Renewable Energy, Juiced Yield Make NEE a Long-Term Power Play

Key Points

• When interest rates go up, it increases the cost of borrowing for debt-dependent utilities and makes it less attractive to take on new projects, resulting in slower profit growth.
• Florida Power & Light remains NextEra Energy's core profit generator, but the company also has a big growth opportunity in renewable energy.
• NextEra offers a 3.4% dividend yield and is the electric utility industry's lone member of the Dividend Aristocrats.

Do you need proof that rising interest rates are taking their toll on corporate profits? Look no further than NextEra Energy, Inc. NYSE: NEE. 

The Florida-based electric utility is feeling the heat from higher rates, and its bottom line is getting burned. After posting 14% profit growth in 2022, NextEra is on pace to deliver just 7% profit growth this year. Increased interest expense is a big reason why.  

Late last month, the company's NextEra Energy Partners (NEP) LP subsidiary dramatically lowered its distribution growth forecast to 5% to 8% (from 12% to 15%) through 2026. This is because elevated interest rates have hurt the limited partnership's ability to access the financing it needs to grow distributable income as previously forecast. Instead of issuing more stock to meet the 12% target, NEP management has effectively waved the white flag on the Federal Reserve's relentless rate hike campaign. 

When interest rates go up, it first increases the cost of borrowing for debt-dependent utilities and second makes it less attractive for those utilities to take on new projects. The result: slower profit growth.

It is an issue that affects the entire utility sector but one that is hitting NextEra particularly hard. Although the parent company hedges interest rate risk, the mechanisms aren't perfect and can still lead to lower profits. 

But don't turn off the lights on NextEra just yet. 

What Is NextEra's Long-Term Growth Outlook?

Higher rates are likely to dent near-term profitability, but they won't change NextEra's long-term growth prospects. This starts with Florida Power & Light (FP&L), America's largest regulated electric utility. Serving more than 12 million people in the nation's fastest-growing state, FP&L can still lean on the tenants that built its successful track record — reliable energy and low cost.  For decades, FP&L has survived devastating natural disasters to provide customers with electricity — and an average residential electricity bill that's 29% below the national average.

Over the next two years, FP&L will invest billions of dollars to construct more power transmission and distribution sites to serve more customers and remain NextEra's core profit generator. From 2012 to 2022, NextEra grew profits at a 10% annualized rate. 

While FP&L accounts for roughly two-thirds of profits, renewable energy is the company's biggest growth opportunity. Already the nation's largest solar and wind power generator, NextEra Energy Resources is positioned to feed the state's increasing appetite for renewable energy for years to come. 

As the U.S. economy transitions to clean energy, renewables and energy storage capacity is forecast to grow 33x by 2050. The growth goes way beyond heating homes. The widespread adoption of electric vehicles and the buildout of AI-powered data centers, along with government incentives, will be major growth contributors. NextEra's leading position and low costs should make it one of the biggest beneficiaries of this shift.

Over the next few years, the company expects to build off its track record. From 2024 to 2026, management projects that adjusted earnings per share (EPS) will grow 6% to 8% annually. Yes, this is slower than the 10% of the past decade, but still solid growth en route to a 25-year growth trajectory.

What Is NextEra's Current Dividend Yield?

NEP's distribution growth warning sent NEE to a 3.5-year low on October 6. The stock bounced nicely last week but remains cheap — and its yield juiced. At 3.4%, NextEra's dividend yield is the highest it has been in a long time. More importantly, the company is a consistent dividend grower, having increased its dividend for 30 straight years. It is the electric utility industry's lone member of the Dividend Aristocrats.

And with Wall Street giving the stock a price target of $75, investors are looking at a possible 40% total return over the next 12 months. It could even be more. Last week, Morgan Stanley gave NEE a $91 target citing alternative financing avenues, rising demand for renewables, and the potential for a strong third-quarter earnings report on October 24.

Higher interest rates and inflation aren't going away anytime soon. Both will continue to weigh on utility sector earnings, including those at NextEra. 

Eventually though, they'll subside and give way to a clean energy movement that, absent financial restrictions, can go full steam ahead. At that point, the market will recognize that NextEra's renewables opportunity overpowers the current macroeconomic headwinds.