The Finance Ghost describes how US energy utilities like NextEra Energy are thriving, providing reliable electricity, making profits, and leading in renewable energy. Discover how this contrasts with South Africa's energy challenges and learn about the growth drivers and investment opportunities in the US utility sector.
Across the pond in the US, they have this crazy scenario that seems almost impossible to us as South Africans: energy utilities that provide reliable electricity and make a profit along the way. Now, ain’t that a thing?
To further blow your mind, they even have substantial installed capacity in renewable energy, thereby having achieved significantly reduced carbon emissions over the past two decades. It just doesn’t seem fair, does it?
Although load shedding seems to have taken a miraculous backseat in the build-up to elections, you can be sure that it isn’t gone for good. Our energy supply in South Africa is a bit of a nightmare really, much like some of our other infrastructure. In the US market, not only do they have working infrastructure, but you can invest in it!
Privatisation will always be a political hornets’ nest, especially in South Africa. In theory, it drives efficiencies and creates accountability, like in any other business. In this case, the product is simply the provision of electricity rather than some consumer product on the shelf at a retailer.
In a sector like energy, there need to be checks and balances to avoid socially unacceptable outcomes like price gouging of a captive market. This means that there are regulators in place who set the pricing of the energy. We see exactly the same situation in the pharmaceuticals market, with the Single Exit Price for medicine in South Africa being set by the regulators. In fact, Eskom already faces a regulatory environment for its pricing in the form of NERSA and approved tariffs.
In the US, things go a step further, as the regulators need to consider an appropriate return on capital for the utility itself. This is where the lens of privatisation comes through, as utilities that aren’t earning a sufficient return won’t attract capital and won’t be able to grow or even maintain the infrastructure supplying the energy. Unlike in the case of Eskom where there are government bailouts, a private utility has little choice but to avoid that scenario, or it may face a bankruptcy situation.
If investing as far up the economic value chain as the provision of energy interests you, then keep reading.
The drivers of growth for utilities
Like any business, revenue growth for utilities is driven by various demand factors. The most basic one is population growth in the region being serviced. It’s a simple formula, really. More people means a higher energy requirement for them to go about their daily lives. This is good news for utilities.
Aside from more warm bodies, a further driver of demand is higher electricity usage per person. The ongoing “electrification” of our lives is relevant here, ranging from electric cars through to a more digital existence in general. Although electric vehicles are having a wobbly at the moment and there’s a surge towards hybrid technology, more developed countries still have plenty of electric vehicles silently going about their business.
The third driver of revenue growth is an increase in energy pricing. Any business grows revenue through a combination of volumes and pricing. Energy is no different, with the aforementioned population growth and electrification driving volumes, while price increases complete the picture for revenue growth. This ensures that utilities can pass on inflationary cost pressures and invest adequately in power generation capacity.
The perfect environment for a utility is thus a region with a fast-growing population (both naturally and through people moving to the area) that offers increasing energy requirements, along with a regulator that is willing to grant reasonable pricing increases.
There’s a name for this environment: Florida.
NextEra Energy has joined the chat
Together with my partner Mohammed Nalla in Magic Markets Premium, I recently researched NextEra Energy ($NEE). This group owns Florida Power & Light Company, the largest electric utility in the state of Florida. They own various other business too, including NextEra Energy Resources that serves as a clean energy incubator. Some of the renewable energy assets are sold off to separately listed company NextEra Energy Partners ($NEP), which effectively operates as a funding conduit for investors looking specifically for green assets. Clearly, this is a complicated and mature operation.
If you look for NextEra Energy online or in your brokerage account, be sure to check the ticker to confirm that you’re looking at the right one. I own NextEra Energy with the ticker $NEE as a way to gain exposure to this sector. NextEra Energy Partners with the ticker $NEP is a far less impressive structure in my view. It has too many other variables at play, like market demand for renewable energy projects. One is the real deal and the other is a cute funding strategy.
I tend to look for sector leaders when allocating capital far away from home, as it’s very hard to sit in South Africa and try and pick out an up-and-coming opportunity. Luckily, bigger really can be better when it comes to market dynamics. NextEra Energy certainly ticks the scale box. Based on the renewable power they put into service in 2023 alone, they would be the 4th largest US renewables company!
This brings us to another important point…
If you like renewables, you’ll like this
There are a number of ways to invest in the renewable energy theme. A lot of deals in this space are taking place in private markets, usually involving specialist infrastructure investment institutions. These deals are impossible for retail investors to be involved in.
In NextEra Energy, you have a business that has set an impressive target: by 2032, around a third of Florida Power & Light’s energy generation will be from solar (vs. just 5% today). As the cost of solar infrastructure keeps coming down, this source of energy becomes increasingly cost effective for consumers. So not only is there a strong renewable underpin, but consumers are actually paying less for energy as well. Thanks to the efficiencies already in the system, Florida’s electricity bills are around 30% less than the national average.
But is it a good investment?
This chart admittedly goes a long way back, but you get the idea:
Aside from the chaos of the pandemic and the macroeconomic volatility during its aftermath, NextEra Energy has been a strong grower. It currently trades on a dividend yield of 3.22%, which is a decent yield particularly in hard currency. The group grew adjusted earnings per share (EPS) by 9.7% in 2023 despite suffering the lowest wind resource on record for 30 years, so that dividend yield is accompanied by strong earnings growth.
And despite the craziness suggested by the share price chart, the two-year compound annual growth rate (CAGR) for adjusted EPS is 11.9%. The management team can’t control the share price, but they can certainly control the earnings growth and they are doing a solid job.
Here’s a data point that strongly influenced my decision to recently invest in this group: the 10-year CAGR in the dividend per share is 11%. That’s a double-digit return in dollars from what is effectively an infrastructure company, not some high-risk tech play.
Given the low correlation with the rest of my portfolio and the solid underlying returns, I felt confident adding NextEra Energy as a long-term play.
What can go wrong?
Of course, no investment is without risk.
NextEra is best-of-breed when it comes to utilities, with many other utilities offering a far less lucrative track record. The trouble at competitors often comes down to disappointing execution, like we discovered in Magic Markets Premium when we researched Canadian-based utility Emera and compared it to NextEra. With regulated pricing as a major consideration in this space, there’s little room for inefficiencies.
NextEra has done incredibly well so far but this can change if management starts to score own-goals. And aside from this, there are risks from external factors. The most important risk is surely the weather, which can (and does) cause a lot of difficulties for utilities. This can range from irritating issues (a poor year of wind) through to far more serious problems like natural disasters.
We also can’t discount political risks. There’s almost nothing more politically charged at the moment than energy policies, so a change in guard can lead to uncertainty around energy policies. This makes it difficult for utilities to invest with confidence in that region, as these are very long-term assets.
Overall, I like NextEra Energy and I bought the stock after researching it for Magic Markets Premium. Fortuitously, the timing of our research was aligned with the stock trading at a surprisingly high dividend yield, which made it look “cheap” relative to its long-term average. I’m already up 16% in dollars in a short space of time, which highlights the value of looking for the right entry point.
Even if you aren’t sure how to find that entry point or you don’t have enough time to watch the markets that closely, you can buy high quality companies with a long-term view and let them do the hard work for you. That’s certainly my approach with NextEra Energy and I have no plans to sell despite the quick gains.
Those looking for strong dividend compounders in their dollar portfolios should spend some time researching NextEra Energy and the utility sector in general.
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