Inflation in the UK is currently running at 7%. In other words, what cost £1 a year ago, costs £1.07 today.
When inflation is high, businesses have to pay more to produce the goods and services they sell. This leaves them facing a dilemma.
They can either fix the prices they charge their customers, which means they’ll make less profit. Or they can increase their prices and risk losing business.
I have a renewable energy stock in my portfolio that I think is well-protected against this inflation dilemma. The stock is NextEra Energy (NYSE:NEE).
NextEra Energy
NextEra is a utilities company based in Florida. The company has two main operations — a regulated utilities business and a renewable energy business.
The regulated utilities business makes up around 80% of NextEra’s overall revenues. It’s this part of the business that I think is protected against inflation.
The business is protected from competition in that it has a legal monopoly in the areas to which it provides electricity, meaning customers can’t easily change to another supplier.
In exchange for this protection from competition, regulators limit the amount of profit NextEra can make by charging its customers. Currently, the business is allowed to make a 10.6% return on its assets.
Importantly, though, NextEra is allowed to make that 10.6% return if its costs increase. In other words, if inflation makes NextEra more expensive to run — which seems likely to me — then it can increase its prices to customers to compensate for this.
As a result, I’m not concerned about the impact of inflation on NextEra’s business. Utilities tend to enjoy steady demand and NextEra’s regulatory protection should allow it to make money consistently, even if high inflation persists.
A buying opportunity
I own NextEra shares in my portfolio. I also think that now might be an attractive time to add more.
The stock isn’t especially cheap, trading at around 23 times next year’s anticipated earnings. To my mind, the biggest risk from an investment perspective is that valuation.
As I see it though, the company’s premium valuation is justified by the advantages it has over its competitors. Being one of the first companies to make substantial investments into renewables infrastructure has allowed NextEra to occupy some of the best sites for generating wind and solar energy in the US.
This kind of advantage is virtually impossible to replicate. Over time, I think it will prove to be extremely important.
Right now, oil prices are high as a result of supply shortages brought on by the Russian invasion of Ukraine. As a result, oil stocks are doing well as the outlook for oil seems positive.
While the broader market is looking at fossil fuels, I’m looking at the renewables sector. High oil prices mean that oil stocks should do well in the near future, but with my focus further into the future, I’m looking at companies that will be part of the energy chain for a long time to come.
Since I think that NextEra is one of the best renewable energy stocks around and will be for some time, I’m happy buying shares for my portfolio here.