NextEra Energy Partners'(NYSE: NEP) dividend currently yields more than 14%. That's 10 times higher than the S&P 500's dividend yield. While a dividend yield in the double digits might seem alluring, it usually signals that the market doesn't believe that the payout's current level is sustainable.
I agree with the market that this renewable energy dividend stock will eventually cut its big-time payout. Here's whyI predict a dividend cut could come within the next year.
Leaving no room for error
NextEra Energy Partners currently believes it will not only be able to maintain its dividend but also continue increasing its payment. It aims to grow its payout by 5% to 8% annually through 2026, with a target of 6%. The company recently increased its payment by another 1.4% compared to the prior quarter's level, putting it 6% above the year-ago payment.
The company has a two-fold strategy to deliver on its dividend growth plan. It expects to complete 1.3 gigawatts (GW) of wind energy repowering projects through 2026 to organically grow its cash flow. These high-return projects will see the company install larger wind turbines at existing wind farms that produce more power and cash flow. It has already secured nearly 1.1 GW of these projects, putting it on track to hit its target.
The other aspect of its plan is to sell its natural gas pipeline businesses by next year. Those sales will give it the funds to repay maturing financing and acquire additional renewable energy assets. NextEra sold its STX Midstream business for over $1.8 billion late last year. That sale will enable it to fund the buyouts of upcoming financing maturities through next June. Meanwhile, the company plans to sell its Meade Pipeline business next year to fund additional buyouts and future renewable energy acquisitions.
NextEra Energy Partners has a strategy to continue growing its dividend while it shores up its financial situation. However, its plan leaves no room for error. The company expects its dividend payout ratio to be in the mid-90% range through 2026, which is extremely high. If the company hits an unexpected speed bump, it might need to cut its dividend to retain more cash to fund future buyouts and acquisitions.
The cost-of-capital conundrum
Surging interest rates in recent years have made it more challenging for NextEra Energy Partners to refinance debt and fund acquisitions at an attractive cost of capital. Interest rates are high, as is its dividend yield, which has made it too expensive to issue new debt and equity. That's why it pivoted to asset sales and high-return organic expansion projects to repay maturing financing and grow its cash flow and dividend.
The company needs to secure a better cost of capital to get on a more sustainable long-term foundation. That's leading it to explore all options to address the situation. For example, the company's CEO, John Ketchum, noted on its second-quarter call that securing private capital is one potential alternative it's exploring. A preferred equity investment or something similar would provide additional capital that the company could use to help repay future funding buyouts and finance acquisitions.
The company might also need to reset its dividend as part of such an investment agreement. Ketchum stated on the call that "the partnership's 6% distribution growth target remains for now." An analyst on the call picked up on that last part, noting that it's somewhat new language when referring to the dividend.
The CEO seems to be dropping hints to lay the groundwork for a future payout reduction. Cutting the dividend would certainly help lower its cost of capital, since the company could then use no-cost excess free cash flow to fund acquisitions and future funding redemptions.
A dividend cut seems inevitable
The market doesn't believe NextEra Energy Partners will be able to maintain its current dividend level for much longer. I agree. I expect the company will eventually reset its dividend to a much lower level (likely 50% or more below the current rate) to retain additional cash to fund acquisitions and strengthen its balance sheet.While painful initially, a cut would enable the company to potentially create more value for shareholders in the long term because it should help boost its stock price and enhance its per-share growth rate.Given the likelihood of a dividend cut, NextEra Energy Partners isn't the best option for investors seeking a lucrative and sustainable income stream right now.
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Matt DiLallo has positions in NextEra Energy Partners. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
