XEL - Xcel Energy: A Blue-Chip Utility Worth Buying

2023-12-02 05:17:01 ET

Summary

• Businesses with steady demand for their products or services benefit from more reliable earnings growth.
• Xcel Energy's ongoing EPS edged 1.6% higher in the nine months ended September 30.
• The company is financially solid, which is why it possesses an A- credit rating from S&P on a stable outlook.
• Xcel Energy looks to be 10% undervalued relative to fair value from its current share price.
• If the company matches growth expectations and reverts to fair value, it could deliver market-beating 174% cumulative total returns over the next 10 years.

Readers who have followed me for a while know that I especially appreciate businesses that provide products or services to customers that are in high demand. This is because all else being equal, high demand for products translates into growing profits.

That's especially the case for regulated utilities operating in a variety of markets. Through additional investments to improve their existing infrastructure and expand it to additional customers, these businesses tend to collect higher rates over time.

One such utility that I don't own but do believe to be a high-quality company is the electric and natural gas utility Xcel Energy ( XEL ). As a reminder, Xcel Energy has operations in eight states, including my home state of Wisconsin. For the first time since September , I will reexamine the company's fundamentals and valuation to expand on why I believe it remains a buy.

Xcel Energy's 3.4% dividend yield is below the utility sector median of 3.9% . However, I believe this is representative of the overall quality of the company. Xcel Energy offers safe dividend income with moderate growth potential at the expense of starting yield. When investing, this is a common tradeoff. For instance, Xcel Energy's 61% EPS payout ratio is comfortably below the 75% payout ratio that credit rating agencies view as safe.

The company's debt-to-capital ratio of 56% is also less than the 60% that rating agencies think is sustainable per Dividend Kings. For these reasons and the fact that Xcel Energy is a well-established business, S&P rates its debt an A- on a stable outlook. This implies the 30-year probability of bankruptcy is just 2.5% according to Dividend Kings.

Xcel Energy isn't just enticing for its decent fundamentals, either. Using historical dividend yield and P/E ratio valuation metrics, Dividend Kings appraises the utility to be worth $68 a share. Contrasted against the $61 fair value as of December 1, that would mean Xcel Energy is priced at a 10% discount.

Provided the utility meets the growth consensus and returns to fair value, here's how its total returns could stack up against the S&P 500 ( SP500 ) through 2033:

• 3.4% yield + 6.1% FactSet Research annual growth consensus + 1.1% annual valuation multiple upside = 10.6% annual total return potential or a cumulative 174% total return versus the S&P's 9% annual total return prospects or a 137% cumulative total return

Earnings Are Moving Higher

Xcel Energy is having a decent 2023. The company's total operating revenue for the nine months ended September 30 was $10.8 billion, which was down 4.4% over the year-ago period. On the surface, I don't prefer a decline in revenue.

However, for the circumstances, I believe the utility's results were fine. Xcel Energy's actual total retail electric sales are down 0.2% year-to-date. Actual natural gas sales were 1.6% lower year-to-date. These results were mostly driven by unfavorable weather patterns. Adjusting for these headwinds, total electric retail sales would have gained 1.1%, and natural gas sales would have been up 0.4%.

The good news for Xcel Energy is that lower consumption of electricity and natural gas does lessen electric fuel and natural gas transportation costs. That explains how the company's year-to-date ongoing EPS grew by 1.6% over the year-ago period to $2.52.

Looking ahead to next year, Xcel Energy had the confidence to issue 2024 ongoing EPS guidance of $3.50 to $3.60. From the $3.345 in midpoint ongoing EPS expected for 2023, this would represent a healthy 6.1% growth rate. This is in line with the 6.1% annual earnings growth rate that FactSet Research is projecting the company will deliver moving forward. It's also squarely within the 5% to 7% growth that Xcel Energy is targeting.

Propelling this growth is the $34 billion in capital investments that CFO Brian Van Abel noted the company expects to make over the next five-year period from the earnings call . The company anticipates that these investments will grow its rate base by an annual rate of 7.6%.

Best of all, Xcel Energy has the financial ability to execute this plan. The bulk of its funding will be derived from cash from operations, which is after accounting for pension funding and paying its dividend. The company's A- credit rating should allow it to bridge the gap with debt at reasonable interest rates.

Expect 6-7% Annual Dividend Growth To Persist

In the last five years, Xcel Energy has grown its quarterly dividend per share by 36.8% to the current rate of $0.52 . That's good enough for a respectable 6.5% compound annual growth rate.

Considering the midpoint of what Xcel Energy expects to generate in annual ongoing EPS growth is 6%, I expect similar dividend growth in the years to come. Compared to its midpoint ongoing EPS guidance for 2023, the $2.0475 in dividends per share that were paid this year equate to a 61.2% payout ratio.

Risks To Consider

As intriguing of an investment option as Xcel Energy may be, it isn't perfect.

I will largely reiterate the risks that I brought up in my previous article. These include the potential for unfavorable outcomes on rate cases to weigh on growth prospects. However, the appeal to Xcel Energy is that its operations in eight states shield it from this risk more than many peers. Simply put, one or two adverse rate cases aren't going to entirely sink the company.

As a utility, Xcel Energy stock faces competition from other investment vehicles that are also perceived to be lower risk. Elevated interest rates could thus weigh on stock performance for the foreseeable future.

Finally, I would just add that Xcel Energy faces 14 complaints stemming from the Marshall Fire in Boulder County, Colorado that started on December 31, 2021. The fire tragically claimed the lives of two people, burned over 6,000 acres, and destroyed or damaged more than 1,000 structures, with an estimated $2 billion in property losses. Since Xcel Energy's insurance coverage is estimated at $500 million, the difference would be at least somewhat material at $1.5 billion if it is held liable. This could temporarily weigh on the company's operating results and weaken its financial positioning.

Summary: A Boring But Undervalued Business

Xcel Energy isn't the most exciting business out there, but I'm in the business of making money. In my opinion, boring is beautiful in the world of investing. The company has all the attributes that I like to see from investments, such as steady growth, disciplined financial management, and a commitment to growing its dividend.

This is why despite not owning Xcel Energy stock (as a predominantly individual stock-focused investor, I can't own them all), I do like it from a dividend growth perspective. Throw in that it could be 10% undervalued, and that explains my buy rating behind the stock.

For further details see: