What a difference a few years makes. Just over a year ago, we wrote about The Biggest Renewable Energy Company in the World which happened to be NextEra Energy (NEE). Today, Exxon Mobil (XOM) is nearly three times the size of NextEra Energy as the price of oil has gone from negative to around $80 a barrel. Most of the world’s infrastructure relies on petroleum, something that won’t change anytime soon. Our rules-based investment strategy means we hold big oil companies and green energy stocks. Provided these companies continue increasing their dividends, we’ll continue holding them into the future.
NextEra Energy is the only stock we hold in our tech portfolio and our dividend growth investing (DGI) portfolio. It’s been a year since we checked in with NextEra, so let’s start with a key metric for disruptive tech stocks – revenue growth.
NextEra’s Revenue Growth
A subscriber recently pointed out that revenue growth for NextEra Energy has stalled, and indeed it has. However, it looks like they’ll be back in the game for 2022 (we used their average quarterly revenues for the first three quarters of this year to estimate Q4-2022).
We came up with our own Q4-2022 revenue estimate (seen above in orange) because NextEra Energy doesn’t provide guidance on revenue growth. The company probably believes that focusing on growth won’t interest value investors who the stock is likely to attract. That raises the question as to why we’d hold a value stock in a growth portfolio. NextEra is a $160 billion mega-cap, which means we should be harvesting those gains based on our size strategy outlined below:
NextEra is categorized as a utility company which means it will attract investors who look for defensive sectors that outperform during bear markets, like utilities. Focus will likely be placed on key metrics such as the debt covenants overshadowing their $54 billion in debt. Regulatory changes will create volatility in growth prospects, something we covered in our recent piece on Solar Stocks and America’s Solar Problem. Surprisingly, NextEra has a beta of .47, which means it’s less volatile than the overall market. That’s more characteristic of value than growth.
Exiting But Not Selling
Editor’s Note: What follows is a long-winded spiel about how we manage our stock portfolios. We’re only providing this so you can see how we thought through our decision to – well – essentially do nothing. See how confusing it is already?
We’ve talked about how NextEra looks more like a value stock than a growth stock, and you might wonder why it’s in our tech stock portfolio and not in our dividend growth portfolio. We actually wondered the same thing last year in a piece titled NextEra Energy Stock Forecast: Sunny and Windy.
Using our simple valuation ratio (calculated at 9.5) doesn’t make a whole lot of sense because NextEra isn’t a tech stock where revenue growth is our primary metric of success. They’re a boring old utility company with a lot of moving parts and complexity that needs to be considered. For that reason, it’s tough to gauge value here.
Nanalyze, November 2021
With a few quick reporting changes we could remove the stock from our tech portfolio and just leave it in our dividend growth portfolio. This would be a non-cash transaction with no effect on overall exposure.
Our tech stock brokerage account doesn’t actually hold shares of NextEra. Those are held in one of the numerous brokerage accounts used to house our DGI portfolio (we use multiple brokerage firms to reduce systemic risk). When aggregating our total assets under management (AUM), we’ve always been careful not to double-count NextEra stock. When calculating performance, we need to run numbers from two sources, then merge them. It’s much easier just to stop reporting a NextEra position in our tech stock portfolio and continue carrying it in our DGI portfolio where it’s always been. As for when to sell the stock, that decision becomes a whole lot easier.
There are two reasons we’d sell a tech stock – revenue growth stalls or our thesis changes. There’s only one reason we’d sell a dividend growth stock – if the dividend payment stops growing. If NextEra Energy is solely allocated to our DGI portfolio, then we could care less about revenue growth. Our focus then switches to dividend safety. How likely is it that NextEra Energy can keep increasing their dividend over time?
NextEra Energy’s Dividend Growth
Over the past decade, NextEra has managed to increase their dividend at a compound annual growth rate (CAGR) of nearly 11%. Starting at a 3.5% yield, that means yield would have increased to nearly 10% over a decade.
| 2012 | 3.5% |
| 2013 | 3.9% |
| 2014 | 4.3% |
| 2015 | 4.8% |
| 2016 | 5.3% |
| 2017 | 5.9% |
| 2018 | 6.5% |
| 2019 | 7.2% |
| 2020 | 8.0% |
| 2021 | 8.9% |
| 2022 | 9.9% |
However, today’s yield is around 2% because the price of the stock has appreciated alongside the increase in yield such that actual yield has been decreasing over time. The red arrow points to NextEra’s yield of 3.5% ten years ago.
Today’s yield of 2% implies investors find the company’s growth potential appealing enough to hold the stock despite the declining yield. For investors who have been holding NextEra Energy for a while, having a high yield on cost makes the experience a lot more rewarding.
For both 2023 and 2024, NextEra anticipates 10% dividend increases which is a testament to the headwinds they’re expecting from the Inflation Reduction Act. While the dividend growth track record shines, sustainability is paramount. Protecting a 28-year track record of increasing dividends takes precedence over the size of dividend increases. That’s why firms like Exxon or Chevron increase their dividends in the smallest possible increments when times get tough.
NextEra Energy’s Payout Ratio
This is where things get convoluted in a hurry. In the world of accounting, there’s a set of financial reporting standards called GAAP (stands for generally accepted accounting principles). Then, some MBA decided we should have “non-GAAP” which just means you start playing with the numbers to make your performance more – ahem – clear for investors. Researchers were shocked to find that most non-GAAP numbers error on the side of showing the company in a more favorable light. For these reasons, we don’t pay much attention to non-GAAP numbers which show a payout ratio of 60% for NextEra Energy.
Payout ratio is simply the percentage of profits a company gives back to shareholders in the form of dividends. A 100% payout ratio means the company used all of their profits to pay the dividend. That’s bad because it doesn’t give them much leeway, and a single dividend decrease means they ruin their dividend champion track record. To calculate payout ratio for any given time period, just compare the GAAP earnings per share (what’s in the SEC filings) to the dividend being paid. Below you can see where we’ve calculated that with some recent quarterly data.
Using GAAP data, the payout ratio is much higher – in the low to mid-90s typically. This is why our Quantigence dividend growth methodology (which uses GAAP data) penalizes them for that. A high payout ratio means management needs to be very attentive to anything that might jeopardize the dividend increases. Given NextEra Energy is an extraordinarily complex firm, this is a risk that’s always looming.
Conclusion
Exxon Mobil’s comeback shows just how volatile commodity stocks can be. Our rules-based approach led us to buy more shares of the company when they were in the doldrums, even when we became very concerned about dividend safety. Since then, we’ve trimmed our XOM position on multiple instances and recouped over a quarter of our cost basis.
NextEra Energy has performed remarkably well over the seven plus years we’ve owned it and seems well positioned to benefit from the Inflation Reduction Act. It’s now a large utility company with a focus on earnings which means the best fit would be in our dividend growth investing portfolio.
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