In this week's episode of Industry Focus: Energy, host Nick Sciple and Motley Fool analyst Matt DiLallo dive into utilities giant NextEra Energy (NYSE:NEE). Learn why renewables are such exciting investments lately and how NextEra stands to benefit from that renewables boom, what NextEra's business model looks like and how the company makes its money, where NextEra's competitive edge comes from, some of the biggest risks that investors have to keep an eye on, what NextEra's growth plans are for the medium term, some exciting projects the company has in its pipeline, and more. And tune in next week for a continuation on NextEra.

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This video was recorded on Nov. 7, 2019.

Nick Sciple: This episode was pre-recorded on Nov. 7. Please be aware that some facts may have changed.

Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, and this is part one of our discussion on the NextEra Energy family of companies. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Matt DiLallo via Skype. How's it going, Matt?

Matt DiLallo: Doing well! How are you?

Sciple: I'm doing all right! We're going to talk about NextEra Energy today. Exciting company when it comes to renewables. The largest utility in the country when it comes to wind and solar generation. Renewables are really hot when it comes to interest of folks. There's a lot of top-of-mind when it comes to solving carbon emissions and those sorts of things. When it comes to the business of renewables, why is today such a great time to invest?

DiLallo: Costs have come down so much. It's been really exciting to watch over the years. Renewables needed to have government subsidies to bridge the gap between the cost of that and natural gas and coal. However, now, the costs have come down so much as they've scaled that it's almost as competitive in a lot of places like wind, for example. It's right there with natural gas and coal. That's been so exciting to see how much the costs have come down, and they're coming down even further. NextEra, as we'll get into, they're so big in this, they have their finger on the pulse and they see it coming down even more so that this is the de facto source of energy going forward.

Sciple: When you talk about the cost of these inputs to renewable energy, the prices have really come down. That's why NextEra Energy CFO Rebecca Kujawa has said that this is the best time for renewables development in the history of the company. In addition to falling costs when it comes to wind turbines and solar panels, another factor that has been really important is falling costs when it comes to battery storage for renewable energy production. Can you talk about how important that is to the renewable energy industry and then to NextEra Energy in particular?

DiLallo: One of the issues that renewables have faced over the years is called intermittency. The sun doesn't always shine, the wind doesn't always blow. Obviously, the sun's not there at night. It doesn't provide what they call in the utilities sector baseload power, what you get from a coal plant that's going to continually generate power, day and night. In order to offset that, there's a couple of ways they can go. They can build what are called natural gas peaker plants. That's to fill in the gap. They're more expensive because you have to build this whole plant to fill in the gap. The other option is energy storage. Think about your battery for a flashlight, whatever, its' energy that's stored in there. To scale that up to do utility scale is very expensive. However, there's been so much progress with what Tesla's doing with batteries, and just scaling batteries, that the costs have come down so much so that NextEra is putting them on 50% of their solar projects this year, which is incredible. They used to not do any. And they see the cost of this coming down so much so that probably by 2023, 2024, it'll be cheaper to have a solar plus energy storage than it will be for coal, nuclear, and even though also energy efficient, natural gas plants. It's just an incredible breakthrough that we're getting. Really, a lot of it has to do with scale. There hasn't been a huge technology breakthrough, but just, as they're building out the plants to build these, it just brought the cost down.

Sciple: Right. A big part of pushing us to that scale has definitely been the subsidies that have pushed into this sector, have really encouraged folks to invest. As you mentioned, we've hit this point where the volumes are such that costs are really starting to come down, and they're becoming economical, which creates an opportunity for utilities like NextEra Energy.

All right, Matt, on the back half of the show, I want to dive in a little bit into NextEra Energy's business itself. There are a few operating businesses under the NextEra Energy umbrella. First off, can you introduce those to us, and what they do from a high level?

DiLallo: Investors need to think of this company as more like a holding company. They own, as you mention, there's two utilities. Utilities, we're used to them, we pay our power bills and gas bills to them. They own two of them in Florida. One's Florida Power and Light. That one got NextEra started. That's one of the largest utilities in Florida. It makes its money by distributing electric and gas to customers in that state. With Florida being a growing state, it's a steadily growing business. A really core business there. And then, they just bought Gulf Power, which is another Florida utility, on the other side of the state, Tampa. Very similar business, regulated. This one tends to be more focused on your fossil fuels, a lot of natural gas, and coal, actually. So, that's the two utilities.

Then they have what's called NextEra Energy Resources. When you think about NextEra, that's the business a lot of investors now think about. It's called a competitive energy business. What they do is, they develop wind farms and solar projects, they'll sell the power to other utilities and other corporations. They get these fixed-price power purchase agreements, and they make steady income with that. And then they've got some other little businesses on the side. But that's your two main focuses there. You got your utilities and then your competitive energy generating business. It really fits well together. It makes for a really good core energy company.

Sciple: Sure. When you're looking at the utility part of the business, they're actually selling the energy they produce to the end consumer, whereas you look at the other part of the business, their customers are more likely to be a utility that they're selling power to that will then sell that on to the end consumer. Would that be a fair characterization, Matt?

DiLallo: Yeah, definitely. That's what it is.

Sciple: OK, cool! Let's talk about the utilities part of the business. First, it's a regulated business, a regulated monopoly. You got a pretty reliable customers. Folks aren't going to turn off their power anytime soon. But when we look at the renewable part of the business that they're focusing on, particularly the Florida Power and Light side of the business on wind and solar, just being in Florida, the geography they have there, how much bigger of an opportunity does this Florida Power and Light, NextEra Energy have in the renewables space that maybe a utility that isn't located in such a sunny, warm part of the country might not have?

DiLallo: Being located in the Sunshine State is definitely a competitive advantage if you're looking for solar. They're really taking advantage of that. They just put out what's called the 30-by-30 plan. They want to install 30 million solar panels by 2030. It'll generate 10,000 megawatts of incremental solar capacity. It'll provide all this clean energy to Florida's grid, help reduce emissions in the state, and based on where power prices are, it'll actually help reduce customer bills, especially as they add some of the energy stores that we mentioned. That'll reduce the need for these peaker plants. It's a really great opportunity for them to grow and take advantage of not only the sun, but there's still some subsidies that they can take advantage of, and falling costs. Great opportunity for them.

Sciple: Sure. We talked about how Florida is a growing state. One other thing to be concerned with, and management has called this out as a place where they're investing in is, Florida, is warm, sunny, it's also on the coast. Hurricanes affect this area. Can you talk about how the business has been investing to manage that, and how that factors into their long-term plans?

DiLallo: Utilities are typically known as the safest investments you can hold in your portfolio. Typically, retirees will hold a utility because they pay these steady dividends. However, as investors unfortunately learned, utilities are not risk-free. Those who held Pacific Gas and Electric over there in California have learned with the wildfires that there's no risk-free investment in utilities. That's the case here with NextEra and hurricanes. We've seen with climate change concerns, hurricanes seem to be getting worse, they seem to be coming more often. The company is really trying to hit this head-on. They want to invest $3 billion to $4 billion over the next few years on storm hardening. That'll primarily be putting power lines underground, so that they don't get knocked over by the wind. They're trying to get ahead of this. But hurricanes can be so devastating. A hurricane could hit them, maybe a quarter or two, they might have to rebuild some things. It is something that keep an eye on for investors.

Sciple: Yeah, one of those things to think about. For some of these businesses, geography really can matter, both on the plus and the minus side when it comes to things you need to be aware of with the business.

Moving on to the NextEra Energy Resources part of the business, that's where you see a lot more of this growth. I believe their most recent quarter, they grew 23% year over year. When you take a look at this business, it really seems to have been really starting to take off. What are the biggest opportunities there for them, and how are they going about pursuing that?

DiLallo: This is their business where they basically work with other utilities and other corporations that build a wind farm. For example, one of the interesting projects they're working on, they announced earlier this year, is with Portland General Electric, where they're doing wind plus solar plus storage. It's the first hybrid with three sources that's out there. They're selling this power that they're going to produce from this to the Portland General Electric. So, it's projects like those. Then, they'll build wind farms for corporations that are backed by this long-term power purchase agreement. Same thing with solar. They look to capitalize opportunities where customers want renewable energy, and they're willing to pay for long-term contracts.

Sciple: Sure. You bring all that together, and you're showing on the financial side of the business really strong performance relative to the rest of the sector. The company expects to grow earnings at a 6% to 8% compound annual growth rate, and is calling for dividend increases of 12% to 14% a year at least through 2021. When you compare those numbers to its peers in the utility sector, really attractive there, Matt.

DiLallo: Yeah. It's really interesting to look at the numbers. As I mentioned, NextEra is one of the largest utilities on country. However, it's growing faster than a lot of its larger peers. Two big ones that a lot of retiree-type of investors would probably look at is like a Duke or a Dominion. Duke, for example, is growing their earnings 4% to 6% per year through 2023, is what they're targeting. That would likely lead to a similar growth rate in their 4% yielding dividend. Dominion, on the other hand, is looking at 5% per year through 2023. That's actually down from their initial view that they'd grow 6% to 8% per year. However, dividend growth there's only 2.5% per year. A lot of that's because they have a larger payout ratio. So, you have much slower growth from there. A little bit higher yields, given that NextEra has 2.2% at the moment. But that growth is one of the reasons that it's outperformed not only as utilities, but a lot of the stocks in the S&P 500 over the years. I think that's what's going to help it outperform its peers going forward.

Sciple: Another place you might want to compare NextEra Energy to the rest of the sector, we talked about their massive share of renewable and the opportunity that gives for them as we move the grid more to a renewable focused energy production. NextEra also, relative to the rest of the sector, has way less of a representation in coal. Can you talk about, does that create opportunities for NextEra in that they don't have to shut down these coal plants and invest in renewables, because a large portion of their output already is in where the market is going toward? How does that lack of presence in coal, at least relative to their competitors, differentiate NextEra?

DiLallo: It's another competitive advantage that they have. They started this shift years ago, so they're already ahead of the game. We see a lot more coal-focused utilities putting out these bold plans. "Hey, we're going to be net zero for carbon emissions by 2050." NextEra is way ahead of them in that. They can focus their efforts on growing earnings, whereas a lot of these companies are focused on reducing carbon emissions first. That should grow earnings. That's why you're getting this difference in growth rates. They're already way past that. It really helps them going forward.

Sciple: Right, they just don't have the distractions of having to remake their entire portfolio, which has to be attractive to you from a management point of view. I'll just ask you, Matt, with the advantages when it comes to the portfolio, the faster growth rate, located in a geography that has a lot of attractive characteristics when it comes to people moving there, when it comes to ability to capture renewables, why would I buy a utility that's not NextEra Energy today?

DiLallo: I don't know. I own NextEra Energy. One of the reasons I do own it is because, I have my money in it, so I'm really focused on what they're doing. I'll force myself to read the conference called transcripts. However, like we mentioned earlier, there's no business that doesn't have risks. NextEra is investing a whole lot of money going forward to build out their business. They're investing, like I mentioned, in storm hardening, renewables. I think the biggest risk for them, and the reason investors should still be mindful of not over-allocating or anything like that, is, they need a lot of money to do this. With paying a growing dividend, that gets harder and harder. I would keep an eye on how they're financing risk. We're going to get into this in the second part of the show. NextEra Energy Partners is one of the ways that they finance their business. That's going to be a risk to watch, as we'll see later.

Sciple: Yeah. Folks that liked this first part of the show, next week, we'll have part two of our discussion of the NextEra Energy family of companies. We'll be discussing NextEra Energy Partners. Until then, Matt, thanks as always for coming on the show!

DiLallo: Thank you for having me!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Matt DiLallo, I'm Nick Sciple. Thanks for listening, and Fool on!