NextEra Energy Partners: 19% Yield, Buy Amid Debt Challenges

seekingalpha11-03

NextEra Energy Partners faces significant debt challenges in a high interest rate environment, but its 19% forward distribution yield presents a compelling value opportunity.Despite potential yield ...

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Bualookkaew Sakchatchawan/E+ via Getty Images  NextEra Energy Partners (NYSE:NEP) is certainly one of the more complex businesses that I have analyzed. Following its Q3 results, the company's valuation has declined substantially, extending a prolonged downturn. I think the market has been quite valid in its reaction, as the company is showing signs of significant fundamental weakness related to its debt amid a high-interest-rate environment at the moment. However, with the forward distribution yield now at 19%, this is a compelling value opportunity. Even if management decides to cut the yield in half to help alleviate concerns with its capital structure and interest payments, I don't believe this is likely in the next year or two. My rating is a Moderate Buy, but passive long-term investors should look elsewhere because this allocation will need to be monitored frequently, given how vulnerable the total returns will be to management's strategic decisions moving forward. Operational Analysis There may be many readers who have not heard of NextEra Energy Partners before—indeed, there may be some who know it but find its operations somewhat confusing. I must admit that NextEra's total operating structure is somewhat complex. However, this simple breakdown should help greatly. NextEra Energy Partners was formed by NextEra Energy (NEE) to acquire, manage, and own contracted clean energy assets. NextEra Energy Partners invests in projects that include wind and solar power generation facilities—as these are typically under long-term contracts, they provide stable cash flows. Critically, NextEra Energy Partners' ability to acquire projects depends on those developed by NextEra Energy (and third parties). For those who don't know, or as a reminder, NextEra Energy Resources, a subsidiary of NextEra Energy, is the world's largest generator of renewable energy from wind and solar. NextEra Energy Resources focuses on project development, complementing NextEra Energy Partners' focus on asset ownership and cash flow generation. NextEra Energy Partners is really a vehicle for recycling capital from operating assets into new development projects. NextEra Energy can continue to invest in new renewable energy projects while maintaining a portfolio of income-generating assets through NextEra Energy Partners. NextEra Energy Partners has a focus on raising debt and equity to support the financing of new facility projects without directly impacting NextEra Energy's balance sheet—there are also tax benefits because NextEra Energy Partners' distributions are considered a return on capital (non-taxable) for unitholders, rather than taxable income from typical dividends (essentially, distributions = dividends, and units = shares, for limited partnerships). Now, the big news recently was a weak Q3 report, and the big hit to unitholders was the following item:   Cash Available for Distribution Decline (NextEra Energy Partners Q3 Presentation) This shows a significantly weaker profile than investors would like, and it is primarily driven by the fact that high interest rates have made the debt burden of the company less manageable. This has caused management to instigate a large sale of its Texas pipeline portfolio to manage its financial profile—allowing it to maintain relatively strong distributions (though management has indicated that the distribution could be cut in the future). In other words, there are problems at the company right now (primarily due to interest rate headwinds), but management has already shown a prudent awareness of this and acted accordingly. It has opened up fear in the market surrounding NextEra Energy Partners' units, and I think it is valid to capitalize on this as a value investment while watching carefully how management continues to operate in light of the challenging interest rate environment. Data by YCharts Valuation Analysis For my valuation analysis, I am using a two-year discounted EBITDA model, which includes an EV-to-EBITDA terminal value multiple. I consider this investment \"safe\" until approximately 2026 (which is when management has indicated it may cut the distribution)—although I will be reviewing it again earlier. This is why I have opted for a short-term valuation model. NextEra Energy Partners' weighted average cost of capital ('WACC')—which I will be using for my discount rate—is 8.17%, based on an equity weight of 23.08% with an 11.406% cost of equity (using CAPM), a debt weight of 76.92% with a 7.1978% cost of debt, and a tax rate set to 0% due to recent financials. The company's five-year average TTM EBITDA margin is 63.25%, but it is currently 56.73%. I estimate that the company's TTM EBITDA margin will be approximately 55% over the next two financial years on average (given the pressures on the company right now), with total revenues of $1.3 billion in the full year 2025 and $1.37 billion in the full year 2026. Given this, we are looking at a total EBITDA of $715 million for 2025 and $753.5 million for 2026. Given that the company has a five-year average EV-to-EBITDA ratio of 26.9, I expect this will be roughly 25 as an average over the next two years, given reduced sentiment from vulnerability to its distribution yield right now. Putting all of these factors into my two-year EV-to-EBITDA-adjusted discounted EBITDA model, I get the following result: Author's Calculation Risk Analysis The greatest risk to my thesis here is that if management cuts the distribution yield in the medium term, this could significantly affect the unit price further. As a result, I do think that investors are a little vulnerable at the moment if owning NextEra Energy Partners' units for the long term. Indeed, the recent price setback is likely disconcerting for unitholders who have owned a position since 2022 or so. Nonetheless, for long-term investors (which I consider myself to be), the recent crash in price is an opportunity to buy more units. That said, we need to carefully monitor how management is going to deal with its debt problems—it appears there needs to be a major event to make the current business model work enduringly, as high interest rates have put the brakes on the current debt-to-equity approach. It is possible that in the next few years, we will see a major distribution yield cut for management to focus on strengthening its capital structure. I see this particularly likely if interest rates are raised again in 2026/2027 due to persisting high inflation issues affecting the macroeconomy. Management is correct to be strategically thinking about this issue—the company's net debt as of the last report is $4.9 billion, starkly higher than the $1.8 billion in 2014. A rise in debt is part of the financing model for NextEra Energy's projects, but with the current interest rate environment, this is no longer sustainable. Management has a serious concern on their hands here, but I consider the much lower unit valuation to already account for some of this concern; therefore, my rating is a Moderate Buy. Conclusion  In closing, I consider NextEra Energy Partners to offer a compelling value thesis right now, but please proceed with caution. There are significant headwinds related to the company's debt and the interest payments on this. Therefore, I expect that management will have to look at potentially cutting the distribution yield in the future or selling some of its assets. That said, the market has already priced in a large amount of these concerns, so an allocation of less than 5% of portfolios seems likely fine to me, especially considering the currently high 19% yield. This is an investment that takes careful monitoring, so for passive investors, I believe it is best to look elsewhere for easier long-term allocations.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":2,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2480359970"}