertainty for NextEra’s earning potential.

Diving Deeper on NextEra Energy ($NEE)

How do they make their money?

NextEra Energy’s strong presence in regulated utility markets in the US, along with their rapidly growing renewable energy business gives investors the best of both worlds: a consistent dividend and solid potential for continued growth in the clean energy space.

In regulated electricity markets, government bodies set the prices that energy companies charge customers. This typically allows regulated utility companies, such as NextEra Energy (NEE), to earn a fair return on the capital they invest to build, operate, and maintain their generation and distribution networks

The regulation of pricing by governments often leads to relatively stable revenues for companies like NEE during market downturns, but can limit earning potentials during periods of high growth. Despite this, NEE is well positioned to maximize growth through economies of scale, and aggressive investments into clean energy projects, where they plan to expand wind, solar and battery holdings by 150% by 2024.

A key advantage offered by utility companies with stable revenue streams is their dividend payouts. NEE offers a dividend yield of 2.15%, which isn’t quite at the level of some dividend aristocrats such as IBM and 3M who offer dividend yields of 5.43% and 5.26%, respectively, but it’s still pretty good!

What risks do NextEra Energy face?

But while NEE has a good track record of consistently paying out dividends, these dividend payments aren’t currently very well covered by available cash, resulting in a $230M cash flow deficit in 2021 after paying out $3.3B USD in dividends. With this being said, the deficit was mainly because NEE has been pumping cash into expanding and enhancing existing electrical systems and infrastructure (~$6.6B USD), along with investing into independent power and their clean energy segment, NEER ($8.2B USD). To cover this $230M deficit in cash in 2021, NEE needed to dip into their cash reserves, while also continuing to take out large amounts of debt ($16.7B USD)

Volatile commodity market prices

It also pays to note that if earnings are down, the ability for a company to pay their dividend can be negatively impacted. In 2021, NEE earnings took a pretty hefty blow due to volatile commodity market conditions, where non-qualifying hedge activity cost them approx. $2.5B USD.

Hedging losses can occur when a company uses derivative contracts to negotiate buying or selling an asset at a future date for a set price; if the agreed upon price of selling electricity ends up being lower than the cost of generating and distributing the electricity, it can result in a loss for the company selling the electricity, which has contributed to NEEs $2.5B USD losses from non-qualifying hedging activity.

Project and infrastructure related risks

Additionally, NEE took a further $1.2B USD loss through an impairment charge relating to their investment in the Mountain Valley Pipeline; a natural gas project that has been halted due to environmental concerns. Seeing as NEE had initially invested in the project in 2020, this $1.2B impairment charge was added to expenses in NEEs 2020 income statement, making it appear that NEE had gained higher income between 2020 and 2021, when in reality they had just adjusted their accounting in 2020 to include a higher value of losses.

Conclusion

With the current high inflationary market conditions, ongoing war following Russia’s invasion of Ukraine, and political turbulence in the UK with the recent resignation of Liz Truss, the global economy has plunged towards recessionary territory, and doesn’t feel like it is set to pull itself out anytime soon. Therefore, we’re keen on finding a few stocks in companies that can withstand the volatility of market downturns, while continuing to deliver stable revenues and dividend payouts.

To provide confidence that NEE can continue to cover their dividend payout, we’d like to see more income being made from their investments in clean energy through NEER, in addition to their existing income from regulated electricity markets through FPL.

Otherwise, NEE ticks the boxes for us pretty well. As one of the largest players in the regulated energy markets in the US, NEE generates sizable earnings. This has enabled NEE to pay stable dividends, along with providing the capital efficiency needed to fuel growth in renewable energy markets, where they are investing aggressively in renewable energies through their subsidiary, NEER. Based on this, we’ll be adding NEE to the Mates Rates Capital as a defensive position.

But it doesn’t stop there! When investing in the stock market it pays to keep your eye on the ball as best you can. To assist with monitoring NextEra Energy’s ongoing performance, we’ve added a couple pointers below.

Things to watch for NextEra Energy (NEE) going forward:

  • Earnings per share. We want to see an increase in income from NEEs investments into renewable energies, so we’ll be paying close attention to net income, losses/gains from non-qualifying hedging activity, and losses/gains on investments.
  • Changes in cash equivalents. We want to be assured that NEE can continue to cover their dividend payouts, so we’ll be paying close attention to capital expenditures, amount invested into renewable energies, and debt issuance.

About us

Here at Mates Rates Capital, we’re just a group of mates trying our hand at investing by pooling together a small amount of our hard earned wages each week.

We started Mates Rates Capital as a project to share our tips, tricks, mistakes, and learnings so that you can go start a group investment fund and reap the rewards of investing with friends.

Come along for the ride! 🤙

Legal stuff

The content shared in this article is based on the opinions of Mates Rates Capital and is not financial advice. Any information shared is only current at the time of writing and is provided without consideration of the financial situation of any individual person. Always do your own research. You should consider seeking legal, financial, taxation or other advice before making any investment decisions.

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