NextEra Energy (NEE) has had a great run-up on the back of the U.S. election with tailwinds of friendly green energy policies being priced in. However, at 38.0x TTM P/E and with its dividend yield pushed down to 1.84%, the company’s valuation is starting to look overblown. This article will take a look at NextEra’s profitability, break growth down into per-share terms that are meaningful to investors, and use Investors’ Adjusted ROE with a sustainable growth rate to conduct a valuation analysis and give investors an idea of the long-term returns they can expect at current stock prices.
Profitable and Growing
NextEra’s portfolio of diverse renewable energy infrastructure has provided the company with solid returns over the past decade. NextEra has been able to achieve an average return on equity (ROE) and return on invested capital (ROIC) of 14.2% and 7.8%, respectively, over the past decade. This level of profitability is right around my rule of thumb of 15% ROE and 9% ROIC rule of thumb, allowing me to be confident that, in my opinion, the company is able to maintain and increase its intrinsic value over a business cycle. The slightly lower ROIC than I prefer is made up for by the fact that the hard infrastructure assets are easily leveraged at low interest rates which increase ROE to an acceptable rate.
Source: data from Morningstar
Looking at Growth on a Per Share Basis
Similar to many infrastructure businesses, REITs and other MLP type businesses, NextEra issues more shares as it undertakes new projects while keeping financial leverage at a relatively steady rate. Because of this, it is critical to look at NextEra’s growth on a per share level as growth for the sake of growth shouldn’t necessarily be rewarded. As can be seen below, growth rates on a per share level have been lower than the totals as more shares are issued for new projects. Total revenues and net income have grown at an average annual compound rate of 1.7% and 6.8%, respectively, while per share figures have been virtually flat for revenues at 0.0% growth and 5.0% for net income per share. The higher net income growth shows that NextEra is gaining economies of scale.
Source: data from Morningstar
What does a Sustainable Growth Rate look like for NextEra?
A company’s sustainable growth rate is the growth that can be achieved without changing the capital structure of the business. As such, it is a good tool to use to assess NextEra’s growth potential as the company continues to issue new equity and debt capital as it tackles new renewable energy projects, all while keeping the capital structure stable.
With an average ROE of 14.2% as discussed earlier and a dividend payout ratio of 68.8% over the last twelve months, NextEra’s sustainable growth rate would be calculated at 4.4% (14.2% ROE x [100% – 68.8% payout rate]). This forecasted long-term growth rate is right around the 5.0% calculated in the previous section.
Getting a Sense of Valuation
NextEra’s 38.0 TTM P/E ratio can also be expressed as a 2.6% earnings yield, but I also always like to examine the relationship between average ROE and price-to-book value in what I call the Investors’ Adjusted ROE. For a predictable business with a stable capital structure such as NextEra, an Investors’ Adjusted ROE is a great way to get an idea of potential long-term yields. Investors’ Adjusted ROE examines the average ROE over a business cycle and adjusts that ROE for the price investors are currently paying for the company’s book value or equity per share.
With NextEra earning an average ROE of 14.2% over the past decade and shares currently trading at a price-to-book value of 3.95x when the price is $75.34 this would yield an Investors’ Adjusted ROE of only 3.6% for an investors’ equity at that purchase price, if history repeats itself. This is well below the 9% that I like to see, but we could add the sustainable growth rate of 4.4% on top which could increase this potential total return up to 8.0%.
NextEra is starting to look expensive at 38.0x TTM P/E especially if growth projects start to get more competitive. The 3.6% Investors’ Adjusted ROE at current prices might be suitable for some conservative investors who want a stable name in a low interest rate environment, but growth investors should not be expecting another leg up.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: Disclaimer: While the information and data presented in my articles are obtained from company documents and/or sources believed to be reliable, they have not been independently verified. The material is intended only as general information for your convenience, and should not in any way be construed as investment advice. I advise readers to conduct their own independent research to build their own independent opinions and/or consult a qualified investment advisor before making any investment decisions. I explicitly disclaim any liability that may arise from investment decisions you make based on my articles.