Soaring interest rates have been a major headwind for NextEra Energy (NEE) and affiliate NextEra Energy Partners (NEP). Higher rates have made it more expensive for companies to borrow money. In addition, rising rates weighed on the valuations of dividend stocks to drive up their yields and compensate investors for their higher risk profiles compared to alternatives like bonds.

Shares of NextEra have plunged more than 27%, while units of the partnership have cratered by nearly 60%. Those declines have driven up their dividend yields. (NextEra yields more than 3%, while the partnership’s payout is over 11.5%.)

However, interest rates could go from a headwind to a tailwind next year if the Federal Reserve cuts them, as many anticipate. That could lift the weight on their shares, causing them to soar in 2024.

Adjusting to the situation
This past year has been a challenging one for NextEra Energy and its partnership. The utility had used that entity as a funding vehicle. It would sell operating renewable energy assets to the partnership, giving it cash to recycle into its massive backlog of development projects. Meanwhile, those deals provided NextEra Energy Partners with the recurring cash flow to grow its dividend.

However, surging interest rates and the declining value of the partnership’s unit price drove up its cost of capital, making it difficult to finance acquisitions. They also made it more expensive for the company to roll over maturing debt. For example, NextEra Energy Partners recently priced $750 million of 7.25% notes due in 2029 to refinance notes that mature next year. The interest rate on those maturing notes is 4.25%. That’s a meaningful interest expense increase.

NextEra Energy Partners’ surging capital costs forced it to slam the brakes on its growth plan. The company cut its dividend growth outlook from 12%-15% annually through 2026 to 5%-8%, with a target of 6%. The company also shifted its growth strategy from acquiring assets from NextEra Energy in drop-down transactions to internally funding organic expansion projects, like repowering existing wind farms.

The issues facing its affiliate also forced NextEra Energy to shift gears. It has pivoted its capital recycling strategy to external sales. In September, the company agreed to sell Florida City Gas to Chesapeake Utilities for $923 million in cash. It will likely need to look externally to recycle more capital next year, since NextEra Energy Partners doesn’t expect to need to make an acquisition to achieve 6% dividend growth in 2024.

From a headwind to a tailwind
While rising interest rates impacted NextEra’s strategy over the past year, that headwind should start to fade in 2024. The Federal Reserve has paused increasing the federal funds rate after hiking it 11 times over the past two years to its current target range of 5.25%-5.5%, the highest level in over two decades.

While the Fed had hinted in the past that it could push rates even higher, it changed its tune at the last meeting, instead indicating that it will likely cut rates three times next year, by 0.25% each time. Further, the Fed’s most recent forecast suggests it would cut rates four more times in 2025 and three more times in 2026, eventually getting rates down closer to 2%.

Falling interest rates will be a major catalyst for NextEra Energy and its partnership. It will reduce the interest rate on their floating rate debt while making it less costly for them to roll over maturing debt. In addition, falling rates will push up the values of income-producing investments as yields adjust to the current rate environment.

We’ve already seen that in the stock prices of NextEra Energy and NextEra Energy Partners, which have rallied off their bottoms. NextEra is up 6% in the past month, while the partnership has surged almost 28%.

Those rate-powered rallies could continue in 2024. In addition, their stocks should get a lift as investors grow more confident that the companies can achieve their long-term growth plans.

The potential to produce powerful total returns in 2024
NextEra Energy and NextEra Energy Partners tumbled this year as rising rates weighed on their values. However, that headwind should fade next year as rates appear poised to start falling. That should lift the weight on their stock prices, which could soar.

Add in their higher-yielding dividends, and they could produce powerful total returns in the coming year. That makes them look like compelling bounce-back candidates to buy now.

— Matthew DiLallo

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Source: The Motley Fool