PNM - OGE Energy: A Safe Haven In Uncertain Times

2023-03-13 19:44:22 ET

Summary

• OGE Energy Corp. enjoys strong stability, which is something that can be appreciated today as the recent troubles with regional banks have created an environment of fear.
• The company has been enjoying customer growth, although Oklahoma is not a particularly fast-growing state.
• The company's rate base growth should allow it to grow its EPS at a 5% to 7% rate.
• The 4.82% yield appears to be reasonably sustainable.
• OGE Energy Corp. stock is fair to undervalued, which is a nice improvement from the last time that we looked at it.

OGE Energy Corp. ( OGE ) is a regulated electric company that operates in Oklahoma and Arkansas. This is not exactly the first area that most people will think of if they want to buy a regulated utility, but that could give the company an advantage in terms of valuation. Indeed, OGE Energy is one of the cheapest utilities in the market today.

This is nice because utilities in general have earned a reputation among investors for their stability and high yields. These are exactly the characteristics that should prove to be quite appealing today, as the instability that came about over the weekend in reaction to the collapse of Silicon Valley Bank has made many people quite fearful. OGE Energy should be quite resilient in the face of this considering that Oklahoma has a very strong economy due to the oil and gas reserves in the region and the state’s proximity to Texas. This has positioned OGE Energy quite well as the utility is benefiting from a growing residential and commercial customer base, which is evident in the company’s fourth-quarter 2022 earnings results .

There are certainly some reasons to consider an investment in OGE Energy Corp. stock today, so let us take a closer look and attempt to determine if this company could be a good addition to your portfolio today.

About OGE Energy

As stated in the introduction, OGE Energy Corp. is a regulated electric utility that operates in the states of Oklahoma and Arkansas.

While this is a fairly large area geographically, the majority of the company’s service area is rural and sparsely inhabited. As a result, the company only had 888,759 customers on December 31, 2022. That is an increase from the 879,447 customers that the company had at the end of 2021, however:

This is something that is quite nice to see because growth in a company’s customer base is one of the only ways that a utility can generate growth. After all, the more customers that it has paying their utility bills, the more revenue the company will have coming in. All else being equal, higher revenue should result in higher profit because more money will be available to cover the company’s fixed expenses and ultimately make its way down to the bottom line.

Unfortunately, Oklahoma does not have a particularly strong growth rate. Currently, the state’s population growth is projected at 0.84% annually, which is 24 ^th in the United States. While this is still better than some states, it is nowhere near as strong as neighboring Texas, which ranks third in the United States at 1.80% annually. With that said, though, population growth is not the only way for a utility to generate growth.

Ultimately, the consumption of electricity by the company’s customers matters more than the actual change in the number of customers. Although the two measures do tend to have a somewhat linear relationship, I pointed out in a recent article that there are some cases in which electric consumption increases much more rapidly than the customer base. For example, strong industrial growth can quickly increase electrical consumption, as can things like major data center developments or a crypto-mining company setting up operations.

OGE Energy has the same situation as PNM Resources ( PNM ) in that it saw its electrical consumption increase much more rapidly last year than did the customer base. The company reports that electrical consumption was up 3.1% in its service area last year compared to 2021 levels:

As customers are billed based on the amount of electricity that they consume, an increase in the load growth results in an increase in revenue. This certainly proved to be true during the fourth quarter as OGE Energy reported total revenue of $711.9 million compared to $581.3 million in the fourth quarter of 2021.

In the introduction, I stated that one of the characteristics of utilities like OGE Energy is that they enjoy remarkable financial stability. This is because of the fact that these companies provide a product that is generally considered to be a necessity for modern life. After all, how many people do not have electric service in their homes today? As such, most people will prioritize paying their utility bills ahead of discretionary expenses when money gets tight.

That is something that could be important today as there was a great deal of uncertainty injected into the market over the past week due to the collapse of a major regional bank and growing concerns that other banks may be facing similar problems. However, the average person will continue to pay their electric bill no matter what happens so owning a stock like OGE Energy could certainly help you sleep well at night through whatever may be coming down the pipeline.

At this point, there may be some readers thinking that they want better than just mere stability and the relatively low 3.1% growth in consumption. After all, companies in other industries are promising much higher growth rates. Fortunately, OGE Energy is positioned to deliver better numbers than these. The way that the company is planning to do this 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 in the rate base allows the company to increase the price that it charges its customers to earn that specified rate of return. The usual way that a utility will increase its rate base is by investing money into upgrading, modernizing, and even expanding its utility-grade infrastructure. OGE Energy is planning to do exactly this as the company has unveiled a $4.75 billion capital investment program to run over the 2023 to 2027 period:

It is actually very nice to see the company unveil a plan for these dates as most utilities are still providing plans running from 2021 to 2025 or 2022 to 2026. At this point, the planned spending for 2021 and 2022 is well in the past and rather irrelevant for future-looking investors. The fact then that this one provides a more current plan is greatly appreciated. Unfortunately, OGE Energy did not state the amount that this plan can be expected to increase its rate base, but it has guided for 5% to 7% compound annual earnings per share growth over the 2023 to 2027 period.

When we combine that with the company’s current 4.82% current yield, investors should be able to expect a 10% to 12% total average annual return, which is very impressive for an otherwise conservative utility company. That is in line with the 6.3% compound annual growth rate that the company is expecting to deliver over the 2021 to 2023 period:

When we consider the overall safety of this utility company compared to many other things, this could prove to be a very reasonable investment given the widespread fears today.

Financial Considerations

It is always important that we review the way that a company is financing 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 usually accomplished by issuing new debt and then using the proceeds to repay the existing debt. That can cause a company’s interest expenses to increase following the rollover depending on the conditions in the market.

As interest rates have been rising over the last year and are currently at the highest rate that we have seen in a decade, this is something that could be very important today. In addition to this, a company must 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 like OGE Energy tend to have remarkably stable cash flows, this is still a risk that we should not ignore as bankruptcies have occurred in the sector.

One ratio 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 through debt as opposed to wholly-owned funds. In addition, it tells us how well a company’s equity can cover its debt obligations in the event of bankruptcy or liquidation, which is arguably more important.

As of December 31, 2022, OGE Energy had a net debt of $4.4953 billion compared to $4.4134 billion of shareholders’ equity. This gives the company a net debt-to-equity ratio of 1.02 today. This is unfortunately worse than the 0.92 ratio that the company had the last time that we discussed it. However, it is certainly not too bad compared to the industry as a whole. We can see this by comparing the company’s ratio to some of its peers:

As we can clearly see, OGE Energy has the lowest net debt-to-equity ratio of any of its peers, despite the fact that the company’s ratio has increased a bit since the last time that we looked at it. Overall, this should be a sign that we do not have to worry too much about the company’s debt as it still has a very reasonable balance sheet.

Dividend Analysis

One of the reasons why utilities have proven popular among more risk-averse investors is because of their relatively high dividend yields. OGE Energy is certainly not an exception to this as the stock has a 4.82% yield at the current price. The company also has a long history of raising its dividend annually, although admittedly recent dividend increases have been very meager:

The fact that the company historically increases its dividend every year is something that we should be able to appreciate in inflationary environments, such as the one that is currently dominating the economy. 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. This can make it feel as though we are getting poorer and poorer with the passage of time. The annual dividend increases that OGE Energy delivers help to offset this effect and ensure that we can maintain our purchasing power over time.

However, the last few dividend increases were much less than the current inflation rate, so they did not have as big of an offsetting effect as we would like. The small increase is still better than a flat payout, though. As is always the case, we do want to ensure that the company can actually afford its dividend. After all, we do not want to find ourselves the victims of a dividend cut, since that would both reduce our incomes and almost certainly cause the stock price to decline.

The usual way that we judge a company’s ability to cover its dividend is by looking at its free cash flow. A company’s free cash flow is the amount of cash that was produced by its ordinary operations that is left over after the company pays its bills and makes all necessary capital expenditures. This is the money that can be used for things like repaying debt, buying back stock, or paying a dividend. In the fourth quarter of 2022, OGE Energy had a negative levered free cash flow of $283.5 million. That is obviously not enough to pay any dividends, but the company still paid out $82.9 million in dividends to its investors. At first glance, this is likely to be quite concerning as the company is clearly failing to generate sufficient cash to cover its dividends.

However, it is not uncommon for utilities to finance their capital expenditures via the issuance of debt and equity while using their operating cash flow to cover the dividend. This is due to the incredibly high costs involved in constructing and maintaining utility-grade infrastructure over a wide geographic area. In the fourth quarter of 2022, OGE Energy had an operating cash flow of $75.3 million. Unfortunately, this was also not enough to cover the $82.9 million that the company paid out in dividends.

That is certainly concerning; however, the company’s full-year operating cash flow was $843.1 million compared to $329.3 million in dividends paid out. Thus, it does appear that overall the company is covering its dividend over the course of the year, although it may fall short during certain quarters. However, the dividend is probably still sustainable overall.

Valuation

It is always critical that we do not overpay for any stock 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 OGE Energy, one method 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 earnings per share growth into account.

A price-to-earnings growth ratio of less than 1.0 is a sign that the stock is undervalued relative to its forward earnings per share growth and vice versa. However, the market remains quite richly valued today and as such, there are not very many stocks that appear significantly undervalued. Thus, the best way to use this ratio is to compare OGE Energy to its peers and see which stock offers the most attractive relative valuation.

According to Zacks Investment Research , OGE Energy will grow its earnings per share at a 10.20% rate over the next three to five years. That is significantly higher than the 5% to 7% guidance that the company’s management provided, and it is somewhat uncertain how Zacks’ analysts came up with that figure. Nonetheless, that gives the company a price-to-earnings growth ratio of 1.66 at the current price. Here is how that compares to the company’s peers:

As we can clearly see, OGE Energy appears substantially undervalued to its peers when using this metric. However, that is assuming that the Zacks earnings growth estimate is correct. If we use the 6.3% growth rate that management projected over the 2021 to 2023 period, the stock’s price-to-earnings growth ratio falls to 2.69, which is relatively in line with its peers. Thus, the company appears to be fair to undervalued today, depending on what we assume for its growth rate.

Conclusion

In conclusion, the events of the past week may have caused investors to begin looking for a safe haven as the collapse of Silicon Valley Bank has sparked a great deal of market volatility. Fortunately, OGE Energy Corp. is a reasonable choice as a safe haven as its strong balance sheet and stable revenue should allow it to weather whatever might come. The fact that it has some growth potential, and a very high dividend yield is icing on the cake. Overall, it appears that there could be some very strong reasons to buy OGE Energy Corp. stock today.

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