Utilities Benefit From Renewable Energy Growth

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Includes: AGR, IBDRY, JKS, NEE, SO
by: Roger S. Conrad

Summary

Why NextEra's earnings per share are up 18 percent in the third quarter.

NextEra management calls current landscape "the best renewables development environment in our history," and expects strong continued growth.

Avangrid Inc.'s wind and solar business continues to thrive and reported a 12.5 percent increase in earnings per share in the third quarter.

Even at a glance, NextEra Energy’s (NYSE: NEE) third-quarter results are impressive. Earnings per share grew 18 percent, thumping management’s long-term compound annual growth target of 6 to 8 percent. That keeps the utility on track for another 12 to 14 percent dividend boost early next year.

But the best news is inside that performance. The company’s south Florida regulated utility had another superb quarter, adding customers and investing in rate base. Management closed the acquisition of Southern Company’s (NYSE: SO) 110,000 natural gas customers in the Sunshine state. And by early next year, it will complete the deal’s second piece, adding Gulf Power’s 450,000 electric customers in the Florida panhandle.

The real eye-opening results, however, were at NextEra’s unregulated Energy Resources unit, operating contracted wind and solar generation throughout the US. The unit increased profits by 18 percent, primarily by running its fleet more efficiently. But it also set the stage for even faster growth by capitalizing on what management calls "the best renewables development environment in our history."

Mainly, Energy Resources added 850 megawatts of new wind power development, along with 447 MW of solar and 120 MW of battery storage. That includes a transaction involving wind, solar and energy storage, advancing CEO Jim Robo’s goal of reducing the intermittency of wind and solar that’s at this point the biggest limitation to their growth.

In the first nine months of 2018, Energy Resources added 4,700 MW of renewable energy to project backlog, which now stands at 9,300 MW. Management expects to sign contracts for another 5.6 gigawatts in 2019-2020, on top of 5.2 GW inked in 2017-18. That adds up to a big lift to the current portfolio of 13.4 GW, and double-digit earnings growth well into the next decade.

Cash flows from these projects are guaranteed by contracts lasting 15 years plus exclusively with high credit quality counterparties, which will limit risk even in an economic downturn and/or sudden tightening of credit markets. As for financing, NextEra shares trade at a premium valuation of nearly 24 times trailing 12-month earnings. Cost of debt capital is very low, with bonds maturing in September 2057 yielding just 5.46 percent to maturity.

Management also has the option of dropping down assets to its yieldco unit NextEra Energy Partners (NYSE: NEP), including a current transaction involving 11 wind and solar projects with 1.4 GW of total capacity. NextEra Energy Partners also has a low cost of debt capital, with February 2038 bonds yielding just 3.9 percent to maturity, while shares trade near an all-time high.

Renewable energy, in other words, is set to be a major driver of earnings at NextEra Energy and NextEra Energy Partners for years to come. In fact, earnings power will increase as the cost of solar panels and energy storage continues to decline. One key factor: China’s JinkoSolar (NYSE: JKS) is building a major manufacturing facility inside the company’s Florida utility service territory, where it can serve the needs of both Energy Resources and Florida Power & Light.

Renewable energy is an equally important growth catalyst for Avangrid Inc. (NYSE: AGR), which announced third-quarter results shortly after NextEra. The company’s overall numbers were not as impressive due to slower growth at its northeast US regulated electric utility operations.

Avangrid’s wind and solar business, however, continues to thrive. And the result was a 12.5 percent lift in third-quarter earnings per share. Management has announced a compound annual earnings growth target of 8 to 10 percent through 2022, based largely on developing 3 GW of renewable energy projects. During the third-quarter guidance call, CEO James Torgerson stated the company has secured 1.8 GW toward this target, of which 970 MW should be operational next year.

The biggest ongoing project is the 800 MW offshore Massachusetts wind farm Avangrid is building with Copenhagen Infrastructure Partners. The facility was the winner of a competitive bidding process for a 20-year power sales contract with the state. If successful, it’s likely to be the first of many plants built. Management expects all regulatory approvals next year, with startup in phases in 2021 and 2022.

Avangrid is essentially the US arm of parent and 81.63 percent owner Iberdrola SA (Spain: IBE, OTC: OTCPK:IBDRY). The Spanish electricity giant, which currently operates about 50 GW of renewable generating capacity worldwide, has a grand plan to operate 10 GW of wind and solar by 2022 in this country. That’s a substantial increase from Avangrid’s current 6,500 MW portfolio, ensuing expansion will be a key driver of long-term earnings and dividend growth targets. I expect a good number more of utilities across the country to get a positive surprise this quarter from renewable energy growth.

I have been following this sector for more than 30 years and it is clear now that renewable energy adoption is a key and perhaps largely unappreciated driver for electric utilities’ growth. And if anything, the trend will accelerate in coming years as global prices continue their rapid descent for battery storage, solar panels and wind turbines.

This is a remarkable turn of events from just a couple years ago, when some observers forecasted renewables adoptions would push electric utilities into a death spiral. It’s a testament to the resiliency of this now more than 120-year-old sector. And it’s another reason why the best in class are still solid portfolio bedrock, even 10 years after the last bear market for stocks.

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Disclosure: I am/we are long NEE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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