The Henry Fund Henry B. Tippie School of Management Jack Smith [[email protected]] NextEra Energy (NEE) November 18, 2019 Energy – Renewable Energy Stock Rating BUY Investment Thesis Target Price $260–285 We recommend a BUY rating on NextEra Energy, Inc with a target price range of $260–285. NextEra is the market leader in United States wind power generation and among the largest companies in the solar power industry as well. We expect that United States electricity generation from wind and solar power will continue to grow by more than 10% per year in the near future. The diversification of its regulated and competitive energy businesses should allow NextEra to maintain favorable margins and a healthy balance sheet while pursuing promising growth opportunities in the renewable energy industry. Drivers of Thesis • We forecast 8.4% compound annual growth rate of NextEra’s competitive renewable energy segment due to favorable prospects for the wind and solar markets and NextEra’s strong position in these markets. • Due to the company’s cost-reduction strategy, the continuing improvement in the cost-effectiveness of onshore wind and utility-scale solar, and potential synergies of the Gulf Power acquisition, we forecast NextEra’s operating margin to improve from 25.59% in 2018 to 29.66% in 2023. Risks to Thesis • Weaker-than-expected development of battery storage is the primary risk which could inhibit the wind and solar industries’ growth prospects. • We expect the growth of wind and solar power to continue with or without renewal of the production tax credit and investment tax credit; a loss of these subsidies may affect NextEra’s renewable energy growth more adversely than we expect Henry Fund DCF $296.40 Henry Fund DDM $267.75 Relative EV/EBITDA $133.85 Price Data Current Price $231.42 52wk Range $164.78 – 239.89 Consensus 1yr Target $243.43 Key Statistics Market Cap (B) $113.11 Shares Outstanding (M) 488.78 Beta (5-year daily) 0.35 Dividend Yield 2.16% Pre-tax Cost of Debt 3.97% Price/Earnings (TTM) 27.52 Price/Earnings (2019E) 27.01 EV/EBITDA (2019E) 14.53 Price/Sales (2019E) 5.77 Profitability Operating Margin (2019E) 28.63% Gross Margin (2019E) 77.09% Return on Assets (2019E) 3.43% Return on Equity (2019E) 9.52% Earnings Estimates Quarter 2019Q1 2019Q2 2019Q3 2019Q4E 2020Q1E 2020Q2E EPS $2.20 $2.35 $2.39 $1.57 $1.88 $2.45 Consensus $2.05 $2.32 $2.29 $1.48 $1.92 $2.52 YoY growth 13.4% 11.4% 9.6% 6.8% –14.5% 4.3% 12 Month Performance Company Description NextEra Energy is a diversified electricity provider based in Juno Beach, Florida. Its regulated utility business in Florida is among the largest in the United States in terms of number of customers served. Its competitive business sells electricity to wholesale customers in the United States and Canada. Due to its competitive business, NextEra is a global market leader in renewable energy generation and has a particularly strong position in the wind power industry. 28.6 12.3 21.3 3.1 18.4 5 0 10 20 30 40 EBIT Margin (%) Order Backlog (GW) NEE AES AGR Data source: Factset, SEC filings -20% -10% 0% 10% 20% 30% N D J F M A M J J A S O S&P 500 NEE Data source: Yahoo Finance
InvestmentThesis TargetPrice $260–285WerecommendaBUYratingonNextEraEnergy,Incwithatargetpricerangeof $260–285. NextEra is the market leader in United States wind powergenerationandamongthe largestcompanies inthesolarpower industryaswell.WeexpectthatUnitedStateselectricitygenerationfromwindandsolarpowerwillcontinuetogrowbymorethan10%peryearinthenearfuture.ThediversificationofitsregulatedandcompetitiveenergybusinessesshouldallowNextEra to maintain favorable margins and a healthy balance sheet whilepursuingpromisinggrowthopportunitiesintherenewableenergyindustry.DriversofThesis• Weforecast8.4%compoundannualgrowthrateofNextEra’scompetitive
renewableenergysegmentdue to favorableprospects for thewindandsolarmarketsandNextEra’sstrongpositioninthesemarkets.
• Due to the company’s cost-reduction strategy, the continuing
improvement in the cost-effectiveness of onshorewind andutility-scalesolar,andpotential synergiesof theGulfPoweracquisition,we forecastNextEra’soperatingmargintoimprovefrom25.59%in2018to29.66%in2023.
NextEraEnergyisadiversifiedelectricityproviderbasedinJunoBeach,Florida.Itsregulatedutilitybusiness in Florida is among the largest in theUnited States in terms of number of customersserved.Itscompetitivebusinesssellselectricitytowholesale customers in the United States andCanada.Duetoitscompetitivebusiness,NextErais a global market leader in renewable energygenerationandhasaparticularlystrongpositioninthewindpowerindustry.
28.6
12.3
21.3
3.1
18.4
5
0
10
20
30
40
EBITMargin(%) OrderBacklog(GW)
NEE AES AGR
Datasource:Factset,SECfilings
-20%
-10%
0%
10%
20%
30%
N D J F M A M J J A S O
S&P500 NEE
Data source:YahooFinance
Page2
EXECUTIVESUMMARY
WerecommendaBUYratingonNextEraEnergy,Inc.Wehave used our Discounted Cash Flow and DividendDiscountmodelstoarriveatatargetpricerangeof$260–285, which represents 12–23% upside from its currentprice. NextEra is the nation’s leader in wind powergeneratingcapacityandisamongthelargestcompaniesintermsofsolarpowerdevelopmentaswell.Weexpectthattheamountofelectricitygenerated in theUnitedStatesfrom these renewable sources will continue to grow bymorethan10%peryear.Thestronggrowthofthismarketis driving our optimistic forecasts for NextEra’scompetitiverenewableenergysegment,whichweexpectto grow at a compound annual rate of 8.4%. We alsoexpectthatthecostofgeneratingelectricityfromthewindand sun will continue its downward trend. This trend,alongwith corporate strategy focusedon cost efficiencyand improving the value proposition of its regulatedbusinesses,shouldallowthecompanytoimproveitsprofitmarginsthroughourforecastperiod.
COMPANYDESCRIPTION
NextEra Energy, Inc. is an electricity generator anddistributorheadquarteredinJunoBeach,Florida.NextErais one of the largest utility and power generationcompanies in North America.1 The company operatesprimarilythroughtwosegments:theFloridaPower&LightCompanyandNextEraEnergyResources.OurforecastforNextEra’s revenue breakdown by segment in 2019 isshowninthefollowingchart.
With more than five million customer accounts servingmore than 10 million people, FPL is one of the largestelectric utilities in the nation. The majority of thissegment’s revenue comes from supplying electricity toresidentialcustomers.1
WehaveforecastedthatFloridaPower&Light’srevenueswill growby 1.1% year-over-year in each quarter of ourforecast period. This figure is consistent with recenthistorical data and consistent with the notion that aregulatedutilitywilltypicallygrowatamodestbutstablerate.Thisfigureisalsoconsistentwithpopulationgrowthaswell,asweshouldexpectthatthepopulationofFloridawillgrowbyabitmorethan1%peryear.16
FloridaPower&Lightstrives tomaintainacost-efficientposition so that they are able to provide services tocustomersatreasonablerates.Duetothisstrategy,FPL’s2018averagetypicalmonthlybillper1,000kilowatt-hoursof consumptionwas$99.36,which is substantially lower
Page3
than the national average of $142.81.1 Accordingly, wehaveforecastedthatFPL’soperatingexpenseswilldeclinefrom72.48%ofrevenuein2019to70.80%ofrevenuein2023.Basedonhistoricaldataandthecompany’slow-coststrategy,wefeelthatthisprojectedimprovementincost-efficiencyisveryrealistic.
NextEraEnergyResources
NextEra Energy Resources, LLC represents NextEra’scompetitive operations focused primarily on thegeneration of renewable energy. NextEra EnergyResourcesistheworld’slargestcompanyintermsofnetgenerationofenergyfromthewindandsunin2018.Asoftheendof2018,NextEraEnergyResources’assetsamountto a net generation capacity of approximately 21,000megawatts (MW), thevastmajorityofwhich isbased inthe United States.1 A map of NEER’s generating assets(excludingitsassetsinSpain,whichaccountforlessthan1%ofitsnetgenerationcapacity)isshownbelow.
NextEraEnergyResourcesNorthAmericanAssets
Source:NEE10-K
Of its 21,000 MW of net generation capacity,approximately13,000MWareattributabletowindpower;forreference,thesecond-largestwindpowergeneratorintheUnitedStatesisInvenergyLLC,withanetgenerationcapacityofalmost7,000MW.7WeestimatethatNextEra’sassetsaccounted forapproximately13.8%of theUnitedStates’ wind power capacity at the end of 2018.17 As aconservativeestimate,13,000MWofwindpowercapacity
should be able to generate 40 million MWh in a year,which would equal about 14.5% of the electricitygenerated from wind power in 2018.8 In a fragmentedmarket such as United States competitive renewableenergy generation, this proportion represents a leadingpositionforNextEraEnergy.
Datasource:NEE10-K
The chart above shows NextEra Energy Resources’s netelectricitygenerationin2018brokendownbyfuelsource.The majority of their business is associated with windpower.Afairlylargeportionoftheirpowergenerationstillcomesfromnuclearplantsasof2018.However,giventhatnuclear assetsmake up only 13% of the company’s netgeneratingcapacity,1andthatthe“nuclearfuel”accountintheproperty,plantandequipmentsectionofNextEra’sbalance sheet has declined since 2016, and that thecompanyhassuchastrongpositioninthewindandsolarindustrieswhichshowgreatpromiseofgrowthinthenearfuture,weexpectthatthenuclearshareofNextEraEnergyResources’spowergenerationwillsoonshrinkfrom33%.
UnliketheregulatedaspectsofNextEraEnergy’sbusiness,thissegment’sperformance(intermsofrevenuegrowthaswellasmargins)tendstoberathervolatile.However,wenoticeatrendthatitsperformancehasbeenrelativelystronginrecentperiods,including59.04%year-over-yearrevenue growth and a 33.05% operating margin in the
59%
33%
7%
1%
2018NetGeneration(MWh)byFuelType
Wind
Nuclear
Solar
NaturalGas
Page4
most recentquarter (compared to2.71%year-over-yearrevenuegrowthanda27.87%operatingmarginforFloridaPower&Light).Basedonthefirstthreequartersof2019andour forecasts for the fourthquarter,weexpect thatfiscal year2019 revenue for this segmentwillbe$5.826billion, an increase of 19.44% from2018, and operatingexpenseswillbe64.51%ofrevenue.Weexpectthatthegrowthofthissegmentwilldrivetheoverallgrowthofthecompany, as we project that NextEra Energy Resourcesrevenuewillgrowatacompoundannualrateof8.4%from2019to2023.
GulfPower
Announced in 2018 and completed in early 2019 wasNextEra’s acquisition of Gulf Power from the SouthernCompany.TheGulfPowerCompany isaregulatedutilityservingeightcounties innorthwestFlorida.NextErapaidapproximately $4.47 billion in cash and assumedapproximately$1.3billionworthofGulfPower’sdebttocomplete the deal.With the acquisition, NextEra addedabout460,000customeraccountslocatedinnorthwesternFlorida.1GulfPower’sserviceareaisillustratedinthetop-leftcornerofthemapbelow.
MapofFloridaUtilitiesbyServiceArea
Source:NationalMarineManufacturersAssociation
Becausetherehavebeenonlythreequarterlyreportsandno annual reports filed since the acquisition wascompleted, we have limited information with which toforecastthissegment’sperformance.Therefore,wehavedecidedtoforecastGulfPowerbasedonourFloridaPower& Light forecasts, seeing as they are both regulatedutilitiesoperatingwhollywithin Florida.Weproject thatGulfPower’srevenuewilldecrease15%fromQuarter3toQuarter4of2019andthengrowby1.1%year-over-yearin each quarter thereafter, whichmakes this segment’srevenuegrowthratesidenticaltothoseoftheFPLsegment(the15%declineinthefourthquartermakessenseduetoseasonality,asintheFPLsegment,a1.1%year-over-yearincrease from Quarter 4 of 2018 corresponds to a 15%quarter-on-quarterdecreasefromQuarter3of2019).GulfPower’s operating expenses have been 79.45% ofrevenues for the first threequartersof2019,which is aconsiderablyhigherpercentagethanthatofFloridaPower&Light.GiventhatGulfPowerisarelativelynewpartofNextEra’sbusinesswhichislessefficientthanFPL,weseegreaterpotentialforNextEra’scost-effectivenessstrategytoimprovemarginsinthissegment.Thecompanyhasalsoaddressed this area in their recent earnings calls andexpressed their intent to implement this strategy toimprove Gulf Power’s value proposition.6 Therefore ourforecasts showGulf Poweroperatingexpensesdecliningfrom78.84%ofrevenuein2019to73.00%ofrevenuein2023.
CompanyAnalysis
WefeelthatNextEraEnergyhaspositioneditselfwelltotakeadvantageofindustrytrends.Electricitygenerationisshiftingmoretowardwindandsolarpowereachyear,andNextEra is at the forefront of both of these industries.Thereforeweexpectthatthecompany’srevenuegrowthwillbedrivenprimarilybythestronggrowthprospectsofNextEra Energy Resources.We are also forecasting thatthissegmentwillbethemostprofitable,withanexpectedoperatingmarginof35.49%in2019.
We also favor the diversification of NextEra’s businessmodel. We feel that it makes good sense to combineregulated and unregulated utilities, as the company hastheopportunitytocompeteandpursuenewinitiativesintrendy markets, such as renewable energy, while alsotaking advantage of the long-term stability of theregulated business. Of the company’s expected 2019
Page5
revenue,70%willcomefrom its regulatedutilitieswhiletheremaining30%isoccupiedbyitscompetitivebusiness.Thus, while themajority of the company’s businesswillprovide relatively stable performance and predictablereturns, the company still has substantial exposure tomarketswithmuchgreaterupsidepotential.
RECENTDEVELOPMENTS
2019Q3EarningsReport
NextErahosted theirQuarter3earnings callonOctober22, 2019. The company reported adjusted earnings pershare of $2.39, which beat the consensus estimate by4.4%, and reported total operating revenues of $5,572,which beat the consensus estimate by 8.0%.3 Thecompany’s reported adjusted earnings for the ninemonthsendedSeptember30,2019are$6.94,anincreaseof11.4%fromthesameperiodof2018,whichisdriveninpartbytheadditionofGulfPowerbutprimarilybystrongexecutionacrossallsegments.3,5,6
Earnings in the Florida Power& Light segmentwere upabout2.2%year-over-yearfromthethirdquarterof2018,anincreasewhichwasmainlydrivenby“capitalprojects,includingoneof the largest solarexpansionsever in theUnitedStates”.6FloridaPower&Light’svaluepropositioncontinues to be industry-leading clean emissions andreliabilityofservice,aswellasrelativelylowbillsbystateand national standards (as mentioned earlier, FPL’saveragebillper1,000kWhofconsumptionisabout30%lowerthanthatofthenationalaverage).6 IntheNextEraEnergyResourcessegment,third-quarterearningsgrewbyabout 19% year-over-year on the strength of newinvestments.6 The company added 1,373 megawattsworth of contracts to its backlog, including 747 MWrelated to solar power and 341 MW related to batterystorage of solar power, as it strives to pioneer thecombination of cost-effective wind and solar powergenerationwithcost-effectivebatterystorage.5,6
Regardingguidanceforthecomingperiods,thecompanyhasprovidedaguidancerangefor2019EPSof$8.00–8.50,andisspecificallytargeting$8.32whichwouldrepresent8% growth over 2018 reported EPS.5 Accordingly,consensus estimates project NextEra’s fourth-quarterearnings at $1.48per share,whichwouldbring its 2019total to$8.42per share.3However, ourmodels forecast
thatthecompany’searningspershareinQuarter4of2019willbe$1.57,bringingitstotalfortheyearupto$8.51.Wefeel that our optimism for NextEra’s competitiverenewableenergybusinessisthemostlikelyreasonthatourforecastsexceedconsensusestimates.
TaxCredits
Theproductiontaxcredit (PTC)wasoriginallyenacted in1992 to create an incentive to invest in wind powerfacilities. The PTC allows for an inflation-adjusted$0.015/kWhtaxcreditonallelectricitygeneratedandsoldwithin the first 10 years of a utility-scale wind system’slife.18 As of now, the PTC is only applicable to systemswhichareinserviceorunderconstructionpriortotheendof2019.Therefore,theEnergyInformationAdministrationisexpectingnear-recordinvestmentsinnewwindpowersystems in2019,withabout12,700MWexpected tobeaddedtoU.S.windcapacitythisyear.Thestrongestyearon record was 13,300 MW added to capacity in 2012,whichwasthelastyearpriorto2019inwhichtheindustryfacedanimminentexpirationofthetaxcredit.19
The investmenttaxcredit (ITC)wasenacted in2006andhas played an instrumental role in the rise of the solarindustry.23TheITCcurrentlyprovidesfora30%taxcreditrelated to initial costs in the construction of new solarfacilities. As the plan exists now, the ITC’s 30% ratewillstepdownto26%in2020,22%in2021,andin2022andbeyonditwillnolongerbeineffectforresidentialsystemsbutwillbe10%forcommercialandutility-scalefacilities.23Beginningin2013,windpoweroperatorsweregiventheoptiontodeclinethePTCandaccepttheITCinstead.22
Asweenterthehomestretchof2019,thereisasignificantpush to try to get these tax credits extended into thefuture, including lobbying from the wind and solarindustriesandapreliminarydraft,createdbyDemocratsintheHouseofRepresentatives,whichdiscussesfive-yearextensions for the ITC and PTC as well as potentialincentives forbatterystorageandelectricvehicles.20Weexpectthatthetaxcreditswillberenewedatsomepoint,mostly likely some time from now and retroactivelyappliedto2020,similartothewaythePTCwasrenewedafteritexpiredin2012.19
tobeveryimportant;23however,someperspectivesinthewind industry have indicated that they could take it orleave it. They note that the cost profile of wind powergeneration has improved to the point that wind cancurrentlybecompetitivewithorwithoutsubsidy.11Somebelievethatthehealthiestcourseofactionfortheindustryistograduallyphasedownthetaxcreditstothepointthatthey are no longer needed.21 We agree that the windindustry can sustain strong growth with or without taxcredits, as it has developed into one of the cheapestsources of electricity generation11 in addition to itsenvironmentaladvantage.Solardevelopersmaybemorepassionateaboutrenewingthetaxcredits,butevenifnolegislationispassed,the10%ITCwillstillbeineffectforcommercial and utility-scale properties in perpetuity.Given that solar power, like wind power, has achievedcontinually improving cost-competitiveness,11 we expectthattheindustrywillbeabletothriveevenwithonlya10%credit.Weconsideritlikelythatthetaxincentivesforwindandsolarwillberenewedbylawmakersinsomecapacity,butwebelievethattheindustriesdonotneedthesetaxcreditsforcontinuedsurvivalandgrowth.
INDUSTRYTRENDS
ShiftinElectricityFuelSources
TheparadigmofelectricitygenerationintheUnitedStateshasshiftedtremendouslyoverthepastdecadeorso.Thismarkethastraditionallybeendominatedbycoal,aswellas nuclear power and natural gas to a lesser extent. In2005, coal and nuclear were the top two fuel sources,accounting fornearly70%ofelectricitygenerated intheUnitedStates.Butnow,naturalgashasalreadyovertakenboth of them to become the primary fuel source forelectricity, and renewable energy appears poised tobecome the second-largest fuel source at somepoint inthenearfuture.Thesetrendscanbeseeninthefollowinggraph.
Source:EnergyInformationAdministration
This industry is trending toward replacing the dirtyemissionsofcoalandthepotentialradioactivewasteandaccidents of nuclear plants with more environmentallyfriendlyalternatives.10
Source:EnergyInformationAdministration
We can see from the chart above that electricitygeneration from renewable sources has showntremendousgrowthoverthelast15-20years.Therewasatotalof712.77billionkWhofelectricitygenerated fromrenewable energy in 2018; compared to 352.75 billionkWh in 2007, that represents a 6.6% compound annualgrowthrate.8GiventhattotalelectricitygenerationintheUnited States has stayed quite level since 2007, thatmeansrenewableenergy’sshareofelectricitygenerationhasgrownfrom8.5%in2007tomorethan17%in2018.8Therehasbeenacorresponding43%declineintheuseofcoal, which accounted for almost half of U.S. electricitygenerationin2007butonlyabout27%in2018.8Thereforewecanseeanobvioustrendinfossilfuelsbeingreplacedbycleanerenergyforelectricitygeneration,andthistrend
The chart also shows us that the overall growth inrenewableenergyusehasbeendrivenprimarilybywindandsolar,representedbythegreenandyellowsectionsatthetopofthegraph.In2007,windpoweraccountedfor34.45 billion kWh of U.S. electricity generation, whichrepresented9.8%ofallrenewableenergyandlessthan1%of all electricity. But wind power then accounted for274.95billionkWhofU.S.electricitygeneration in2018,whichrepresented38.6%ofrenewableenergyand6.6%oftotalelectricitygeneration.8Furthermore,solarpoweraccounted for only 0.61 billion kWh in 2007 and 1.82billion kWh in 2011, representing less than 1% ofrenewableenergyandabout0.04%oftotalelectricity.Butin2018,electricitygenerationfromsolarpowerwas66.6billionkWh, representing9.3%of renewableenergyand1.6% of all electricity.8 We can see that theaforementioned6.6%CAGRofelectricitygenerationfromrenewable fuel sources over the last 11 years has beenprimarilydrivenbya21%CAGRinwindpoweranda53%CAGRinsolarpoweroverthesameperiod.
We see tremendouspotential for this trend in thewindandsolarindustriestocontinueunabated.In2007,morethan 70% of electricity from renewable sources wasattributabletohydropower,butnowwindpowerispoisedto overtake hydropower as the largest source ofrenewable energy very soon.8 It was our understandingthat costs were an obstacle preventing wind and solarfromtrulyreplacingconventionalfuelsources,butrecentdata suggests that isno longer thecase.11The followingimageshowsusthetrend in levelizedcostofgeneratingonshorewind and utility-scale solar power over the lasttenyears.
IncreasingCost-EfficiencyofWindandSolar
Source:Lazard
Thelevelizedcostsofgeneratingwindandsolarpowerona per-Megawatt-hour basis have each declined at least70%overthepasttenyears,tothepointthattheircostsarenow favorable relative toother fuel sources.Due toenvironmentalconcernsaswellasthefactthatwindandsolarpowerarenowcost-competitive,weexpectthatthemeteoric rise of wind and solar will continue and thatrenewable energy will continue to cut into fossil fuels’shareofUnitedStateselectricitygeneration.
BatteryStorage
Oneoftheprimarychallengestothegrowthofwindandsolarpoweristhattheyareintermittent(notcontinuous)sources of energy and thus will not consistently meetelectricitydemandunlesssomeofthisenergyisabletobestoredandusedlater,andenergystoragetothispointhasbeen considered relatively costly and ineffective.10 Theglobalcapacityofenergystoragesystems isexpected tobe21.6GWh in2022; for comparison,21.6GWhequals21.6millionkWh,whereaselectricitygeneratedin2018intheUnitedStatesalonewas66.6billionkWh fromsolarpower and 274.95 billion kWh fromwind power.8,15Wecanseethatthecapacityofenergystoragesystemsisverysmall relative to the amount of power produced andconsumed.AccordingtoLazard,theunsubsidizedlevelizedcost of generating onshore wind and utility-scale solarpowerrangesfrom$28to$54permegawatt-hour,whichmakes wind and solar among the cheapest sources ofelectricity,11asshowninthefollowingimage.
Page8
UnsubsidizedLevelizedCostofEnergyAnalysis
Source:Lazard
Thisgraphicshowsusthatonshorewindandutility-scalesolarhasactuallybecomecheaperperMWhofelectricitygeneration than coal, nuclear, and most natural gasgeneration. The problem is that the cost of storing thisenergy is at least $100/MWh, according to Lazard’slevelized cost of storage analysis.14 This high cost ofstorageremainsaconcernregardingthecontinuedgrowthofwindandsolar.
However,trendssuggestthattheprogressbeingmadeonreducing the cost of storage is promising. Lithium-ionsystems are achieving outsized cost declines relative toother battery storage technology.14 Recent growth inelectricvehicleshascontributedtoinnovationinlithium-iontechnology,whichhashadasideeffectofmakingsolarenergy storage efforts progressively less expensive.15Lithium-iontechnologycurrentlyrepresentsalmost99%ofbattery storage systems, and the input costs for thesesystems are declining at a rate of 8% per year.15 Solarpanelsareincreasinglybeingsoldintandemwithenergystorage systems in order to make their supply morereliable, and the economics of doing so are becomingmorereasonable,particularlyforutility-scalegeneration.14Thereforewefeelthatthecapacityandcost-effectivenessofbatterystorageforwindandsolarpowerwillbeabletoimprovequicklyinthenearfuture.Thisareawillcontinuetobethe largestchallenge facingwindandsolarpower,butweareoptimisticthatprogressinbatterystoragewillcontinue.
MARKETSANDCOMPETITION
Renewable energy has burgeoned in recent decades aspeople have increasingly sought alternatives toconventionalfuelsources.Theindustry’srisecantraceitsroots back to the 1970s, when the OPEC oil embargocreated an energy crisis in the United States.8,9 Theindustryhaspickedupevenmoresteamsincethe1990samidst growing environmental concerns.8 As Americanshavelearnedmoreinrecentyearsabouthowthesupplyof fossil fuels is not infinite and may not always besufficienttomeetdemand,andhowtheburningoffossilfuels creates carbon emissions which have an adverseeffect on our planet’s environment,10 their interest inrenewablealternativeshasgrown.
Theexistenceofgovernmentsubsidiesandtaxcreditshasbeenanimportantpartoftherenewableenergyindustry’sgrowth, dating back to the Energy Policy Act andproduction tax credit being passed in 1992.9 However,according to Lazard’s 2019 levelized cost of energyanalysis, the unsubsidized costs per megawatt-hour ofwindandsolarpowerhavedecreasedbymorethan70%overthepasttenyearsandhavebecomecompetitivewiththecostsofmoretraditional fuelsources.11The industryhas achieved economies of scale and innovated itstechnology as it has grown, and nowonshorewind andutility-scale solar are among the cheapest sources ofelectricity.11Governmentswill likely continue to supportwind and solar projects as they continue to encourageclean-energy initiatives, but based on this analysis, itwould seem that wind and solar power generation isalready favorable regardless of subsidies or tax credits.Given its environmental favorability, present cost-competitiveness, and potential further innovation andeconomiesofscaleastheindustrycontinuestogrow,weseegreatpotential forwindand solar to gainmoreandmoreshareoftheelectricitymarket.
NextEraEnergyResourcesis“theworld’slargestgeneratorofrenewableenergyfromthewindandsun.”7IntermsofUnitedStateswind-relatedgenerationcapacity,NextEraisthe market leader by a substantial margin, followed byInvenergy LLC, EDP RenewablesNorth America LLC, andAvangridRenewables.7Amongtheworldleadersinsupplyof wind-generated energy, as well as innovation of theequipment and machinery required to generate windpower, are Vestas Wind Systems A/S, GE Renewable
Page9
Energy, and Siemens Gamesa Renewable Energy SA.3,7NextEra is also among the leading players in theUnitedStates solar energy space. The market leader in solargenerating capacity is a private company called CypressCreek Renewables, but First Solar Inc. and NextEra arefollowingclosebehind.7
PeerComparisons
Datasource:YahooFinance
Thechartaboveshowstheperformanceofselectedstocksover the past 12 months. As we can see, NextEra hasoutperformed the S&P 500, while the other diversifiedutilities (Avangrid,AES, Sempra,Vistra andExelon) havemostlyunderperformedthemarket.WecanalsoseethatFirst Solar has had a strong year, demonstratingmomentuminthemarketforsolarpanelsin2019.
PeerComparisonsofLeverage,Valuation,Margins
Company Debt/EVEV/EBITDA(2019E)
EBITDAMargin(2019E)
EBITMargin(2019E)
NextEra(NEE)
0.28 14.53 50.4% 28.6%
Avangrid(AGR)
0.32 10.96 32.9% 18.4%
AESCorp(AES)
0.63 9.00 32.1% 21.3%
Exelon(EXC)
0.44 9.58 26.9% 15.4%
Sempra(SRE)
0.43 14.10 36.6% 23.2%
Vistra(VST)
0.48 7.09 26.7% 16.1%
FirstSolar(FSLR)
0.11 8.79 15.1% 9.0%
Datasource:Bloomberg,FactSet,HenryFundforecasts
In this table,we notice that NextEra is leading all of itspeers in terms of EBITDA margin and EBIT margin.NextEra’sEBITDAmarginseemedremarkablyhigh,soweincluded EBIT margin for reference as well, perhaps tocontrol for differences in depreciation and amortizationexpenses,butNextEraistheleaderintermsofEBITmarginaswell.
We also notice that NextEra’s EV/EBITDA valuationmultiple looks quite high in comparison to the chosencompanies.Wearenotconcernedthatthisstocktradingatsuchahighmultiplefortworeasons.Firstly,NextErahasaleadingpositioninanindustrywithimmensepotential,so the company’s growth prospects justify trading at apremiumtocomparablecompanies.Secondly,wesuspectthatitsmultiplesmayonlybethathightemporarilyasthecompanytemporarilyassumedmoreshort-termdebtthannormal during the process of acquiring Gulf Power.Weforecast that these debt accounts will decline towardtypical levels in our forecast period as the companygenerates sufficient operating cash flow to sustain itscapital expenditures, and we expect that NextEra’svaluationmultipleswill soon decrease as earnings growrelative to debt and equity values. However, the tableabove shows that even with their unusually high debtlevels, NextEra remains lightly leveraged relative to the
Page10
selected peers and especially relative to the otherdiversifiedutilities.
FromthistablewecanseethatNextEraisthelargeststockamong the chosen peers. We also see that NextEra’scapitalexpendituresasapercentageofrevenueishigherthan any of the selected competitors. NextEra isreinvestingagreater shareof itsearnings towardassetsforfutureoperationsthananyofitspeers.WeexpectthatthesetwoadvantagescontributetowardNextEra’sabilityto gain amarket-leading position in the quickly-growingandcapital-intensivewindandsolarpowerindustries.WealsofeelthatNextEra’sdividendiscompetitiverelativetoitspeers.
Wewould like to compare these companies in terms ofmegawattsinareassuchasorderbacklogsandportfolioofgenerating assets, but unfortunately it is difficult tocompareapplestoapplesbecausethesecompaniesdonotreport these things consistent with each other in theirrespectiveSECfilings.NextEraEnergyResourcesclaimsatotal net generation capacity of about 21,000 MW, ofwhichabout13,000MWareassociatedwithwindpower,1andalsoclaimsanorderbacklogworthmorethan12,300MW.5 NextEra Energy, Inc. is also among the leaders insolar power capacity and is planning one of the largestbatterystorageprojectsinthecountry.7AESreports3,079MW worth of signed renewable power purchaseagreements in their backlog, but do not provide muchinformation on renewable energy generating capacity.12Exelon does not providemuch useful information at all.However, according to Energy Acuity, neither AES norExelon has a net generating capacity of wind powergreater than 3,000MW.7 Avangrid claims total installedcapacityof7,995MW,almostallofwhichiswind-powered
and68%ofwhich(morethan5,000MW)isundercontractwith customers.13 Thus we conclude that NextEra isoutpacingotherdiversifiedutilitiesintermsofrenewableenergy generation and customer contracts. Due to itsleading market position, as well as its relatively highmarginsandhealthybalancesheet,wefeelthatNextErahasthestrongestpositioninthisindustry.
ECONOMICOUTLOOK
GDPGrowth
UnitedStatesrealGDPgrewatanannualizedrateof1.9%in the third quarter of 2019. This is one of the lower-growthquartersobservedinthelastfewyears,asshowninthefollowingchart.
Source:BureauofEconomicAnalysis
However,ourperspectiveisthatGDPgrowthisremainingmoreresilientthanweexpectedearlierintheyear.Therehasbeenenoughbadnewsin2019,particularlyregardingtheconflictintheU.S.–Chinatraderelationship,thatouroutlook was grim and we were expecting a weakeningeconomy.However,theeconomyhascontinuedtogrowatanannualizedrateofabout2%,whichisnotdissimilarfrom the observed growth rates in 2016 and 2017.Weconcludethattheeconomyisholdingmuchsteadierthanweexpecteditwouldinthefaceofnegativepressuresandbadnews.
InterestRates
Until recently, theUnited Stateswas in a rising interestrateenvironment.TheFederalReserveraisedtheirtargetfederal funds rate four times in 2018 alone, from 1.25–1.50%up to2.25–2.50%,although this level is still quitelow by historical standards, as shown in the followinggraph.
Page11
Source:FederalReserveEconomicData
However, the Fed has shifted toward decreasing thefederal funds rate in 2019, cutting its targetby25basispointsinJuly,25basispointsinSeptember,andanother25basispointsinOctober.Alackofinflationarypressurehas allowed the Fed to pivot toward expansionarymonetary policy in recent months. Over the next sixmonths,weexpectthefedfundsratetoeitherdecreaseanadditional25basispointsorholdsteadyinthecurrent1.50–1.75% range, and this view is consistentwith bothourHenryFundteamconsensusandtheFed’sSeptemberdotplotprojectionsasshownbelow.
Source:Bloomberg
The yield curve of U.S. Treasury securities has been inpartial inversionformuchof2019.The10-yearTreasuryyieldbrieflydippedbelowthe1-yearTreasuryyieldinMay(falling to 2.31%while the 1-year yieldwas 2.32%), andthenspentmostofAugustandSeptemberlowerthanthe1-yearyield(beginningwithadecreaseto1.75%whilethe1-year yield was 1.78%).Meanwhile, the 1-month T-Billyieldwashigherthanbothofthemforalmosttheentirespan of May until October, trading in the 1.80–2.40%range.12 The yield curve was not painting an optimisticpicture of the near-term economic outlook: the longer-term yields falling below T-Bill yields indicated that
investor demand was shifting toward the safety of thelonger-term securities as they were discouraged by theshort-termeconomicoutlook.However,assistedinpartbytheFederalReserve’sreductionsoftheirtargetrate,theshort-termyieldshavefallenbelow1.75%,theyieldcurvehasnormalized,andtheconcernsaboutaninvertedyieldcurve have been eased somewhat. The following chartshowstheyieldcurveasofNovember18,2019,andwecan see that the left side of the curve is relatively flat,which is a positive development because it had beendownward-slopinginrecentmonths.
Source:GuruFocus
Noteveryyieldcurve inversion leads toa recession,butevery recession is typically preceded by a yield curve,thereforeitisanimportantindicatortomonitor.However,thebeginningofarecessiontypicallylagstheyieldcurveinversionbyayearormore,soatthispointitistooearlytosayyetwhethertherecentflatteningoftheyieldcurveis too littleand too late,or isa sign that theshort-termeconomicoutlookisimproving.Giventheuncertainty,we
Page12
expectthatdemandfortherelativelysafeTreasurynotesand bonds will continue and therefore their yields willremainlow.
With the resilience of real GDP growth, the FederalReserve’sshifttowardexpansionarymonetarypolicy,andthe recent flattening of the yield curve, our short-termoutlook for the economy is growing slightly moreoptimistic.Giventhattheeconomyhascontinuedtogrowthroughthebadnewsandwarningsignsofthisyear,weare gaining hope that the economy is further from arecession than we initially thought, and that just a fewpositive developments could create momentum foreconomic growth to become stronger. This should befavorableforNextEra’scompetitivesegment,particularlyregarding the required capital expenditures to add newassetstotheirgenerationportfolio.Weexpectthatcapitalexpenditureswouldbediscouraged inatougheconomicenvironment, but should continue to be strong as theeconomycontinuesgrowing.
INVESTMENTPOSITIVES
• Wehave a favorableoutlook for thewindand solarpower industries, and NextEra is a major player inthese industries; therefore, we have optimisticforecastsforNextEra’scompetitiverenewableenergysegment,which should grow at a compound annualrateof8.4%inourforecastperiodandbetheprimarydriverofthecompany’sgrowth.
• Our forecasts show the company’soperatingmarginincreasing from 25.59% to 29.66% in our forecastperiod, an improvement which we attribute tocontinuingreductionofthelevelizedcostofwindandsolarenergy,corporatecost-controlstrategy,andthepotential synergies and room for improvement ofoperatingefficiency related to thecompany’s recentacquisitionofGulfPower.
INVESTMENTNEGATIVES
• Tocontinuetobecomeamoreviablesourceoflarge-scale electricity, wind and solar power likely needfurtherdevelopmentinbatterystoragetechnologytoimprove the availability and cost-effectiveness ofenergystorage;weareoptimisticthatthisinnovationwill happen quickly in the near future, but if thisprogressturnsouttobedisappointing,itcouldhinderthegrowthprospectsofwindandsolar.
• We expect that the production tax credit andinvestment tax credit will be renewed in the nearfuture,andthatthewindandsolarindustrieswillbeable to sustain their growth evenwithout these taxcredits being renewed; if it happens that the taxcredits are not extended and the wind and solarindustriesaremoreadverselyaffectedbythelackofsubsidy than we expect, then NextEra EnergyResources’s growth prospects may fall short of ourexpectations
VALUATION
Wehavedetermineda target price rangeof $260–$285pershareofNEEstock,whichshowsanupsideof12–23%from its current price.We reached this target using ourDividend Discount Model, which yielded a value of$267.75basedonthetheoreticaldividendNextEracouldaffordtopayinthelastyearofourforecastperiodgivenits EPS, growth rate, and return on equity, and ourDiscounted Cash Flow model, which yielded a value of$296.40.Inoursensitivitytests,wefindthatbothofthesemodelsoftenstay in the$260–285 range in response tochangesinvariablessuchasbeta,risk-freerate,andequityrisk premium. In addition, we performed a relativevaluationusingtheaverageEV/EBITDAmultipleofagroupof comparable companies, including Sempra Energy,Avangrid, First Solar, Exelon, Vistra Energy, and AESCorporation. This approach yielded a target price of$133.85pershareofNextErastock.WedonotfavorthisapproachbecauseNextEra’sbusinessisdiversifiedenoughthat there is not a great deal of truly comparablecompanies.
Page13
WACC
In calculating the weighted-average cost of capital forNextEra,we used ourHenry Fund consensus equity riskpremiumof4.95%,andusedthe30-yearTreasuryyieldof2.308%torepresenttherisk-freerate.UsingBloomberg,wedeterminedthebetaofNEEtobe0.349,basedonaregressionofweeklyreturnsofNEEandtheS&P500overthelasttwoyears.PluggingthesenumbersintotheCAPMformula,wecomputedNextEra’scostofequityat4.04%.WeestimatedNextEra’spre-taxcostofdebttobe3.972%basedon2018 interestexpenseasapercentageof totaldebt, and we find that this number appears consistentwith the average interest rate of the outstanding debtlisted in the company’s 10-K. Taking into account themarginaltaxrateof26.5%(includingtheFloridastatetaxof5.5%),wefindtheafter-taxcostofdebt tobe2.92%.NextEra’smarketcapitalization is$113.11billion,and itstotalvalueofdebtandpresentvalueofoperatingleasesamounts to $37.89 billion, so the relevant weights are74.91%equityand25.09%debt.Usingtheseweightsandthe cost of debt and cost of equity, we find NextEra’sweighted-averagecostofcapitalis3.76%.
RevenueDecomposition
To forecast NextEra’s revenue, we began with thequarterlyhistoricalsegmentinformation.Thisinformationistypicallypresentedintermsofoperatingrevenuesandoperatingexpensesforeachsegment.Weanalyzedtheserevenuevaluesintermsofyear-over-yearandquarter-on-quarter growth and analyzed expenses in terms of apercentageofrevenue.
WegrowFloridaPower&Light’srevenueby1.10%year-over-year in each quarter of our forecast, which isconsistent with historical growth rates, consistent withFlorida’spopulationgrowthrate,andalsoconsistentwiththe notion that a regulated utility should have stable,modestgrowth.WefoundthatFPL’soperatingexpensesasapercentofrevenueweretypicallyhighestinQuarter4andlowestinQuarter2,soweforecastedexpensesas71%ofrevenueinthefirstquarter,67%inthesecondquarter,70% in thethirdquarter,and76% in the fourthquarter.Given that NextEra has only reported Gulf Power’sperformanceforthepastthreequarters,wehavelimiteddata with which to forecast this segment, so we haveappliedthesameapproachfromtheFloridaPower&Light
segment.ThedifferencefromtheFPLsegmentisthatGulfPowerisstartingfromahighercostposition,asoperatingexpenses have been about 80% of revenue through thefirstthreequartersof2019.BecausethisisarelativelynewpartofNextEra’sbusiness,andbecausethecompanyhasaddressedtheircostreductionstrategyforGulfPowerontheirearningscalls,weseemorepotentialtoimprovecostefficiency in this segment. Our forecasts show that GulfPoweroperatingexpenseswillfallto75.66%ofrevenuein2020 and down to 73% of revenue by the end of ourforecastperiod.
FortheNextEraEnergyResourcessegment,thehistoricaldataismuchmorenoisyandvolatile.However,wenoticea tendency that the segment’s performance has beenslightlystrongerinQuarters1and3.Therefore,wehaveforecasted quarter-on-quarter revenue growth of 2% inthefirstandthirdquarterand1%inthesecondandfourthquarter of each year. Our forecasts show a compoundannualgrowthrateofNextEraEnergyResourcesrevenueof8.38%from2019to2023.Wefeelthatitmakessenseforthisnumbertobesomuchhigherthanthe1.1%growthratesofFPLandGulfPowerbecauseNextEra’scompetitivebusinessshouldhavestrongergrowthprospects than itsregulatedbusiness.Wefeelthisgrowthratealsoreflectsouroptimismforthissegment,asithasastrongpositioninamarketwithgreatpotential.Wehavefoundthattheoperating expenses of the NextEra Energy Resourcessegmenttendtobea lowerpercentageofrevenuethantheothersegments,andweseeopportunityforimprovedcostefficiencyastherenewableenergyindustrycontinuesto develop. Therefore our forecasts show that thissegment’soperatingexpenseswillbe69%of revenue in2020andwilldeclineto67%ofrevenueby2023.
Thesesegmentforecastsleaveuswiththecompany’stotalrevenueof$4,976inthefourthquarterof2019,$4,646inthefirstquarterof2020,and$5,247inthesecondquarterof 2020. Each of these figures is optimistic relative toconsensusestimates,whichis likelyduetoouroptimismfortheNextEraEnergyResourcessegment.Wefeel thatthe company’s competitive renewable energy businessshould exhibit strong growth in our forecast period,particularly as onshore wind and utility-scale solarcontinue to become more cost-competitive withconventional fuel sources and are increasingly seen asviablereplacementsforfossilfuels.
Page14
IncomeStatement
Fortheincomestatement,wehavedeterminedthetotaloperatingrevenuesandtotaloperatingexpensesfromtherevenue decomposition described above. Many of theexpense accounts are irregular items or are positive insome periods and negative in others, so we have keptthese accounts at zero throughout the forecast period.Cost of fuel, purchased power and interchange isforecasted as 22.00% of revenue in the first quarter,22.25% of revenue in the second quarter, 23.50% ofrevenueinthethirdquarter,and22.75%ofrevenueinthefourth quarter, based on historical data. We haveforecastedotheroperationsandmaintenanceexpenseasa percentage of total operating expenses according tohistorical data, so it is projected to fall from 19.91% ofsalesin2018to18.29%ofsalesin2023.Depreciationandamortizationexpenseineachquarterisforecastedas1.1%ofgrossproperty,plantandequipmentattheendofthepreviousyear,merger-relatedexpenseis0.15%ofrevenueineachquarter,andtheremainingoperatingexpensesfallintothe“otherexpenses”account.Forthenon-operatingincome and expenses, quarterly interest expense isforecastedas¼timesthepre-taxcostofdebtusedintheWACCcalculation (3.97%) times totaldebtat theendofthepreviousyear,andtheotheraccountsareforecastedas a consistent percentage of revenue. The companycurrently has 488.78million shares outstanding, andweprojectthatthisnumberwillincreaseto499millionbytheendof2023asthecompanyissuesmorestocktohelppayfor its capital expenditures.We expect the company tocontinuegrowingitsdividedeachyearby$0.40–0.60pershareasithasinrecentyears.
BalanceSheet
Forthebalancesheet,webeginbyforecastingmanyofthecurrent assets and liabilities, including accountsreceivable,inventory,currentregulatoryassets,accountspayable,andcustomerdepositsasaconstantpercentageof total revenue. We also project that many of thenoncurrent assets and liabilities, such as electric plants,construction work in progress, investments, derivativeassetsandliabilities,regulatoryassetsandliabilities,anddeferred income tax liability,will groweach yearby theprevious year’s return on invested capital. Some of theother accounts, such as goodwill, accumulated othercomprehensive income,andnoncontrolling interests,we
have decided to keep constant rather than speculatewhether they will go up or down in any given period.Retained earnings is increased by total net income anddecreasedby total cashoutflows fordividendspaid.Weexpect the common stock account to increase at acompound annual rate of about 6%,which is consistentwith the trend in recent years and also keeps thecompany’s capital structure consistent throughout theforecastperiod,with itsdebt/assetsratioholdingsteadyatabout0.36.Finally,weforecastdebtandcashlevelssothattheyarereasonablegiventheirhistoricallevels,resultin leverage ratios which are consistent over time, andallowfortotalassetstoequal total liabilitiesandequity.We have consultedNextEra’s reported balance sheet attheendofQuarter3toassesstheseforecastsandadjustthemifneedbe.
The company has long-term debt outstanding withmaturitydatesrangingfrom2019to2079.1Wehaveusedtheinformationprovidedinthe10-Ktoforecastthatthecurrentportionoflong-termdebtwillbe$2,888millionattheendof2019,$4,125millionin2020,$1,872millionin2021, and$1,743 in2022.Weexpect that the companywillhavenoissuescoveringtheseshort-termobligations,asourforecastednetcashflowsfromoperatingactivitiesexceed$9billionineachyearoftheforecastperiod.Ourforecasts fornetexpenditures for investingactivitiesare$9.3billionin2019and$10.0billionin2020,comparedto$11.0billionreportedin2018.Weforecastanetincreaseindebtandcommonstockof$5.46billion from2018to2019, which represents the external financing that willhelptofundthecompany’scapitalinvestments.
KEYSTOMONITOR
The primary thing to monitor will be developments inenergy storage systems. This is the one variable whichcouldgreatly enhance thegrowthpotential ofwindandsolarpower if itsprogress isstrong,orcouldrestrict thegrowthpotentialofwindandsolarpowerifitsprogressisunderwhelming. We could also monitor the reportedrevenues of NextEra Energy Resources, as well as theEnergy Information Administration’s data on electricitygenerationby fuel source, to checkwhetherourgrowthexpectations for the company are reasonable. We mayalso monitor economic and political developments,particularly as they relate to investments in new
HenryFundreportsarecreatedbystudentsenrolledintheAppliedSecuritiesManagementprogramattheUniversityofIowa’sTippieCollegeofBusiness.Thesereportsprovidepotential employers and other interested parties anexample of the analytical skills, investment knowledge,andcommunicationabilitiesofourstudents.HenryFundanalystsarenotregisteredinvestmentadvisors,brokersorofficially licensed financialprofessionals. The investmentopinion contained in this report does not represent anoffer or solicitation to buy or sell any of theaforementionedsecurities.Unlessotherwisenoted,factsand figures included in this report are from publiclyavailable sources. This report is not a completecompilation of data, and its accuracy is not guaranteed.Fromtimetotime,theUniversityofIowa,itsfaculty,staff,students, or the Henry Fund may hold an investmentpositioninthecompaniesmentionedinthisreport.
