NextEra Energy (NYSE: NO) has done a masterful job of creating shareholder value over the years. Over the last decade has utility has generated a striking overall return of 700%. It has obliterated the return of its colleagues ( S&P 500 Utility Index’s the total return was 191% during this time frame) and S&P 500 (267%). Promoting market-crushing performance has been NextEra’s leading growth in earnings per share. Shares of 8% compounded annually over the last decade against less than 3% on average for the 10 largest electricity companies, mainly due to its focus on renewable energy.
However, NextEra has all this outperformance trading at a premium value compared to its peers. While NextEra deserves to trade at a certain premium, the current valuation is starting to get a little uncomfortable given its relative growth rate.
An assessment of nosebleeds
The shares in NextEra have risen by almost 40% since the beginning of 2020. The adjusted earnings per. Shares, however, rose only by 10.5% in 2020. In addition, they are about to grow by approx. 7% in 2021 in the middle of its current forecast. NextEra now trades more than 30 times its forward earnings. It is quite a large valuation multiple for a tool.
For the sake of comparison, big rivals Duke Energy (NYSE: DUK), Dominion Energy (NYSE: D)and Southern Company (NYSE: SO) trades in the mid-teens of their future earnings. While they are growing more slowly – and do not place as much emphasis on renewable energy as NextEra – it is still difficult to justify paying almost twice as much for NextEra compared to other large utilities.
Meanwhile, it is trading at a big premium to other utilities with a similarly strong renewable energy-driven growth plan. E.g, Xcel Energy (NASDAQ: XEL) expects to increase its earnings by 5% to 7% annual rate through 2024 – driven by its turn towards clean energy – which is slightly slower than NextEra’s expected annual growth rate of 6% to 8% through 2023. Despite these similar profiles, Xcel trades only about 20 times its forward-looking earnings, which means that NextEra achieves a premium of approx. 50%.
Even NextEra knows that its stock is expensive
NextEra’s management team is fully aware that its shares are traded at a premium price. Therefore, they have examined the use of stocks as currency to make a major acquisition. The company made a takeover approach to Duke Energy last year, valuing its rival at about $ 60 billion. However, Duke rejected this bid for fear it would not gain approval from the law.
NextEra also made an offer on everything to buy Evergy (NYSE: EVRG) for about $ 15 billion. However, this rival also rejected its bid due to an inadequate price and the potential for regulatory barriers.
The company appears to be looking for a deal that leverages its securities stock to make a very accretive transaction. However, the company also seems to be careful not to pay too much as it wants an agreement that will create shareholder value. CEO James Robo made it clear and said at an industry conference last year that it would not attempt a hostile takeover bid as it would likely require it to pay too much for a goal. Instead, it seeks a mutually beneficial transaction that will create value for all stakeholders.
One expensive stock
NextEra’s valuation gets a little too rich for my liking. Although I would not sell shares – I plan to hold for decades given its leverage for the energy transition – I probably will not buy more anytime soon. I will wait for a significant withdrawal, watch it grow to its valuation, or for NextEra to secure a very valuable transaction before increasing my allocation to this burning hot tool so I do not get burned if the stock cools down.
This article represents the opinion of the author (s) who may disagree with the “official” recommendation position for a Motley Fool premium advisory service. We are motley! Questioning an investment dissertation – even one of our own – helps all of us think critically about investing and make decisions that help us become smarter, happier and richer.
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