NextEra Energy Partners(NYSE: NEP) is showing up on high-yield screens today thanks to its huge 12%+ distribution yield. This wasn't always the situation, noting that the yield was closer to 4% at the end of 2022. The steep unit price decline that pushed the yield higher is worth examining, but the potential fallout from that decline is also worth considering. To get an idea of why the latter consideration is important, just look at what's happening with Equitrans Midstream(NYSE: ETRN) today.
What went wrong at NextEra Energy
NextEra Energy Partners was created by NextEra Energy(NYSE: NEE), one of the largest utilities in the United States. In addition to being a large regulated utility, NextEra Energy is also one of the largest producers of solar and wind power in the world. To take advantage of Wall Street's once hot demand for anything related to clean energy, NextEra Energy created a master limited partnership (MLP) to own clean energy assets.
Image source: Getty Images.
NextEra Energy Partners is basically a funding vehicle for its parent, NextEra Energy. The parent sells clean energy assets, or "drops them down," in industry lingo, to the MLP. The MLP buys the assets by issuing units and taking on debt. NextEra Energy uses the cash from the asset sales to fund future investments. NextEra Energy Partners uses the cash flow from the assets it buys to pay distributions to unitholders.
But investors have soured on the clean energy space, leading to a notable decline in the price of NextEra Energy Partners. That makes it more expensive to sell units. Making matters worse, rising interest rates increased the cost of debt capital, too. At this point, it isn't nearly as attractive for NextEra Energy to sell assets to NextEra Energy Partners. And, as you might expect, NextEra Energy has announced plans to pull back on drop downs. That, in turn, will lead to slower growth at NextEra Energy Partners.
What does this have to do with Equitrans Midstream?
The big story for Equitrans Midstream is that EQT Corp.(NYSE: EQT), the company that created the MLP, is buying it back. This isn't the first time that a parent company of an MLP has bought back the MLP it created. The list includes utilities like Dominion Energy and pipeline operator Kinder Morgan, among others.
As you might expect, EQT is pitching its purchase of Equitrans Midstream as a positive. In fact it called the transaction "transformative," even though it is, in many ways, just recreating the company as it was before Equitrans Midstream was spun off. The real story is that Equitrans Midstream is being bought back at a price that is far below the price at which it was spun off.
Now think back to NextEra Energy Partners. The purpose of that MLP is to be a funding vehicle for NextEra Energy, but it just isn't as valuable as it once was on that front. With the unit price dramatically lower than it was, there's a very real possibility that NextEra Energy simply buys the MLP back on the cheap.
To be fair, the runway for growth in the clean energy sector is more attractive than the growth opportunity in the pipeline sector. That suggests that NextEra Energy might want to wait longer to see what happens with NextEra Energy Partners before doing anything rash. But there are multiple examples of MLP spinoffs being bought back once they have outlived their usefulness. If you own NextEra Energy Partners you should keep the Equitrans Midstream situation in the back of your mind.
Buy with at least a little caution
The real concern here, however, should be for investors who are considering adding NextEra Energy Partners to their portfolio because of its hefty 12%+ distribution yield. While that yield is backed, to some degree, by a strong parent, NextEra Energy could just as easily decide to buy the MLP, effectively making what was an attractive yield quickly go away. Equitrans Midstream, among others, shows that this is, in fact, a very real possibility and a risk dividend investors shouldn't ignore.
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Reuben Gregg Brewer has positions in Dominion Energy. The Motley Fool has positions in and recommends EQT, Kinder Morgan, and NextEra Energy. The Motley Fool recommends Dominion Energy. The Motley Fool has a disclosure policy.
