NEP: NextEra Energy Partners Adds Value By Leveraging up to Achieve Growth, Avoid Equity Issuance
Eric Selmon Hugh Wynne
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June 23, 2017
NEP: NextEra Energy Partners Adds Value
By Leveraging up to Achieve Growth, Avoid Equity Issuance
We have updated the valuation of NextEra Energy Partners (NEP) published in our note of June 20th, Winning the Yieldco Confidence Game: Long and Short Opportunities Among the Yieldco Stocks, to reflect the increase in leverage and delay of new equity issuance announced by NEP management at the company’s June 24th investor conference. Our cash flow forecast and dividend discount valuation, which we are happy to share with investors, suggests fair value for the stock at $41 per share, some 12% above yesterday’s close of $37.06 and an increase on 10% on our prior valuation. We continue to see NEP as the most attractive of the yieldco stocks (Exhibit 1).
- NEP management yesterday announced that the company does not expect to sell common equity until 2020 at the earliest. Rather, the company is raising $550 million through an offering of convertible preferred units (see summary of terms on page 2), and has plans to access the access the high yield bond market, raising its holdco leverage to a range of 4.0x to 5.0x project cash available for distribution (CAFD), up from a forecast 3.0x at year end 2017.
- We have modified our cash flow forecast and dividend discount valuation of NEP to reflect the changes in financing strategy announced by management:
- We have added $550 million of preferred to NEP’s balance sheet, assuming that the current issue is converted at the earliest conversion date (6/20/2019), and continually replaced with new convertible preferred issued on identical terms every two years thereafter.
- We have assumed that NEP increases its holdco debt to 4.5x CAFD going forward.
- On this basis, we expect NEP will be able to increase its distributions per unit at over 12% p.a. from 2017 through 2023 (from $1.52 to $3.02 per unit), and at 5.5% p.a. from 2023 through 2036. Applying an 8% discount rate to these forecast distributions, we calculate fair value for NEP stock to be $41.41 per share, 12% above yesterday’s close of $37.06 and an increase on 10% on our prior valuation. We continue to see NEP as the most attractive of the yieldco stocks (see Exhibit 1).
Exhibit 1: Dividend Discount Valuations of NextEra Energy Partners and its Yieldco Peers (1)
1) For NEP and PEGI, companies that have the ability fund asset purchases through equity issues that are accretive to cash flow per share, we have assumed continued asset acquisitions and cash flow growth. At ABY, we have assumed that the company uses retained cash, the product of its lower dividend payout ratio, plus its unused holdco debt capacity to gradually expand its asset portfolio; however, we assume no further equity issuance. At CAFD and NYLD, we have assumed that distributions are made from the cash available for distribution generated by the existing portfolio of assets, net of maintenance capex and the service of outstanding debt.
Source: Company reports, SSR analysis
- NEP management announced yesterday that it had priced 14.0 million convertible preferred units, to be sold in one or more tranches through December 31, 2017, raising $550 million for the company. Unitholders will receive cumulative quarterly distributions of $0.4413 per unit, equivalent to an annual yield of 4.5% on the offering price of $39.2253 per unit. The offering price of the preferred units represents a 15% premium to the volume-weighted average price of NEP’s common units over the prior 45 days. The preferred units are convertible into common units on a one-for-one basis beginning June 20, 2019.
- NEP may force conversion of all or a portion of the preferred units into common units if the closing price of the common units exceeds (i) 120% of the purchase price of the preferred units after the first anniversary date of the closing, or (ii) 130% of the purchase price of the preferred after the second anniversary, or (iii) 140% of the purchase price after the third anniversary.
- The preferred shares were sold to funds managed by BlackRock Energy and Power Infrastructure Group, and KKR Flatirons Aggregator L.P., an affiliate of Kohlberg Kravis Roberts & Co. L.P.
- Yesterday, Moody’s and Fitch announced long term issuer ratings for NEP of Ba1 and BB+, respectively. Based on its discussions with Standard & Poor’s, NEP management expects S&P shortly to rate NextEra Energy Partners BB. NEP management believes that the company’s credit profile supports holdco leverage of 4.0x to 5.0x project CAFD, compared to a forecast level of only 3.0x at year-end 2017.
- We view NEP as the best positioned of the yieldcos to grow in the long term, reflecting its continued capacity to fund accretive acquisitions. At the current cash yield of its common units, NEP can fund accretive acquisitions through the issue of common units. The convertible preferred issue and long term issuer ratings announced yesterday enhance the firm’s financial flexibility, allowing it to fund acquisitions while avoiding the sale of common units (excluding modest issuances executed through NEP’s at-the-market program) until 2020 at the earliest.
- A second critical advantage is the huge renewable portfolio of its sponsor, Nextera Energy (NEE). NEE is the largest U.S. owner and developer of renewable power and its current plans should bring online enough new projects to support NEP’s ambitious growth plans. In addition, NEP has the capacity to acquire assets from third parties, having acquired contracted intrastate gas pipelines in Texas from NET Midstream, the private developer of the assets. NEP will likely have the opportunity to acquire similar pipeline assets that NEE might acquire from third parties or build on its own, including large pipelines in the Southeast U.S.
- Critically, at a drop down CAFD yield of 9%, the projects NextEra sells to NEP are valued much higher than they are as part of NEE, encouraging NEE to continue to support its yieldco. And as NEP’s issue of 4.5% convertible preferred demonstrates, NEP remains capable of funding these acquisitions on a basis that is cash flow accretive to its shareholders. NEP thus retains the capacity to attract low cost capital for its parent company, permitting NEE to recycle its capital in completed projects to higher return investments in project development.
- NEE’s actions since 2014 suggest that they view NEP as an important tool for their growth: they have reduced their incentive distribution rights to allow for continued growth at NEP, they have purchased large amounts of NEP equity to fund acquisitions by NEP when NEP’s valuation was at its lowest levels, and they have continued to drop down projects at valuations that allow for material accretion at NEP even when those valuations were lower than the valuations of acquisitions made by other yieldcos.
- Assuming these dynamics continue, we expect NEP will be able to increase its distributions per unit at over 12% p.a. from 2017 through 2023 (from $1.52 to $3.02 per unit), and at 5.5% p.a. from 2023 through 2036.
Exhibit 2: Heat Map: Preferences Among Utilities, IPP and Clean Technology
Source: SSR analysis
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