PEG - Ameren Corporation: Might Make Sense To Accumulate This Stable Growing Utility

2023-04-17 12:44:35 ET

Summary

• Ameren Corporation is a regulated electric and natural gas utility that serves a large portion of Missouri and Illinois.
• The company has remarkably stable cash flows over time, which should position it well to ride through any near-term recession or economic problems.
• The company is well-positioned to deliver solid EPS growth and a 9% to 11% total annual return over the next five years.
• The dividend yield is only 2.82%, but it does appear to be quite safe and well-covered.
• Ameren Corporation has a reasonable valuation, although a patient investor could get a better entry point if the market turns downward in the second half of 2023.

Ameren Corporation ( AEE ) is a regulated electric and natural gas utility that serves the eastern part of Missouri and most of the southern part of the state of Illinois. The utility sector in general has long been one of the favorite investments among more conservative investors that are looking for a safe place to park money due largely to their overall stability and high dividend yields. With that said, the yields of most of these companies are not as high as many people think, as the iShares U.S. Utilities ETF ( IDU ) only yields 2.45% as of the time of writing. Fortunately, Ameren Corporation does better than this, as it has a 2.82% yield today. This is still not very impressive considering that it is well below the rate of inflation and far below the rate that is currently being offered by most money-market funds. Ameren Corporation’s stock price is also down 7.05% over the past year, which further reduces its appeal:

However, the company does have a few things going for it. Particularly, it has a long history of raising its dividend on an annual basis, which is nice to see during periods of inflation. The company also trades at a reasonably attractive valuation. In fact, its current valuation is quite a bit more attractive than what it had the last time that we looked at the company. This actually makes Ameren Corporation one of the few companies to get more attractive during the first few months of this year, as the strong market has made most stocks become less attractive, particularly as there are growing signs that the nation will shortly enter a recession. Therefore, let us revisit Ameren and see if this company could be a worthwhile addition to a portfolio today.

About Ameren Corporation

As stated in the introduction, Ameren Corporation is a regulated electric and natural gas utility that serves the eastern part of Missouri along with most of the state of Illinois, with the notable exception of Chicago:

Despite the exclusion of Chicago, this is still a fairly populous area as it includes the city of St. Louis, Missouri, and its surrounding suburbs. As we can see above, Ameren Corporation has approximately 2.4 million electric customers and 900,000 natural gas customers throughout its service area. Thus, the company is somewhat more heavily weighted towards electricity than some of its peers like CMS Energy Corporation ( CMS ) that are roughly evenly split between the two products. That is something that may appeal to more progressive investors given the general perception that electrification will soon render natural gas obsolete. Indeed, the U.S. Energy Information Administration believes that the provisions and subsidies in the Inflation Reduction Act will reduce the demand for natural gas in favor of electricity over the coming years, but the agency still expects that natural gas consumption will remain reasonably strong between now and 2041:

As such, we should not completely write off Ameren’s natural gas utility business, although it may be reasonable to assume that the business will depend more on industrial customers than residential ones over the long term. Ameren’s electric business, meanwhile, will likely see some long-term growth but admittedly there are numerous signs that the demand for electric vehicles and similar things will not grow nearly as much as some politicians and media personalities want one to believe. This is particularly true in rural areas, which describe most of Ameren’s service territory apart from St. Louis. As such, we should not expect to see enormous growth here, but the U.S. Energy Information Administration does project that the proportion of electric cars in use will roughly double over the next twenty years. As I discussed in a previous article , that should still cause a surge in electricity demand that could benefit Ameren Corporation’s electric utility business.

One of the defining characteristics of a utility like Ameren is its remarkably stable cash flows and finances through all different economic situations. This comes from the fact that its product is generally considered to be a necessity for our daily lives. After all, how many people do not have electric service to their homes and businesses? As such, most people will prioritize paying their utility bills ahead of discretionary expenses during times when money gets tight. That could be especially relevant today. As I pointed out in a recent blog post , the incredibly high inflation that has been permeating the American economy has strained the budgets of many people. This has caused them to resort to things such as taking on second jobs, going into debt, or drawing down their savings just to maintain their lifestyles. This sort of situation cannot continue long-term as people only have a limited amount of savings and credit available to them, so eventually they will be forced to cut back and rely on just what comes in via their income. It seems likely that they will cut back on discretionary spending long before they start missing utility payments and risk having their service cut off. Thus, a company like Ameren offers an attractive proposition as the economy heads into a recession, which is looking ever more likely to occur in the near future.

We can see Ameren’s overall cash flow stability by looking at its operating cash flow over time. Here are the figures from the past eleven trailing twelve-month periods:

As we can clearly see, the company’s operating cash flows have generally risen over time, and they have generally not exhibited much in the way of variation. This is exactly the kind of thing that we like to see with a company like this as overall stability helps a great deal when it comes to budgeting for large regular payments, such as the company’s dividend or debt service payments. After all, it is much easier to budget for something when the company can be reasonably certain that it will have a similar amount of cash available during the next quarter.

Ameren’s Growth Potential

Naturally, as investors, we are unlikely to be satisfied with simple stability. After all, we like to see a company in which we are invested grow and prosper over time. Fortunately, Ameren Corporation is fairly well-positioned to do this. The primary way through which this can be accomplished is by increasing its rate base. The rate base is the value of the company’s assets upon which regulators allow it to earn a specified rate of return. As this rate of return is a percentage, any increase to the company’s rate base allows it to increase the price that it charges its customers in order to earn this specified rate of return. The normal way that a utility will grow its rate base is by investing money into upgrading, modernizing, and possibly expanding its utility-grade infrastructure network. This is exactly what Ameren Corporation is planning to do. Over the 2023 to 2027 period, the company is planning to invest $19.7 billion into its rate base:

This is a more current five-year plan that we had available to us the last time that we discussed this company. This is nice because some of the company’s peers are still providing us with outdated plans that only cover the 2021 to 2025 period, which is not particularly helpful since we are nearly halfway through such a program. The fact that this one is more current is nice to see because it allows us to see what the company’s forward growth prospects are and predict the return that we might be able to get by investing in the company. As we can see above, the company’s stated growth plan should allow it to grow its rate base at an 8% compound annual growth rate over the period. This should allow the company to grow its earnings per share at a 6% to 8% compound annual growth rate through the end of 2027, which works out to a 9% to 11% total annual return when combined with the dividend. This is certainly a reasonable total return that is very much in line with its peer group. In fact, this is slightly better than many of the company’s peers are likely to deliver over the period and thus looks pretty good for any investor looking to ride out any near-term economic problems in relative safety.

This growth would be a continuation of the company’s long-term growth trajectory. Ameren Corporation has grown its earnings per share at a 7.5% compound annual growth rate over the past ten years:

This has supported the company’s dividend growth over the period. Indeed, Ameren Corporation has increased its dividend from $1.60 per share in 2013 to $2.36 per share in 2022. The company is planning to increase it again to $2.52 per share in 2023. That is a 48% increase over the period, which will likely satisfy many dividend growth investors. The fact that the company grows its dividend on an annual basis is also quite nice during today’s inflation as it helps to maintain the purchasing power of the dividend, which is especially nice for retirees and others that are depending on the company’s dividend to pay their bills and finance their expenses. We can almost certainly expect that the company will continue to grow its dividend over time as its just-discussed growth program plays out.

Financial Considerations

It is always important to review the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. This is typically accomplished by issuing new debt and then using the proceeds to repay the existing debt. Depending on the conditions in the market, this can cause a company’s interest expenses to increase following the rollover. That is something that could be important today, as interest rates are currently at the highest level that we have seen since 2007. In addition to this risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company’s cash flows to decline could push it into financial distress if it has too much debt. Although utilities such as Ameren Corporation typically have remarkably stable cash flows, bankruptcies have occurred in the sector so this is not a risk that we should ignore.

One metric that we can use to evaluate a company’s financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. It also tells us how well a company’s equity can cover its debt obligations in the event of a bankruptcy or liquidation event, which is arguably more important.

As of December 31, 2022, Ameren Corporation had a net debt of $14.845 billion compared to $10.637 billion of shareholders’ equity. This gives the company a net debt-to-equity ratio of 1.40 as of its last quarterly report. This is a fairly significant improvement from the 1.45 ratio that the company had at the end of the third quarter, which is something that we all should be able to appreciate.

Here is how Ameren Corporation’s financial structure compares to its peers:

As we can clearly see here, Ameren Corporation appears to be more conservatively financed than its peers. This is quite nice to see as it should indicate that the company is not relying too heavily on borrowed money to finance its operations. As such, the company’s debt load should not pose an outsized level of risk and investors should not have to worry too much about it.

Dividend Analysis

As stated in the introduction, one of the reasons why many investors like utilities are that they tend to have a higher yield than most other sectors. This comes from the fact that these companies do not have the same growth prospects as firms in other areas of the economy, so the market typically assigns lower multiples to their stock prices. When we combine this with the fact that many of these companies pay out a higher proportion of their earnings than companies in other industries, we get a situation in which a given stock has a high yield. Indeed, Ameren Corporation’s current dividend yield is 2.82%, which is quite a bit higher than the 1.57% yield of the S&P 500 Index ( SPY ). However, the company's current yield is lower than the 4.50% yield that many money market funds are paying, and it is lower than what we can get from midstream companies or even shale oil drillers. That is admittedly disappointing since it is a clear sign that the utility sector has not yet regained the shine that it had prior to the current stock market bubble. Fortunately, Ameren Corporation does have a long history of increasing its dividend on an annual basis:

This is something that is quite nice to see during inflationary periods, such as the one that we are currently experiencing in the United States. This is due to the fact that inflation is constantly reducing the number of goods and services that we can purchase with the dividend that the company pays out. This can make it feel as if we are progressively growing poorer and poorer all the time, especially for retirees that are dependent on their portfolio incomes to finance their lifestyles. The fact that the company increases its dividend on a regular basis helps to offset this effect and ensures that the dividend maintains its purchasing power over the long term, although admittedly the 6.78% dividend increase that we got in the most recent quarter was just barely enough to keep up with inflation.

As is always the case though, it is critical to ensure that the company can actually afford the dividend that it pays out. After all, we do not want it to suddenly be forced to reverse course and cut the dividend, as that would both reduce our incomes and almost certainly cause the company’s stock price to decline. Thus, a dividend cut ends up being a double blow to investors since we lose both income and principal.

The usual way that we judge a company’s ability to maintain its dividend is by looking at its free cash flow. The free cash flow is the amount of money that was generated by the company’s ordinary operations and is left over after the company pays all of its bills and makes all necessary capital expenditures. This is therefore the money that the company has available to do things that benefit the shareholders, such as reducing debt, buying back stock, or paying a dividend. During the trailing twelve-month period that ended on December 31, 2022, Ameren Corporation reported a negative levered free cash flow of $1.4249 billion. That is clearly not enough to pay any dividend, but the company still paid out $610.0 million to its shareholders over the period. At first glance, this is likely to be quite concerning as the company clearly has insufficient free cash flow to cover its dividend.

However, it is not unusual for utilities to finance their capital expenditures through the issuance of equity and debt, while simultaneously financing their dividends out of operating cash flow. This is because the incredibly high costs involved in constructing and maintaining utility-grade infrastructure over a wide geographic area would otherwise make it nearly impossible for a utility to ever pay a dividend. During the trailing twelve-month period ending on December 31, 2022, Ameren Corporation had an operating cash flow of $2.2630 billion. That was clearly more than enough to cover the $610.0 million in dividends that the company actually paid out with a significant amount of money left over. It does not appear as though we really need to worry too much about the sustainability of its dividend.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return on that asset. In the case of a utility like Ameren Corporation, one metric that we can use to value it is the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes a company’s forward earnings per share growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to the company’s forward earnings per share growth and vice versa. However, there are very few stocks that have such a low price-to-earnings growth ratio in today’s overheated market. As such, the best way to use this ratio today is to compare Ameren’s valuation to that of its peers in order to determine which company offers the most attractive relative valuation.

According to Zacks Investment Research , Ameren Corporation will grow its earnings per share at a 6.97% rate over the next three to five years. This seems quite reasonable as it is in line with the earnings per share growth that we derived from the company’s rate base growth. It is also in the 6% to 8% range that we used to project Ameren’s total average annual return. As such, it seems like a pretty solid growth figure to use. That earnings per share growth gives Ameren a price-to-earnings growth ratio of 2.95 at the current stock price. Here is how that compares to the company’s peers:

Unfortunately, we can see that Ameren Corporation is on the expensive side, although it is hardly the most expensive company on the list. The company’s current valuation is a bit more attractive than the 3.03 price-to-earnings growth ratio that the company had the last time that we looked at it, however. Overall, the current price is probably not a bad entry point, although there is the possibility that the market goes lower once the economy enters a recession if Chairman Powell sticks with his conviction that there will not be a pivot in the central bank’s interest rate policy. Thus, it may be possible to get a better entry point later this year, but the current price is certainly not bad for a long-term investor.

Conclusion

In conclusion, Ameren Corporation could be a reasonable investment for the remainder of the year, if not longer. We are seeing a number of signs that the economy may soon enter into a recession and Ameren is well-positioned to ride through that without getting into too much trouble. The downside to Ameren Corporation is that the stock is not nearly as cheap as some of its peers, but it is admittedly not the most expensive in the sector. The Ameren Corporation dividend yield is also not as high as some other utility companies possess. However, Ameren Corporation still might make sense to start accumulating a position.

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