NEE - Eversource Energy: A Solid Utility Selling At An Attractive Valuation

2023-07-12 18:28:37 ET

Summary

• Eversource Energy is one of the largest utilities in the United States, serving a sizable portion of the highly-populated New England region.
• The company enjoys remarkably stable cash flows, which is something that could prove advantageous as the consumer and economy weaken.
• The company is positioned to deliver a 9% to 11% total average annual return over the next five years.
• The company is less leveraged than its peers, although the higher interest rates from its recent debt rollovers will be a headwind.
• Eversource Energy stock is trading at a reasonably attractive valuation relative to its peers.

Eversource Energy ( ES ) is a regulated electric and natural gas utility that serves the New England region. This is one of the most populated areas of the country, and so Eversource Energy is one of the biggest utilities in the United States. However, it is perhaps not as familiar to many households as some of the other major utilities.

The utility sector in general has long been a favorite among conservative investors, such as retirees. There are several reasons for this, including the fact that these companies tend to have remarkably stable cash flows in any economic situation. They also typically have fairly high yields, as evidenced by the fact that Eversource Energy currently yields 3.78%. As long-time followers of this company might notice, this is a higher yield than the company had the last few times that we discussed it here on Seeking Alpha. This comes from the fact that the company has significantly underperformed the broader market, as it is down 13.28% over the past twelve months:

This is a substantial underperformance relative to the 2.59% decline that the U.S. Utility sector ( IDU ) exhibited over the same period. It is, however, not especially unexpected, as Eversource Energy sacrificed some of the popularity that it had with renewable energy activists when it began making statements about disposing of its offshore wind unit. As I discussed in my last article on the company, Eversource Energy also has substantial near-term debt maturities that will almost certainly cause its interest expenses to go up once it rolls them over.

The steep price decline has created a potential entry point for value investors though, as Eversource Energy currently trades at a more attractive valuation than we have seen in a long time. Therefore, let us investigate and see if this company could be a worthy addition to your portfolio.

Above Eversource Energy

As stated in the introduction, Eversource Energy is a regulated electric and natural gas utility that serves the New England states of Connecticut, Massachusetts, and New Hampshire:

This is one of the most populated areas of the country, which gives Eversource Energy a very large customer base, despite the fact that its service area is not particularly large geographically:

This is sufficient to make Eversource Energy one of the fifteen largest utilities in the United States in terms of customer count. This is despite the fact that it does not have the name recognition that Duke Energy ( DUK ), NextEra Energy ( NEE ), or Exelon Corporation ( EXC ) do for investors that do not reside in the company's service territory.

As I have pointed out numerous times in the past though, a utility's size does not affect the fact that it will possess certain inherent characteristics. The most important of these is that Eversource Energy tends to have remarkably stable cash flows over time. We can see this quite clearly by looking at the company's operating cash flows. Here they are for each of the past eleven twelve-month periods:

As we can clearly see, the company's operating cash flows tend to fall pretty close to $2 billion during any given twelve-month period. The only real exception to this was the time right around when the COVID-19 lockdowns happened. Those lockdowns caused a lot of people all across the United States to fall behind on their utility bills due to the fact that they were out of work. In addition, businesses used a lot less electricity than normal due to the fact that they were closed. That was undoubtedly a once-in-a-lifetime event, so we can excuse it away and make the statement that Eversource Energy is very stable in terms of cash flows.

The reason for this overall financial stability should be fairly obvious. Eversource Energy provides a product that is typically considered to be a necessity for our modern way of life. After all, nearly everybody has electric service to their homes as well as some sort of heating system in place. In fact, the presence of these things is required under habitability laws in just about every location in the United States. The overwhelming majority of people cannot possibly imagine life without these modern conveniences, and of course without the things that are powered by electricity. As such, most people will prioritize paying their electric bills ahead of any discretionary expenses during periods in which money gets tight. As I pointed out earlier today in a blog post , money has gotten extremely tight for many consumers all across the United States. It seems likely that it will get even tighter should the economy descend into a recession and we start seeing layoffs more frequently. This will cause consumers to tighten their belts and reduce spending, but it seems likely that they will continue to ensure that their electricity bill gets paid.

Thus, Eversource Energy is much better positioned to weather through the current environment than companies in other market sectors. This thus makes this a company that we should have some exposure to in the present environment.

Growth Prospects

Naturally, as investors, we are unlikely to be happy with mere stability. We like to see any company in which we are invested grow and prosper with the passage of time. Fortunately, Eversource Energy is well-positioned to accomplish that. The primary way through which the company will deliver growth 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 certain rate of return. As this rate of return is a percentage, any increase to the rate base allows the company to increase the amount that it charges its customers in order to earn that specified rate of return.

The usual way that a utility increases the size of its rate base is by investing money into upgrading, modernizing, and even expanding its utility-grade infrastructure. Eversource Energy is planning to do exactly this, as the company recently provided its investors with a five-year plan that details a $21.5 billion infrastructure investment program to be carried out over the 2023 to 2027 period:

It is nice to see that Eversource Energy provided us with projections through 2027. As regular readers may recall, I criticized a few of the company's peers in recent articles for only providing their spending plans through 2025. The root of my criticism stems from the fact that the more information that we have about the company's capital expenditures, which tend to be substantial uses of funds for utility companies, the more accurately we can make financial projections and predict where the company will be at a given point in the future. This is very important for long-term investors, which would probably include most retirees. The fact that this company is providing us with a five-year planning horizon thus makes it a bit more shareholder-friendly than some of its peers, which we can certainly appreciate.

The company's capital investment program as detailed above should allow it to grow its rate base from $24.4 billion at the start of 2022 to $37.7 billion at the end of 2027. That represents a 7.5% compound annual growth rate over the period.

At this point, some readers might point out that the projected rate base growth is substantially less than the amount of money that the company has to invest in order to achieve this growth. Over the full six-year period in question, Eversource Energy will invest a total of $25.305 billion but only get $13.3 billion in rate base growth. That will make this growth program seem like a very bad deal on the surface.

However, we have to consider two factors here:

• Depreciation
• Asset Retirements.

The first, depreciation, is something that every capital-intensive business experiences. Depreciation is constantly reducing the value of the assets that the company has in service. In fact, if it were to invest nothing, its rate base would actually decline during that period. The company must therefore spend an amount equal to its depreciation every year just to keep the rate base static. It has to spend more than its depreciation in order to grow the rate base.

The second factor is asset retirements, which completely remove an asset from the rate base. This obviously offsets some of the spending that the company engages in. Eversource Energy has not specifically mentioned any assets that it intends to retire, but the company will undoubtedly be removing things like old transformers and distribution lines from service during the period.

Overall, the company's growth program should allow it to grow its earnings per share at a 5% to 7% compound annual growth rate over the 2023 to 2027 period. That should allow it to deliver a total return of 9% to 11% annually over the period when we take the current 3.78% dividend yield into account. That is certainly a very acceptable total return for a conservative utility investment like this.

Financial Considerations

It is always important that we analyze 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. That is typically accomplished by issuing new debt and using the proceeds to repay the existing debt as very few companies have sufficient cash on hand to completely repay their debt as it matures. This process can cause a company's interest expenses to increase following the rollover, depending on the prevailing interest rate in the market. As of the time of writing, the federal funds rate is at the highest level that it has been since 2007:

Thus, this is a very real risk today as any debt rollover will almost certainly increase the company's interest expenses. In addition to interest-rate risk, the company must also make regular payments on its debt if it is to remain solvent. As such, an event that causes a company's cash flow to decline could push it into financial distress if it has too much debt. Although utilities such as Eversource Energy usually have remarkably stable cash flows over time, there have been bankruptcies in the sector before so this is not a risk that we should ignore.

The usual metric that we use to analyze a company's financial structure is its 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 the company's equity can cover its debt obligations in the event of bankruptcy or liquidation, which is arguably more important.

As of March 31, 2023, Eversource Energy had a net debt of $23.8056 billion compared to $15.9049 billion of shareholders' equity. This gives the company a net debt-to-equity ratio of 1.50 today. Here is how that compares to some of the company's peers:

As we can clearly see, Eversource Energy is generally less leveraged than many of its peers. This is a positive sign as it illustrates that the company is not overly reliant on debt to finance its operations. Thus, its debt probably poses less risk than the debt load of many of its peers. In fact, as I pointed out in my last article on the company (linked earlier), the biggest concern here with respect to the company's debt is that it has a significant amount of debt maturing this year:

Eversource Energy has already begun rolling its debt over, and as we can clearly see, the new debt has substantially higher interest rates:

The concern with this company's debt is not the amount of it. Eversource Energy has a lower level of leverage than many of its peers. The concern is that the higher interest rates on these new debt issuances will increase the amount of money that the company has to pay to service its debt and thus leave it with less money that can be used to reward the shareholders. Overall though, this is not the "end-of-the-world" situation that some analysts have made it out to be.

Dividend Analysis

As stated in the introduction, one of the biggest reasons why many investors purchase shares of utility companies like Eversource Energy is the fact that these stocks tend to have higher dividend yields than many other things in the market. This comes from their relatively low growth rates that result in the companies paying out a significant portion of their cash flows to the investors in order to provide a competitive total return with other assets. As the market does not assign particularly high multiples to most utility stocks, the dividends end up being a significant percentage of the stock price. Eversource Energy is certainly no exception to this as the stock yields 3.78% at the current price. Eversource Energy also has a fairly long track record of growing its dividends over time:

This is something that is very nice to see during inflationary periods such as the one that we are experiencing today. This is because inflation is constantly reducing the number of goods and services that we can purchase with the dividend that the company pays out. Thus, it can feel as though we are getting poorer and poorer with the passage of time. This phenomenon is particularly noticeable for those individuals that are depending on their portfolios to provide the income that they need to support themselves, such as retirees. The fact that Eversource Energy increases the amount of money that it pays to its shareholders every year helps to offset this effect and maintains the purchasing power of the dividend.

As is always the case though, it is critical that we ensure that the company can actually afford the dividends that it pays out. After all, we do not want to be the victims of a dividend cut, as that would reduce our incomes and almost certainly cause the company's share price to decline.

The usual way that we determine a company's ability to pay its dividends is by looking at its free cash flow. The free cash flow is the amount of money that was generated by a company's ordinary operations and is left over after it pays all of its bills and makes all necessary capital expenditures. This is the money that is available for things such as reducing debt, buying back stock, or paying a dividend.

In the twelve-month period that ended on March 31, 2023, Eversource Energy reported a negative levered free cash flow of $1.2821 billion. That was obviously not enough to pay any dividends, yet the company still paid out $875.5 million to its shareholders during the period. This is something that will likely be concerning at first glance as Eversource Energy is clearly not earning enough money to cover its dividends out of its free cash flow.

However, it is not uncommon for utilities to finance their capital expenditures through the issuance of debt and equity. They will then pay their dividends out of operating cash flow. This is necessary because otherwise, the extremely high costs of constructing and maintaining utility-grade infrastructure over a wide geographic area would otherwise prevent these companies from ever providing a return to their shareholders.

During the twelve-month period that ended on March 31, 2023, Eversource Energy reported an operating cash flow of $2.0985 billion. That was easily enough to cover the $875.5 million that the company paid out in dividends with a significant amount of money left over that can be used for other purposes. Thus, the company's current dividend appears to be reasonably safe and we should not have to worry about a near-term dividend cut.

Valuation

It is always critical that we do not overpay for any assets in our portfolio. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of a utility like Eversource Energy, we can value it by using 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 its forward earnings per share growth and vice versa. However, there are very few companies that have such low ratios in today's richly-valued market. As such, the best way to use this ratio today is to compare Eversource Energy's ratio to its peers to determine which stock offers the most attractive relative valuation.

According to Zacks Investment Research , Eversource Energy will grow its earnings per share at a 6.34% rate over the next three to five years. This is in line with the growth rate that we projected earlier based on the company's rate base growth so it seems pretty solid. This earnings per share growth rate gives the company a price-to-earnings growth ratio of 2.58 at the current stock price. Here is how that compares to the company's peers:

As we can see, Eversource Energy generally looks reasonably valued relative to its peers. Entergy and FirstEnergy both have substantially higher levels of debt, which explains their lower valuation ratios. In short, both of those companies are somewhat riskier than Eversource Energy. Eversource Energy is cheaper than Exelon or DTE Energy though, and has lower leverage than either of them. As such, it might be the best value here when we consider its balance sheet strength.

Conclusion

In conclusion, Eversource Energy is one of the largest utilities in the United States, as it serves one of the most highly populated regions in the nation. It still has the financial stability of any company in the sector, which could serve it very well as the economy and the consumer continue to show signs of weakening. Eversource Energy is also well-positioned for growth despite the fact that it is exiting its offshore wind business. Eversource Energy stock trades with an attractive valuation despite all these nice things, though, so it could be worth purchasing today as a bulwark in the face of near-term economic troubles.

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