fanaticism
I initially purchased NextEra Energy Partners (NYSE:NEP) a little too quickly (last year fell before a big drop in late September).However, while several prominent writers at Seeking Alpha are calling it a “sell” and/or urging investors To compete for the exits, I doubled down on the low $20s and explained my thesis reasons in my in-depth article, which you can read here. The courage of that belief paid off, with the stock returning about 45% since then, more than double the S&P 500’s total return over the same period and helping me recoup the losses I suffered from the initial share price decline. .
That being said, despite NEP’s high 12.2% share price and growing distribution yield, I recently sold my shares, and in this article, I’ll explain why.
Why I Sold NEP Stock
I pointed out in a recent article Update article NEP believes it has a viable path to maintaining its high yield, although I’m less optimistic about its ability to maintain a 6% distribution CAGR through 2026 unless interest rates fall significantly in the near future.
As I concluded in that article:
Ultimately, the NEP story boils down to two big questions:
- Will interest rates be matched by a gradual decline over the next few years, giving NEP a better cost of capital and easing the pain of refinancing its debt, Meade pipeline asset sales and CEPF repayments?
- Can management successfully navigate this challenging financial tightrope and then come up with creative financing methods to deal with remaining CEPF in 2026 and beyond without destroying unitholder value and having to cut distributions?
Inflation has appeared to remain quite troublesome in recent months, reducing the likelihood of significant interest rate cuts this year and next. While we still expect the Fed to cut interest rates somewhat this year and next, given the relative resilience of the economy and the stickiness of inflation, we believe the magnitude of potential rate cuts has declined, at least in the short term.
Furthermore, it appears that only a recession will ultimately prompt the Fed to take more aggressive action in cutting interest rates. While NEP’s business model (its cash flow from long-term power purchase agreements spanning more than a decade with investment-grade tenants is highly deflated) is very defensive, its weak link is its junk credit rating. If the economy eventually experiences a severe recession—especially one triggered by a group of overleveraged landlords and companies that default on their debt as it comes due—we’re likely to see the spread between junk bond rates and investment-grade bond rates skyrocket. This will significantly increase NEP’s capital costs, thereby greatly harming NEP.
Ultimately, NEP’s path to maintaining its distribution and avoiding being gobbled up by its parent NextEra Energy (NEE) at a less attractive price is narrowing. We still believe that NEP has the potential to emerge as a big winner relative to current unit prices, but our confidence in this has declined. While we still think it offers an attractive risk-reward profile for investors looking to bet on a significant drop in interest rates in the near future, it’s still quite risky.
Meanwhile, we’ve seen other opportunities in the renewable generation space take a big hit recently, such as Clearway Energy (CWEN)(CWEN.A), Brookfield Renewable Partners (BEP)(BEPC), Algonquin Power & Utilities (AQN) ) and Atlantica Sustainable Infrastructure (AY) – all heavily discounted deals with stronger balance sheets and safer dividends than NEP. Therefore, by investing in these companies, we can still gain significant upside potential amid falling interest rates and attractive current yields, without the need for significant dividend cuts and the further deep downside risk of NEP.
So while it’s very difficult to sell high-yield stocks with huge upside potential like we just did in NEP, we believe it would be a big mistake to continue doubling down when other opportunities have almost already presented themselves. From an upside perspective, this is an attractive opportunity, but the downside is far less severe.
Important points for investors
While part of me wants to continue holding NEP to see its thesis play out because the yield is so good and if management successfully executes its plan it will likely deliver 2-3x total returns over the next few years, I can’t It should be held when there are many other opportunities in the sector that offer better risk-reward potential. As a result, we sold NEP and recycled capital into other renewable energy production companies, and are particularly bullish on the rapid upside potential of AQN and AY as their strategy reviews and asset sales are likely to be concluded this summer.
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