1 very high performance action that I wouldn’t touch with a 10 foot pole

There are some very clear things that I like NextEra Energy Partners (NYSE:NEP)including its high 13%+ distribution yield and a decade-long string of annual distribution increases. The truth is, I was tempted to buy it. However, there has been a huge change in the limited liability partnership (MLP) business position that keeps me from pulling the trigger. Here’s why I’d rather keep this renewable energy MLP 10 feet away.

Why does NextEra Energy Partners exist?

Before deciding to buy or sell with NextEra Energy Partners, it is important to understand the purpose of an MLP. At first glance, the answer is to buy and own clean energy investments. While that is essentially what NextEra Energy Partners does, that is not the real reason it exists. It exists because giant utilities NextEra Energy (NYSE:NEE) I created. But why?

NextEra Energy is unique in the utility sector because it has a large regulated utility business and a large renewable energy business. The regulated assets grow slowly and reliably, while the clean energy portfolio provides faster growth. Together, these two businesses have allowed NextEra Energy to grow distribution by 10% per year over the past decade, which is incredibly fast for a utility (half that would be considered quite good). To help fund NextEra Energy’s clean energy capital investment plans, it formed NextEra Energy Partners.

This relationship is by no means unique. Other utilities have done essentially the same thing (though not necessarily with clean energy assets). NextEra Energy, as the parent company, sells assets to NextEra Energy Partners, known as a drop-down transaction, which NextEra Energy Partners finances by selling units and taking on debt. As long as NextEra Energy Partners’ cost of capital is low enough, the cash flow it buys will be enough to cover the financing costs and also pay a healthy and possibly growing distribution. In short, NextEra Energy Partners exists to be a source of financing for the parent company NextEra Energy.

NextEra Energy Partners’ equation has changed

A few years ago, NextEra Energy Partners’ math worked very well and it was able to issue units and debt at very attractive levels. This allowed NextEra Energy to regularly discount assets. However, as interest rates rose, debt financing became less attractive. And as the price of a NextEra Energy Partners unit fell, selling units became less attractive. NextEra Energy Partners simply does not have the same value to its parent company that it once did.

The story continues

In fact, in 2023, NextEra Energy Partners has pulled back on its growth plans. It has lowered its distribution growth target, announced plans to sell non-core assets, said it has no new units to issue until 2027, and its plans to buy more units in development from NextEra Energy have been suspended. The primary purpose NextEra Energy Partners serves seems to have disappeared. There are a few solutions.

NextEra Energy could simply spin off NextEra Energy Partners to become a separate entity, which is more complicated than it sounds given the MLP’s structure. It would also require the MLP to put up enough cash to buy out NextEra Energy’s general partner position, which is no easy feat in today’s capital environment. And if it did, NextEra Energy Partners could end up cutting off distribution as it looks for a way to fund the deal.

On the other hand, NextEra Energy could simply buy NextEra Energy Partners, bringing the business back into the company. That’s exactly what happened recently with several midstream MLPs. NextEra Energy Partners units trade at high yields and below book value, so that could be an attractive option for NextEra Energy’s parent company. Interestingly, NextEra Energy’s yield of 2.6% is significantly lower than NextEra Energy Partners’, so income would be lost there as well.

Or, as the easiest route, NextEra Energy Partners could simply trim distribution and hold onto cash until capital markets become more attractive again. While it’s possible that NextEra Energy Partners could continue to plow ahead as it is, which the MLP says it will do, there’s only so long before it becomes a burdensome distraction that parent company NextEra Energy no longer wants to deal with. At that point, something will have to give, and cutting distribution would be the quickest and easiest course of action.

The likelihood of an unfavorable outcome for income-focused investors appears too great, which is why I am avoiding working with NextEra Energy Partners until further notice.

This can be a huge opportunity, but don’t ignore the risks

Aggressive investors may be willing to take the risk of owning NextEra Energy Partners for the ultra-high yield it offers. But for me, the risks clearly outweigh the rewards. This is especially true as I try to build a reliable income stream that I can eventually live off of in retirement. A potentially large distribution cut from a core holding is simply not something I want to willingly set myself up for. And that is exactly what I think could realistically happen in the future at NextEra Energy Partners.

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Reuben Gregg Brewer has no position in any stocks mentioned. The Motley Fool has a position in and recommends NextEra Energy. The Motley Fool has a disclosure policy.

1 The Ultra High-Performing Stock I Wouldn’t Touch With a 10-Foot Pole was originally published by The Motley Fool