Is NextEra Energy Partners stock worth buying?

If you’re looking for income-producing stocks, NextEra Energy Partners (NYSE:NEP) and a dividend yield of 11% is a tempting choice. A renewable energy company provides insight into future growth, but that can be a disadvantage when expectations suddenly change, as happened last September.

The company is feeling the effects of higher interest rates and has taken actions to strengthen its financial situation. With shares down 45% from their 52-week high, NextEra Energy Partners represents an intriguing opportunity for patient investors today.

NextEra Energy Partners revised growth forecasts

NextEra Energy Partners is a limited partnership formed by the parent company, The energy of the next era (NYSE:NEE)in 2014. NextEra Energy is one of the world’s largest producers of wind and solar energy and formed a limited partnership (MLP) in the form of NextEra Energy Partners to provide investors with the opportunity to invest directly in renewable energy sources.

The benefit of investing in NextEra Energy Partners is that you have visibility into the company’s future cash flows. This is because its projects are under long-term contracts and generally pay a fixed fee over the life of the contract. While investors have visibility into NextEra Energy Partners’ future cash flows, that could expose the company’s stock to significant volatility if growth expectations change, as they did last year.

In September, the MLP announced a lower expected dividend increase, reducing expected growth to 5% to 8% per year, down from its previously targeted increase of 12% to 15% per year. In the days after this announcement, the company’s shares fell 56%.

NextEra Energy Partners is settling some of its debt obligations

NextEra Energy Partners finances its acquisitions using financial instruments such as debt, convertible equity or other lines of credit. It then uses the cash flow from these assets to pay shareholder distributions, which have increased in amount each year since going public. This business model can thrive in times of low interest rates because a lower cost of financing can help finance more projects thanks to a lower cost of capital.

Since going public, NextEra Energy Partners has made a steady stream of acquisitions through convertible equity portfolio financing (CEPF). These financing options are similar to loans in that the investor provides the capital, but the loan can later be converted into equity.

As long as the company’s share price continues to rise, this can be attractive because it allows investors to participate in the increase in its share price. For the company, this means that it must issue fewer shares for the conversion to take place. However, if the company’s share price falls, it must issue more shares to satisfy this equity conversion option, further diluting its existing shareholders.

As interest rates have risen in recent years, financing costs have increased, negatively impacting NextEra Energy Partners’ acquisitions. This, combined with a falling share price, puts the company between a rock and a hard place.

Image source: Getty Images.

NextEra Energy Partners is waiving some of its outstanding liabilities and rebuilding its capital to alleviate this pressure. Last year, the company sold its natural gas pipeline portfolio in Texas to the company Kinder Morgan for $1.8 billion. It used the proceeds to pay down project debt and had $1.4 billion left to buy out other CEPFs.

A high payout ratio can make the dividend susceptible to cuts

NextEra Energy Partners paid investors approximately $0.88 per share in the first quarter, and management expects the payout ratio to be in the mid-90% range through 2026. This means it has a narrow margin for error and failure to fulfill its obligation to improve its balance sheet while maintaining growth could lead to an eventual reduction in its payout.

The high cost of debt may continue to weigh on the partnership. At the beginning of this year, many market participants expected interest rates to fall along with inflation. However, inflation, as measured by the annual change in the Consumer Price Index, remains consistently above the Federal Reserve’s 2% target.

After pricing in as many as six interest rate cuts this year in January, market participants now expect three interest rate cuts by April next year, according to CMEFedWatch tool.

Is NextEra Energy Partners stock right for you?

Falling interest rates could be a tailwind for the company, but for now, higher financing costs will continue to weigh on it and its distribution will be uncertain if it fails to implement its plans. If you’re looking for steady income you can trust, NextEra Energy Partners may not be right for you.

However, a potential injection of private equity funding could help fund buyouts of other CEPFs and further strengthen its balance sheet. This, combined with a luscious 11% dividend yield, could make it an intriguing choice for investors willing to tolerate such risk.

Is it worth investing $1,000 in NextEra Energy Partners now?

Before you buy NextEra Energy Partners stock, consider this:

The Motley Fool Stock Advisor a team of analysts have just identified what they think it is 10 best stocks for investors to buy now… and NextEra Energy Partners wasn’t one of them. 10 stocks that made a cut could deliver monster returns in the coming years.

Consider when Nvidia created this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you would have $677,040!*

Stock advisor provides investors with an easy-to-follow blueprint for success, including portfolio-building tips, regular updates from analysts, and a selection of two new stocks each month. The Stock advisor the service has more than four times return of the S&P 500 since 2002*.

See 10 stocks »

*Stock Advisor returns from May 28, 2024

Courtney Carlsen has no position in any of the companies mentioned. The Motley Fool holds positions on and recommends Kinder Morgan and NextEra Energy. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.