NWE - NorthWestern Energy Group: Potential Is Overshadowed By Significant Risk

2023-12-05 21:20:18 ET

Summary

• NorthWestern Energy Group's share price has pulled back due to weaker-than-expected earnings.
• The company has a significant debt load and is overvalued based on DCF figures.
• Despite paying a high dividend, the risk of debt and high payout ratio make it a hold for investors.

NorthWestern Energy Group (NWE) has seen a pullback in share price due to several earnings misses along with analyst downgrades notably due to the Q2 2023 release . I believe that NorthWestern Energy Group is currently a hold because even though they pay an excellent dividend, the firm has a significant debt load and is overvalued assuming my DCF figures.

Business Overview

NorthWestern Energy Group supplies electricity and natural gas to residential, commercial, and various industrial clients. The corporation produces, buys, stores, transmits, and distributes natural gas in addition to producing, buying, transmitting, and distributing electricity. It also owns municipal franchises that allow it to provide local towns with natural gas services. With over 121 transmission and distribution substations, the organization oversees a vast infrastructure that includes 6,597 miles of electric transmission lines and 18,534 miles of electric distribution lines. It runs 5,099 miles of natural gas distribution and 2,235 miles of natural gas transmission lines throughout Montana, in addition to around 135 municipal gate stations.

In addition, the corporation manages 2,342 miles of electric distribution lines and 1,308 miles of electric transmission lines in South Dakota, together with around 121 substations for distribution and transmission. It oversees 2,545 miles of natural gas distribution lines and 55 miles of transmission lines in South Dakota and Nebraska. Approximately 764,200 people are served by NorthWestern Energy Group, which offers natural gas and/or electricity in Nebraska, South Dakota, Montana, and Yellowstone National Park.

NorthWestern has a market capitalization of $3.15 billion and has delivered a 4% Return on Invested Capital. The stock's 52-week trading range has seen highs at $61.24 and lows at $45.97. Presently valued at $51.32 and a P/E GAAP ratio of 17.21, Northwestern is trading near its 50-day moving average of $49.21. Furthermore, the company's P/E GAAP ratio is between its industry counterparts, suggesting a possible fair value proposition.

NorthWestern also pays a dividend of 4.98% demonstrating an 85.93% payout ratio. Although this dividend is rather high, I believe that NorthWestern will be able to meet these payout needs due to its increasing earnings as shown below which will expand the firm's FCF and result in a safer payout. I also believe that the dividend is the most prudent value option for shareholders because NorthWestern is a well-established utility company with smaller room for growth thus making profits more effective when being distributed due to the low ROIC.

Performance Compared to the Broader Market

Over the last 10 years, NorthWestern has underperformed the broader market when adjusting for dividends. I believe that this underperformance by over double is due to the current decline in share price which I believe should provide solid value in the coming years.

Balance Sheet

NorthWestern also holds a leveraged balance sheet with not much room for debt increases. As a utility, this leverage does not worry me as much due to the firm's increasing operating revenues but can pose an issue if earnings fall suddenly. With an interest coverage of 2.82, a Current Ratio of 0.63, and an Altman-Z-Score of 0.81, NorthWestern can see future troubles if it continues to miss expectations and may see a dividend cut to pay off debt obligations.

Earnings

NorthWestern also reported disappointing Q3 2023 earnings with EPS missing by $0.05 at $0.49 and revenues missing by $26.1 million at $321.1 million showing a 4.2% YoY decline. I believe that this miss demonstrates NorthWestern's struggle to hold profitability thus posing a risk to the dividend if earnings continue to disappoint. But, with impressive revenue and EPS growth in the upcoming years, NorthWestern might be able to overcome current struggles and reestablish balance in its balance sheet and dividend.

Analyst Consensus

Analysts currently rate NorthWestern as a "hold" with a 1-year price target of $51.13. This demonstrates that although analysts believe in revenue and profitability growth, the risk of debt coupled with a high dividend does not present a favourable risk to reward.

Valuation

Before finding a fair value for NorthWestern, I decided to calculate the firm's Cost of Equity by using the Capital Asset Pricing Model. Assuming a Beta of 0.72 and a risk-free rate of 4.25% based on the 10-year treasury yield , I calculated a Cost of Equity of 7.47%.

Based on this calculation, I used a 5-year Equity Model DCF based on net income to find NorthWestern's fair value. I decided to use a discount rate of 9% demonstrating a 1.53% risk premium due to debt and operational headwinds due to guidance and earnings declines. I also estimated revenues and margins to grow in line with analyst expectations. This resulted in a fair value of $45.301 demonstrating a 13% overvaluation.

Grid Modernization Resulting in Margin Expansion

Northwestern Energy Group has initiated a comprehensive program to update its electrical infrastructure, acknowledging the revolutionary potential of grid modernization. The corporation is making investments in cutting-edge technology as part of its aim to build a smart grid that improves the dependability and efficiency of energy delivery. Northwestern Energy, for instance, has installed smart meters, sensors, and communication systems throughout its service region to allow for the real-time monitoring of grid functioning and energy use.

This helps with more accurate load control and gives consumers comprehensive information about how much energy they are using. Reliability is increased by the updated grid's capacity to identify and respond to outages more quickly. Northwestern Energy Group wants to build a more flexible and resilient energy infrastructure by adopting grid modernization, guaranteeing its consumers in the Northwestern region of the United States a steady and sustainable supply of electricity. Because of the rapid identification, there will be fewer outages, increasing margin and revenue. As a result of more precise operations and expenditure projections, the company's revenue and margin predictability will also be enhanced.

Risks

Regulatory Risks: Numerous regulations that impact utilities' operations, costs, and profitability exist. The firm may be exposed to risks from unforeseen regulatory judgments or changes in rules.

Market Risks: The supply, demand, and price fluctuations for energy can affect a utility company's financial success. Uncertainties can be introduced by market dynamics and economic factors.

Conclusion

To summarize, I believe that NorthWestern Energy Group is currently a hold because even though they pay an excellent dividend, the firm has a significant debt load and is overvalued assuming my DCF figures.

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