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I‘ve spent the last few hours reviewing the earnings reports of NextEra Energy (NYSE:NEE) and its affiliate, NextEra Partners (NYSE:NEP), which were released earlier today. While I always encourage taking a little time to reflect on new information before formulating firm conclusions, there were a few things about this report that it seems are safe to say already.
Nice To Get Some Peace & Quiet
Coming so soon after Netflix (NFLX) earnings that practically turned the whole tech sector upside down, and on the same day that Snapchat (SNAP) reported a lower-than-expected number that threw social media industry watchers for a loop as well, NextEra‘s report was positively tame. There really weren‘t any giant surprises in it.
Not that I was expecting there to be. Those who follow my work will know that I recently expressed some concerns about NextEra‘s success in obtaining some major changes to net metering rules in its core market, Florida. In my opinion, NextEra has chased a prize it should never have wanted to catch. It may well be impaled on its own sword.
But that doesn‘t mean I was necessarily expecting fireworks today. My article last month was a long-term analysis, not prone to change with the vagaries of a single earnings report. And, honestly, we won‘t know for a while whether I‘m right or not. It will take months to get a clear picture of what shape the response to the new fees is taking.
Nevertheless, there are things worth noting in this earnings report.
NextEra Energy: Capital Overview
Obviously, most of the readers will already be familiar with NextEra. For those who are just coming to the stock: NextEra is a little unusual in that in addition to the publicly traded parent company, one of NextEra‘s affiliates, NextEra Energy Partners, is also publicly traded. NextEra reports its core operations in the parent company in two segments, the FPL (Florida Power and Light) segment and the NEER (NextEra Energy Resources) segment. A third segment, Gulf Power, was a recent acquisition which has now been fully integrated into the FPL segment and no longer reports separately. To oversimplify only slightly, FPL is the traditional utility piece and NEER is the clean energy portfolio which management is committed to building.
The structural ties and relationships between NextEra Energy and the Partners subsidiary is, frankly, convoluted. The short version is that Partners and the parent company are joint owners of yet another subsidiary, Operating Partners, which is the actual investment vehicle for NextEra Partners various energy investments. As of the end of 2021, Partners owned roughly 45.3% of this joint venture, with NextEra Energy itself owning the remainder.
For purposes of reporting, NextEra Partners consolidates the results of the joint venture onto its balance sheet. NextEra Energy, however, reports profits received from Partners on the equity line of the income statement and does not fully consolidate Partners onto its balance sheet.
Confident Leaders With Strong Answers…
All in all, this was what I would call a “steady as she goes” report. There were no major surprises in it. The major focus of analysts concern on the ensuing earnings call was the recent announcement that the Department of Commerce has opened a new investigation into the production and importation of certain solar cells, used in the assembly of solar panels. NextEra management didn‘t bother to disguise its consternation – which I would say bordered almost on open disdain – over this new announcement, but it also provided a strong explanation for why it doesn‘t see itself as being majorly threatened by it regardless of outcome – which is not to say they don‘t have a very strong opinion on what the outcome should be.
Still, the outlook from management on the impact on shareholders could best be characterized as placid. NextEra has firm contracts in place already with various Southeast Asian suppliers that they feel insulate them well from new tariff costs, and that‘s if the Commerce investigation actually produces a tariff action at all, which it may not. The report of a subpoena being issued to the company in another legal matter was completely erroneous, and there is no indication that NextEra is the target of anything.
…But I Had Different Questions
If anything, I was more interested in the questions that weren‘t asked. In a distressingly common practice, NextEra allocated well over half its total time to prepared statements, so analysts had to prioritize and I‘m sure with more time they would have gotten to a lot of these. But even so, while I generally thought that NextEra had good answers at today‘s call, I would have asked different questions.
What Collateral Risk, If Any?
One of the things that jumps out about this report is the unusually large negative revenue number that the NextEra Energy Resources segment reported. Officially, on a GAAP basis, Energy Resources reported negative $800 million in revenue for the quarter, which combined with its usual level of operating expenditures produced a total loss for the quarter of $1.5 billion. This loss was nearly twice the size of FPL‘s gain and was enough to push NextEra deep into the red for the quarter.
This is, again, something that will probably most alarm those who are relatively new to the stock. Anyone who regularly invests in energy companies probably already knows exactly what this is, but I will briefly explain anyway. In a nutshell, this loss isn‘t real, and neither I nor management is worried about it.
Well-Established Hedging Pattern
Despite its large and growing renewable energy portfolio, NextEra remains first and foremost a utility company. Like many utilities, it operates and transacts with power lines and gas pipelines and power plants which burn natural gas to generate electricity for customers. And like most energy companies, it seeks a certain degree of short-term stability in the gas it both produces and consumes.
This means that it has entered into a large number of hedging arrangements with intermediaries to lock in short-term prices on natural gas, as well as on other commodities and potentially even interest rates or foreign currency. Among these are various short positions for gas traveling through its pipelines. Because these are considered “non-qualifying hedges,” they are marked-to-market, while the physical gas itself usually is not.
This produces a somewhat silly, and meaningless, paper accounting exercise. At the end of every quarter, accountants check the current price of a commodity against the price in the hedge contract. If prices have risen – and prices shot up in Q1 because of the Ukraine conflict – this is reported as a “loss” on the income statement, since NextEra is selling the commodity for less than what it is going for in the open market at that moment. But the gas itself is not written up in the same way to account for the same price increase. Effectively, the accountants declare that the contract will lose money because gas is worth $8 per KCF today, but that the gas in the pipes is somehow still only worth $3 per KCF, or whatever price NextEra locked in.
It‘s a meaningless number on a piece of paper that doesn‘t mean anything. When NextEra delivers the gas, or the foreign currency or whatever it was hedging, the contract will be closed and no money will change hands beyond what was already agreed to months ago. NextEra doesn‘t actually owe anyone anything except whatever commodity it already fully expensed and promised to deliver. That‘s why neither management nor the analysts on the call even thought this “massive loss” worth remarking upon.
But What Are Collateral Requirements?
I don‘t consider it worth much either, but there is one question about it I do have: is there any collateral tipping point? When Peabody (BTU) found itself in a similar predicament last month, it was compelled to post collateral to the contract to account for the “loss” it had suffered. That collateral in turn required going hat in hand to its bankers for a 10% loan. Now, that loss is real.
NextEra is not nearly such a beaten-down company as Peabody, and collateral requirements vary. Still, I would have thought we would see some discussion about what, if any, stress tipping points NextEra‘s hedging deals may have. Is there any point at which it can be required to post a level of collateral that goes beyond what it might be able to source internally? Reports are growing that a full embargo of Russian energy is being increasingly considered, so further price hikes are well within reason. Is there a price at which collateral requirements mean losses will stop being mere paper and become actual money?
I am disappointed this wasn‘t asked, but I wouldn‘t be too concerned about it. US gas prices remain well below global ones, given natural gas‘s less fungible nature. NextEra is a high-quality company – unlike Peabody, whose main commodity might not even be in use in another decade – and its collateral terms are almost certainly far more reasonable.
Still, it would have been nice to know.
Other Questions
Writedown Prospects?
Slightly more serious was the news that NextEra had taken no less than a $800 million write down on the Mountain Valley Pipeline. Once again, this is something that actually sounds worse than it is…but I‘m still surprised no one considered it worth mentioning.
For those who don‘t know, this is a proposed pipeline to transport natural gas across West Virginia to customers on the East Coast. The pipeline is a joint venture of various stakeholders including principal owner Equitrans (ETRN) but NextEra also holds a stake.
Again, though, there is a little less to this than meets the eye. Unlike the hedging issue, the loss here is quite real, but NextEra had already announced this decision two months ago so it was fully baked into the stock well before today.
What‘s more, it may still be a little too soon to throw in the towel on MVP. The writedown predates the Ukraine conflict, which has thrown into sharp relief the need for reliable energy that isn‘t dependent on unfriendly regimes. Just last week MVP won its latest legal skirmish – not the last one it will have to fight, to be sure – and the pipeline is now 94% finished. So it may yet enter into operation and give NextEra a chance to claw back at least some of those losses.
What About The (OK, my) Elephant?
The last question I would have liked to have asked was simply about my own perennial issue, mandatory connection laws and the potential for new fixed grid fees – lobbied for by NextEra – to produce a backlash against them. I would have liked to know how NextEra management feels about this, but to be honest, I wasn‘t really expecting this question to get asked. Few besides me consider the issue even worthy of mention. I already wrote a full article about this issue and this one is plenty long enough, so I will leave this issue here and refer you to my previous work.
Other Risk Factors Minor
There are a number of other, smaller risk factors which, in my view, do not materially alter the thesis at this time but cannot afford to be dismissed entirely.
Political Risk
The first is, loath as I am to bring it into any business discussion, political; as most are probably already aware, the state of Florida has become a battleground for a number of corporate/government disputes, the most public of which has undoubtedly been the clash between the governor and Disney (DIS) CEO Bob Chapek. This last has now, as of just this morning, resulted in final legislative approval of the official disbandment of Disney‘s privileged “special district status” with unknown but presumably negative effects on the company. Many view the change in law as retaliation for Disney‘s (belated) stance on another recently passed bill, dubbed the “Don‘t Say Gay” law by its opponents.
It has been suggested – by industry analysts, not just critics of the bill – that Florida‘s willingness to make such pivotal changes in business arrangements on short notice, in what is perceived by many as a retaliatory act, will hobble future investments into the state and hurt the state‘s overall growth. There is also worry that other companies could become future targets for similar changes. As a utility stock, NextEra is unusually dependent on macroeconomic patterns in its core market, Florida; if there is less economic growth it’s safe to assume that people will be buying less electricity.
I don‘t dismiss these concerns completely, but I don‘t consider them material yet. As for the macro side, it is far from clear that this is anything more than a one-off; Disney was almost unique among major businesses in benefitting from a highly favorable arrangement which effectively allowed a private corporation to act as its own local government. It‘s not clear that Florida‘s decision to revoke that favoritism has any real implications for other businesses which have, to be frank, far more normal business relations with the state. So the idea that other businesses are going to consider Florida a bad place to invest is unproven, at best.
As for the idea that NextEra might find itself in the crosshairs, so far it has been almost universally consumer-facing companies with major brand cache that have found themselves in these sorts of dilemmas. Disney and Florida in Don‘t Say Gay, Starbucks and the open carry issue, Major League Baseball and voting rights in Georgia , the NBA stance on discrimination law exemptions in North Carolina, etc. Hardly any consumer pressures utility companies to turn the lights off in a state because they disagree with a political decision, and politicians aren‘t likely to do anything so punitive to a company that it might get the lights turned off.
Complexity Discount?
The other issue brings us back to the complexity of the capital structure, and the rather strange ins and outs of cash flowing from NextEra Energy to NextEra Partners and then back again. There are certain investors who feel – and I understand why – that companies with elaborate, convoluted and difficult to untangle ownership structures deserve some sort of discount for the sheer mass of research and due diligence they require investors to wade through. The theory is that certain investors simply won‘t do the due diligence, or buy a stock they haven‘t done due diligence on, producing a lower price for those who are willing to.
There‘s no evidence this is happening right now, and in NextEra‘s case, I consider it unlikely it ever will. Returning to my own, admittedly outside-the-box thesis for a moment, NextEra is almost certainly on one of two paths: either mandatory connection laws will survive the introduction of fixed fees, in which case NextEra is in pole position for very strong growth; or they will not, in which case NextEra simply has too much exposure to traditional utility structure, through FPL and even NEER, to be a strong investment at all. It simply isn‘t very likely, in NextEra‘s case, that it will find itself in any sort of “middle position” where capital complexity will break the tie in an investor’s mind.
Investment Summary
I wasn‘t impressed with the questions on this earnings call, but NextEra‘s answers seem fine to me. While I still consider NextEra to be at risk from the mandatory connection issue, few share my reticence in that regard. And for those who don‘t, there was nothing in this earnings report to raise any red flags, despite some deceptively dangerous looking headline numbers. Most bulls will probably look at this report and feel vindicated. I don‘t challenge that interpretation of this report. Since I am still worried about mandatory connection, however, NextEra remains a Hold, rather than a Buy, in my book.
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