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NextEra Energy Is Getting Ever More Expensive

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About: NextEra Energy, Inc. (NEE)
by: Robert & Sam Kovacs
Robert & Sam Kovacs
Long only, dividend investing, dividend growth investing
Summary

Six months ago, I felt like NEE was becoming overvalued.

It is up 20% since then. Utilities at large are now becoming expensive.

Investors might want to consider trimming some of their position to reduce their exposure to what has become an overvalued stock.

Written by Sam Kovacs

Introduction

Six months ago, I wrote an article on NextEra Energy (NEE) where I stated that while I believed it was a stock with great dividend potential, it was becoming overvalued. Lesson learned: just when you think something can’t get much more expensive, it still can.

Source: Open Domain

NextEra Energy now has a dividend yield of only 2.20% & trades around $227.11. Based on my M.A.D Assessment NEE has a Dividend Strength score of 51 and a Stock Strength score of 63.

Source: mad-dividends.com

I couldn’t have imagined NEE trading above 30x earnings for a sustained period of time. In my previous article, when NEE was trading at 32x earnings, I claimed that “NEE is in uncharted territory”. That didn’t stop it from going up 20% since then.

I believe valuations in utilities are getting ever more dangerous. While it was possible for me to find stocks which I believe still offered good value half a year ago, it has now become increasingly hard.

There has been a clear flight to safety during the last year. This safety, however might only be perceived. An investment in a safe business can only be considered safe if it is made at a reasonable valuation.

Keeping shares of an overvalued company should only be done if nothing cheaper can be found (and if one doesn’t want to hold cash).

That’s the dilemma many utility investors face today, and one I brought up with WEC Energy (WEC): there are very few cheap utilities out there.

In this article, I will analyze NEE from the perspective of income investors before considering potential for capital appreciation.

Dividend Strength

Our strategy is to invest in strong dividend stocks which we believe are well poised to outperform the market. But our first objective is to grow our income stream. For our income stream to grow, we first need to invest in safe dividend stocks. Investing in a stock which can’t sustain its dividend is a surefire way to compromise your income goals. So safety comes first. But we also need this dividend to contribute significantly to our total returns. For that, we need a combination of dividend yield and dividend growth potential.

With utilities, the common theme we are starting to see, is that their dividend yields are becoming too low in light of their dividend growth potential. Of course, this is just another way to say that prices have become too expensive in relation to current dividends and our expectation for future dividends. As we will see, this is also the case for NEE.

Dividend Safety

74% of NextEra Energy's earnings are paid out as dividends. This is a more attractive payout ratio than 25% of dividend stocks.

NEE pays 31% of its operating cashflow as a dividend, putting it ahead of 44% of dividend stocks.

NextEra has a free cashflow payout ratio of 95%, a better ratio than 24% of dividend stocks.

30/09/2015

30/09/2016

30/09/2017

30/09/2018

30/09/2019

Dividends

$3.0400

$3.3800

$3.8100

$4.3100

$4.8600

Net Income

$6.97

$5.24

$8.94

$17.60

$6.60

Payout Ratio

44%

65%

43%

25%

74%

Cash From Operations

$13.25

$14.80

$13.09

$13.56

$15.66

Payout Ratio

23%

23%

30%

32%

32%

Free Cash Flow

$6.08

$6.29

$3.64

$3.11

$5.12

Payout Ratio

50%

54%

105%

139%

95%

Source: mad-dividends.com

NEE is one of the safest electricity utilities out there. Unlike most of its peers, which don’t generate enough cashflow to cover the dividend, NEE has managed to keep dividend payments within the confines of its free cashflow for most of the past 5 years.

Given the company’s 37 year history of growing dividends, it seems unlikely that NEE’s dividend will be cut in the foreseeable future.

Dividend Potential

NextEra Energy's dividend yield of 2.20% is better than 44% of dividend stocks. It might be worth pointing out that the stock hasn’t yielded so little at any time in the current market cycle.

Source: mad-dividends.com

This last year, the dividend grew 13% which is in line with their 5 year CAGR of 11%.

Source: mad-dividends.com

Management announced that they expect the dividend to have increased by 12-14% annually through 2020 from their 2017 base. This means that in the following quarter, investors should expect the quarterly dividend to be raised to between $1.38 and $1.45. I expect it to be towards the lower end of that range, towards $1.4 quarterly.

This would imply a forward yield of about 2.4%. By how much will the dividend grow? Management is expecting EPS to come in around $8.3 for the full year 2019. It is expecting 6-8% EPS growth in the three next years, without counting accretion of $0.15 to $0.2 from acquisitions. By 2022 management sees EPS being between $10 and $10.75.

I believe this gives us a good idea for the direction of the dividend, which will probably grow at around 9 to 10% from 2020 onwards.

This makes the combination of dividend yield and dividend growth potential borderline acceptable. I wouldn’t advise new money to be invested in NEE at current prices because of it.

Dividend Summary

The combination of the data presented above gives NEE a dividend strength score of 51 / 100. The stock’s attractiveness as an income investment is clearly suffering from the reduced dividend yield. The dividend is super safe, and should continue to grow attractively, yet pouring new money into NEE might not be the best idea at current prices.

Stock Strength

Ok, so I believe the dividend yield is low given the prospects for dividend growth over the next few years. But what should current owners do with their shares? To answer this difficult question I will look at four factors: value, momentum, financial strength and earnings quality.

Value

  • NEE has a P/E of 34.41x
  • P/S of 5.81x
  • P/CFO of 14.50x
  • Dividend yield of 2.20%
  • Buyback yield of -1.80
  • Shareholder yield of 0.4%.

These values would suggest that NEE is more undervalued than 48% of stocks, which is worrying. Based on its multiple of sales and its multiple of earnings, NEE is in the most expensive quintile of stocks in the stock market. Over time, the most overvalued stocks have usually generated market lagging returns, which doesn’t paint a rosy future for NEE’s stock price.

Source: mad-dividends.com

When I last wrote about NEE, I said that at 32x earnings, the stock was incredibly expensive. You can imagine that at 34.4x earnings my mind hasn’t changed. I believe all utilities are getting expensive. Yet the median utility trades at 24x earnings and 2.8x sales, 30 to 50% less than NEE.

Sure NEE’s quality might justify a slight premium to its peers, but it is hard to justify this much of a premium based solely on quality of the underlying business.

Value Score: 48 / 100

Momentum

NextEra Energy's price has increased 9.16% these last 3 months, 18.03% these last 6 months & 33.04% these last 12 months and now currently sits at $227.11.

Source: mad-dividends.com

NEE has better momentum than 89% of stocks, which tells quite the story. NEE has been dwarfing the market and its sector. In fact, if the numbers are on its side, the stock price could go even higher.

Who am I to judge how high a utility stock can go? We’ve seen water utilities yield as little as 1.4% in this market, so why wouldn’t NEE yield less than 2%?

If investors continue to purchase NEE blindly, regardless of the price, as do the shareholders which own 10% of NEE through ETFs, the price could go up more.

Is this a reason to purchase the stock? No. Is it reason enough to hold on to it a little longer? Maybe.

Momentum score: 89 / 100

Financial Strength

NEE's gearing ratio of 2.1 is better than 38% of stocks. NextEra Energy's liabilities have increased by 21% this last year. Operating cashflow can cover 9.8% of NEE's liabilities. These ratios would suggest that NextEra Energy has better financial strength than 42% of stocks. While liabilities have increased faster than the sector median, the stock retains a lower amount of gearing than the sector and better liability coverage. The stock has a financial strength score similar to that of the median utility.

Financial Strength Score: 42/100

Earnings Quality

NextEra Energy’s Total Accruals to Assets ratio of -16.9% puts it ahead of 74% of stocks. 84.7% of NEE's capital expenditure is depreciated each year, which is better than 37% of stocks. Each dollar of NEE's assets generates $0.2 of revenue, putting it ahead of 25% of stocks. Based on these findings, NEE has higher earnings quality than 47% of stocks. The high level of depreciation relative to CAPEX is what differentiates NEE from the rest of the sector and gives it better earnings quality. This should benefit the company’s earnings in upcoming periods.

Earnings Quality Score: 47 / 100

Stock Strength Summary

When combining the different factors of the stocks profile, we get a stock strength score of 63 / 100 which is tells a polarized situation. NextEra has the wind in its back. The whole sector is on a role, and it has been leading the pack. However, the valuation is now looking rather stretched. During October the stock price crossed below the 20 day SMA. This might be another fluke signal, but investors will want to monitor whether the stock is able to bounce back above the SMA. If not, the stock could trade lower in the next few weeks.

Looking further than that, at a few quarter horizon, it is possible NEE will continue to get more expensive, as long as utilities continue to be the favored sector.

Conclusion

With a dividend strength score of 51 & a stock strength of 63, NextEra Energy is no longer such a great stock for dividend investors. Current shareholders might want to consider trimming some of their position to realize value and rebalance their exposure to the security, which undoubtedly beat most of its peers in the past year.

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Disclosure: I am/we are long WEC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.