Riding the Green Wave: Why Long-Term Investors Should Buy Into NextEra Energy

Key Takeaways:

- NextEra Energy, a leader in wind, solar, and energy storage, benefits from IRA incentives and growing demand for clean energy, presenting a promising future for investors.

-The dual business model of regulated utilities and unregulated renewables provides stability and growth, though high debt and rising interest rates present financial risks.

-Macroeconomic pressures and reliance on government policies create vulnerabilities to regulatory or market changes, potentially impacting growth.

-With a P/E of 21x and 8-9% EPS growth projected, the target price is $77-$84, offering modest upside amidst near-term uncertainties.

Share Price Overview

Source: Tradingview

Sector Overview

Business Cycle: The utilities sector is vital for meeting the essential needs of households, businesses, and industries. Historically, it has underperformed relative to broader market indices like the S&P 500. However, the sector commonly outperformed during both late-stage expansions and recessions of economy.

U.S. Business Cycle

Source: Fedility

U.S. Electricity Market: The U.S. electricity market is generally balanced between supply and demand, though the system faces reliability challenges during extreme weather and high-demand spikes. Renewable energy (solar and wind) is growing, while natural gas remains the dominant source and coal is declining. Demand is rising due to factors like electric vehicle adoption and increased use of air conditioning, especially during peak summer and winter periods.

Supply Side: According to the U.S. Energy Information Administration (EIA), U.S. electricity generation has fluctuated over the past decade, generally staying within the 4,000 to 4,100 TWh range annually. The energy mix has shifted notably during this period, with fossil fuels—primarily natural gas—remaining dominant, though their share has been gradually decreasing. At the same time, renewable energy sources, particularly wind and solar, have seen significant growth, now accounting for c.24% of total generation. Despite these changes, coal-fired power plants continue to contribute, though at a declining rate, as part of the transition to cleaner energy. The increasing share of renewables is also driving the need for enhanced grid flexibility and energy storage solutions to manage their intermittent nature.

Renewable energy generation is a growing trend

Source: U.S. Energy Information Administration

Demand Side: U.S. electricity demand is projected to grow 55% by 2040, a significant acceleration compared to the 9% increase over the past 20 years. This surge is driven by widespread electrification, including the rapid adoption of electric vehicles (EVs), the rise of AI-powered data centers, and growing reliance on electric heating and cooling systems. Data centers are a major driver of this growth, with their energy consumption projected to increase by 30% in the coming years, fueled by AI and digital transformation trends.

Growing Demand from Data Centers

Source: The Wall Street Journal, Goldman Sachs

To support rising power loads, renewable energy and storage capacity are expected to triple by 2030, reaching 375-450 GW. This expansion is critical for maintaining grid stability amid increasing demand. The EIA forecasts a 2% rise in U.S. commercial electricity sales in 2024, driven by colder weather and accelerated electrification. Meeting these demands will require substantial investments in grid modernization, energy storage, and renewable infrastructure to ensure a reliable and resilient energy system capable of supporting future consumption growth.

Source: Company Data

U.S. Electricity Market Features:

1. Regional Diversity: Market structures and regulations vary significantly by region, influencing competition, pricing, and energy resource utilization (e.g., natural gas in Texas vs. hydropower in the Pacific Northwest).  

2. Regulatory Oversight: Heavily regulated markets dictate pricing mechanisms, competition, and grid operations, with some regions implementing price caps to manage volatility.  

3. Transmission and Integration Challenges: Limited transmission capacity affects power flow, pricing, and renewable energy integration, requiring significant grid modernization to address growing demand and intermittent supply.  

4. Service Segmentation: Electricity markets are segmented into energy (power delivery), capacity (generation availability), and ancillary services (grid stability), with regional variations in definitions and pricing structures.  

Operation Models: In the U.S., electricity is delivered through two main market structures: vertically integrated and non-vertically integrated models.

Comparison of Two Utility Operation Models

Source: Tradingkey.com

Company Overview

NextEra Energy, Inc. (NYSE: NEE) operates through two primary subsidiaries: Florida Power & Light Company (FPL) and NextEra Energy Resources (NEER). Each entity plays a distinct role in the company's overall strategy, facing unique competitive landscapes, growth drivers, and challenges. NEECH, a NEE subsidiary, finances NEE's operations, excluding FPL. NEP, an NEER affiliate, manages long-term clean energy assets.

Source: Company Data

FPL, as NextEra Energy's primary revenue source, accounted for 65.3% of its 2023 revenue, with NEER adding 34.4% and leading the growth with a 160% surge.

Revenue by business segment

Source: Company Data, Tradingkey

FPL: Florida Power & Light (FPL), the largest rate-regulated electric utility in the U.S., serves over 12 million Floridians. Its market dominance is bolstered by a large customer base and a supportive regulatory framework. Regulated by the Florida Public Service Commission (FPSC), FPL reported Q3 2024 net income of $1.29 billion, up 9.3% from $1.18 billion in Q3 2023, driven by ongoing investments. Core revenues mainly come from retail customers, with a ~4% growth in customer accounts from Q4 2021 to Q3 2024. FPL also serves select wholesale customers in Florida. However, potential bottlenecks include regulatory hurdles that could delay project approvals and the inherent challenges of managing large-scale capital projects.

FPL Revenue breakdown

Source: Company Data

NEER (Growth Engine): NextEra Energy Resources (NEER) is a leading player in the renewable energy sector with a diverse portfolio including wind, solar, and battery storage across North America. The renewable energy market is highly competitive, with key players like Duke Energy, Dominion Energy, and Exelon vying for market share. NEER’s competitive edge comes from its scale, technological expertise, and strategic partnerships. Currently, NEER has approximately 38 GW of net generating capacity and is well-positioned to leverage expected U.S. power demand growth. With plans to nearly double its capacity to 81 GW by 2027, NEER is strategically positioned through long-term agreements, capitalizing on the growing renewable energy market.

NextEra Energy Resources Development Plan

Source: Company Data

Strengths of NextEra Energy lies in:

A) Leadership in Renewable Energy

NextEra Energy is a U.S. leader in wind, solar, and energy storage. As the largest wind power generator and a major solar developer, it is well-positioned to benefit from the global shift to clean energy. Advances in energy storage and strong government and consumer support further enhance its growth prospects.

B) Solid Financial Performance

With consistent revenue growth and robust cash flows, NextEra Energy combines stability with growth. Its dual model of regulated utilities (Florida Power & Light) and unregulated renewables (NextEra Energy Resources) balances risk while capitalizing on high-growth opportunities.

C) Tailwinds from the Inflation Reduction Act (IRA)

The Inflation Reduction Act (IRA) has significantly boosted NextEra’s outlook by offering two decades of clean energy incentives. These federal tax credits for renewable energy and battery storage investments create a favorable environment for NextEra to continue its expansion in renewable infrastructure. As a market leader, NextEra is well-positioned to maximize these benefits and strengthen its competitive edge.

Concerns and Risks lies in:

A) High Debt Levels and Financing Challenges

While NextEra Energy’s financials remain robust, its high debt levels are a notable concern. Renewable energy projects require substantial upfront capital, and the company has heavily relied on debt to fund its expansion, leaving it exposed to interest rate fluctuations. Recent inflation-driven rate hikes have already increased financing costs, potentially straining its capital structure. However, the rising EBIT-to-short-term-debt ratio indicates that the company can cover its short-term obligations, suggesting low immediate risk despite long-term vulnerabilities.

Capital Structure

Source: Company Data, Tradingkey

Additionally, NextEra Energy Partners (NEP), a key subsidiary, reduced its dividend in June 2024 due to financing pressures, signaling potential liquidity and cash flow constraints. This move reflects the rising borrowing costs that could impact profitability and future dividend stability, posing a concern for income-focused investors.

B) Slowing Growth and Earnings Miss

In Q3 2024, NextEra Energy reported a slight earnings miss, highlighting potential near-term growth challenges. Large-scale renewable projects, like wind and solar, are capital- and time-intensive, often subject to delays and cost overruns. Additionally, industry demands for high dividends and leverage may constrain capital expenditures (CapEx), further slowing growth momentum.

EPS and Dividend

Source: Company Data, Tradingkey

C) Macroeconomic Pressures

The broader macroeconomic environment, marked by rising inflation and higher interest rates, has heightened investor caution in equity markets. These factors amplify risks for capital-intensive sectors like renewable energy, where returns take longer to materialize. NextEra Energy's high debt load increases its vulnerability to macroeconomic shifts, such as liquidity constraints or capital market disruptions. Furthermore, its reliance on government policies, including IRA incentives and favorable renewable energy regulations, makes it susceptible to potential policy or regulatory changes.

Our view:

A) Long-Term Growth Potential in Renewables and Potential Risks in Interest

From a long-term perspective, NextEra Energy remains an attractive investment in the renewable energy sector due to its leadership position, strong financial position, and extensive pipeline of renewable projects. The IRA and similar initiatives will likely provide ongoing support, which helps mitigate some of the risks associated with high capital expenditures. Given the long-term structural shift toward cleaner energy, NextEra is well-positioned to benefit from these secular trends. However, we should consider NextEra Energy's high debt levels and sensitivity to interest rates as significant risks. Additionally, project delays and earnings volatility could be mitigated by closely monitoring the company’s renewable development timeline and operational efficiency.

B) Valuation  

NextEra's current P/E ratio of 21x is in line with historical averages and industry peers. We project 8-9% annual EPS growth for 2025 and 2026, consistent with the upper end of the company’s guidance. While elevated U.S. inflation has kept interest rates high, a potential modest decline next year could boost earnings growth. However, prolonged high rates remain a risk, potentially weighing on valuation. Based on the 8-9% EPS growth outlook and a reasonable forward P/E range of 21x-23x, NextEra’s valuation translates to a target price range of $77-$84.  

C) Recommendation  

We recommend a Cautious Buy. NextEra Energy offers compelling long-term growth potential as a leader in the renewable energy transition. However, its high debt, potential near-term growth deceleration, and reliance on favorable regulatory policies warrant a prudent stance in today’s challenging macroeconomic environment. This stock is best suited for long-term investors confident in the green energy transition and willing to navigate short-term headwinds.

Historical P/E ratio

Source: Macrotrends, Tradingkey