There are some very clear things to like about NextEra Energy Partners(NYSE: NEP), including its lofty 13%+ distribution yield and a decade-long string of annual distribution increases. The truth is, I've been tempted to buy it. However, there's been a huge change in the master limited partnership's (MLP's) business position that holds me back from pulling the trigger. Here's why I'd rather keep this renewable power MLP at a 10-foot distance.
Why does NextEra Energy Partners exist?
Before making a buy or sell decision with NextEra Energy Partners, it is important to understand the purpose the MLP serves. On the surface, the answer is to buy and own clean energy investments. While it is, in fact, true that this is what NextEra Energy Partners does, it isn't really the reason for its existence. It exists because giant utility NextEra Energy(NYSE: NEE) created it. But why?
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NextEra Energy is unique in the utility sector because it operates a large regulated utility business and a large renewable power business. The regulated assets are slow and reliable growers, while the clean energy portfolio provides more rapid growth. Together, these two businesses have allowed NextEra Energy to increase its distribution at 10% per year over the past decade, which is incredibly fast for a utility (half that level would be considered quite good). To help fund the capital investment plans NextEra Energy had in the clean energy space, it created NextEra Energy Partners.
The relationship isn't unique in any way. Other utilities have, basically, done the same thing (though not necessarily with clean energy assets). NextEra Energy, as the parent, sells assets to NextEra Energy Partners, called a drop-down transaction, which NextEra Energy Partners funds by selling units and taking on debt. As long as NextEra Energy Partners' cost of capital is low enough, the cash flows it is buying will be sufficient to cover its financing costs while it also pays a robust and perhaps growing distribution. All in, however, NextEra Energy Partners exists to be a funding source for parent NextEra Energy.
NextEra Energy Partners' equation has changed
A few years ago, the math for NextEra Energy Partners worked out very well, and it was able to issue units and debt at highly attractive levels. That allowed NextEra Energy to drop down assets regularly. However, when interest rates rose, debt funding became less attractive. And when NextEra Energy Partners' unit price fell, it made selling units less attractive. NextEra Energy Partners just doesn't have the same value to its parent as it used to have.
In fact, in 2023, NextEra Energy Partners pulled back on its growth plans. It reduced its distribution growth target, announced plans to sell non-core assets, said it wasn't planning to issue new units until 2027, and its plans to buy more drop-downs from NextEra Energy were put on hold. The core purpose that NextEra Energy Partners serves appears to be gone. There are a few solutions here.
NextEra Energy could simply cut NextEra Energy Partners loose to be its own entity, which is more complicated than it sounds, given the MLP structure. It would also require the MLP to come up with enough cash to buy out NextEra Energy's general partner position, which is not an easy task in today's capital environment. And, if this were the direction, NextEra Energy Partners could end up cutting the distribution as it looks to fund the transaction.
Conversely, NextEra Energy could just buy NextEra Energy Partners, bringing the operation back in-house. This is exactly what happened with a number of midstream pipeline MLPs not too long ago. NextEra Energy Partners' units are trading at a high yield and below book value, so this could be an attractive option for parent NextEra Energy. Notably, NextEra Energy's yield, at 2.6%, is far lower than that of NextEra Energy Partners, so income would be lost here, too.
Or, as the easiest route, NextEra Energy Partners could simply trim the distribution and hold cash until the capital markets turn more attractive again. While it is possible that NextEra Energy Partners will continue to muddle through as is, which is what the MLP is saying it will do, there's only so long that can go on before it becomes a bothersome distraction that parent NextEra Energy doesn't want to deal with anymore. At that point, something will have to give, and cutting the distribution would be the quickest and simplest course of action.
The odds of a bad outcome here for income investors just seem too great, and I'm avoiding NextEra Energy Partners until further notice.
There could be a huge opportunity, but don't ignore the risks
Aggressive investors might be willing to take on the risk of owning NextEra Energy Partners in exchange for the ultra-high yield on offer. But for me, the risks clearly outweigh the rewards. That's especially true since I'm trying to create a reliable income stream that I can eventually live off of in retirement. A potentially big distribution cut from a core holding just isn't something I want to willingly line up for. And that is exactly what I think could realistically happen in the future at NextEra Energy Partners.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends NextEra Energy. The Motley Fool has a disclosure policy.
