A Dividend Aristocrat to Buy That’s 17% Undervalued

NextEra Energy NEE stock is down more than 30% from its 2021 highs. Rising interest rates have taken their toll on this dividend aristocrat, as has increasing regulatory risk in Florida. We nevertheless think this narrow-moat company’s long-term growth will be supported by the clean energy transition. In fact, NextEra is one of the top picks in Our 10-Year Utilities Forecast: Renewable Energy to Triple by 2032. The dividend stock is also among Morningstar chief U.S. market strategist Dave Sekera’s five cheap stocks to buy before interest rates fall.

NextEra Energy’s high-quality regulated utility in Florida and fast-growing renewable energy business give investors the best of both worlds: a secure dividend and industry-leading renewable energy growth potential. Florida Power & Light has enjoyed constructive regulation, but regulatory uncertainty has increased, given numerous press allegations of campaign finance violations. After completing an internal review, management said it believes the company would not be liable for any violations. However, we think it’s more likely that allowed returns will be lower than currently allowed. NextEra Energy Resources has proved to be a best-in-class renewable energy operator and developer and was an early adopter of wind generation. We believe there is a long runway of strong demand for renewable energy resources beyond our five-year outlook.

Key Morningstar Metrics for NextEra

• Fair Value Estimate: $74
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Medium

Economic Moat Rating

Service territory monopolies and efficient scale advantages are the primary sources of an economic moat for regulated utilities like Florida Power & Light. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. In exchange for regulated utilities’ service territory monopolies, state and federal regulators set returns at levels that aim to minimize customer costs while offering fair returns for capital providers. This is particularly true for FP&L, which enjoys above-average returns on equity, forward-looking rate adjustments, and automatic general base-rate adjustments for investments upon completion. We also believe NextEra’s renewable energy business has a durable competitive advantage. It has secured some of the country’s most desirable wind and solar generation sites, and its large, diversified generation fleet gives this segment scale, cost, and flexibility advantages over smaller competitors.

Read more about NextEra’s moat rating.

Fair Value Estimate for NextEra Stock

Our near-term profit outlook accounts for forecast rate increases and capital investments at FP&L through 2027, additional wind and solar generation investments at NextEra Energy Resources, normal weather, and continued strong demand and economic growth in Florida. We forecast 8% annual earnings growth through 2027. At FP&L, we assume a 10.5% long-term allowed return on equity beginning in 2026, when the utility’s next rate case will go into effect. For every 100-basis-point reduction in allowed return on equity, we estimate our fair value estimate would fall roughly 10%, all else equal. We estimate NextEra will invest more than $80 billion through 2027. We forecast it will deliver the midpoint of its 2023-26 target range of 33-42 gigawatts of wind, solar, and battery storage additions. In our discounted cash flow valuation, we use a 5.8% cost of capital based on a 7.5% cost of equity. This is lower than the 9% rate of return we expect investors will demand for a diversified equity portfolio, reflecting NextEra’s lower sensitivity to the economic cycle and lower degree of operating leverage.

Read more about NextEra’s fair value estimate.

Risk and Uncertainty

The primary uncertainty surrounding our fair value estimate is NextEra’s ability to achieve timely, constructive regulatory rate adjustments, particularly given the company’s investment plans. Our rating also incorporates higher uncertainty at the company’s renewable energy development subsidiary in a higher-interest-rate environment. FP&L plans to invest aggressively to build out its solar portfolio. This would reduce the utility’s reliance on natural gas and nuclear generation, although both forms of generation will play a key role in grid reliability in the near term. Higher costs could threaten near-term renewable energy development.

Read more about NextEra’s risk and uncertainty.

NextEra Bulls Say

• FP&L operates in one of the most constructive regulatory environments and has numerous capital investment opportunities.
• NextEra Energy Resources has benefited from renewable energy federal tax credits, but state renewable portfolio standards, corporate purchases, and attractive economics are also supporting renewable energy investments.
• Management’s long runway of capital investment opportunities supports our outlook for industry-leading 8% annual earnings growth through 2027.

NextEra Bears Say

• The company’s campaign finance practices have come under scrutiny, potentially threatening its constructive regulatory environment in Florida.
• NextEra’s aggressive investment plan increases regulatory, execution, and inflationary risk.
• Rising interest rates raise financing costs and could make development of the renewable energy backlog more difficult to achieve.

This article was compiled by Susan Dziubinski and Sylvia Hauser.