2023-05-08 17:25:41 ET
Summary
- Two companies both growing EPS at 6% per year, the first one not paying a dividend, the second one paying a dividend, yielding 4% and increasing at 6% per year.
- If the P/E multiple for each company remains constant, even if different, then share prices for both will increase by 6% per year.
- In the scenario described above, the total return on investment in the first company's stock will be 6%, while for the second company, total return will be 10% per year.
- That is the magic of DGI investing, of which Allete is a good example.
- What I mainly explore in this article is the failure of Allete to meet its, "long-term objective of achieving average annual earnings per share growth of 5 to 7 percent".
Investment Thesis
Background -
On Dec. 28, 2020, with the share price at $60.90, I published an article on ALLETE, Inc. ( ALE ), " Allete: Potential Returns Above 25%, Manageable Risk ." Two years and four months later at May 5, 2023 the share price has increased to 62.59, a mere 1.2% average yearly increase in share price. Add the 4.1% average yearly dividend yield on cost and we have a total return of 5.3% average per year, far short of the potential returns above 25%. But at least the dividend has delivered a positive return in the mid-single digits. One of the great advantages (or perhaps pitfalls) of quantitative analysis is the ability to look back and quantify why 'what if' estimates have or have not been realized.
Potential for return above 25% was real -
Subsequent to publication of above mentioned article, the Allete share price hit a high of $73.10 on Aug. 6, 2021. At that point in time, total gain per share, including dividends, was $13.46, an annualized return was ~36%, well above 25%. But to be honest that was not what I projected in my investment thesis in December 2020.
The basis for the December 2020 investment thesis -
The December 2020 projected return quantification was based on four analysts' EPS forecasts for 2022 ranging from low $3.92 to high $4.05, with consensus of $4.01. The assumed multiple was a calculated average P/E ratio for 2016 to 2020 of 21.99, giving a projected share price at end of 2022 of $88.18 based on consensus EPS estimates. The actual price at the end of 2022 was $62.59.
What went wrong -
In February 2021, Allete announced preliminary EPS guidance for 2022 in the range $3.70 to $4.00. In April 2021 analysts' consensus estimate for 2022 was $3.93, down from $4.01 in December 2020. In February 2022, Allete lowered guidance for 2022 to a range of $3.60 to $3.90 with a midpoint of $3.75 (regulated operations $2.60-$2.80 and Clean Energy and other $1.00-$1.10). Allete confirmed this guidance as late as November 2022, by which time analysts had reduced their consensus EPS estimate for 2022 to $3.76. On Feb. 16, 2023 Allete announced 2022 EPS of $3.38, down ~10% on November midpoint guidance of $3.75. A reconciliation of FY 2022 actual results to guidance, from Allete's Slide 10 in the Q4 earnings call presentation appears in Fig. 1 below.
Figure 1
Excerpted from SA Premium Allete Q4 earnings call transcript ,
These financial results were below our third quarter guidance update, where we expected... the midpoint of our 2022 earnings guidance range of $3.60 to $3.90 per share... primary reasons relate to recording a full year of intermittent reserves in the fourth quarter for the outcome in the Minnesota Power rate case decision, further cost and losses taken out ALLETE Clean Energy on the now completed northern wind project, and weather impacts in the fourth quarter due to winter storm events.
The narrative above reads like the major cause of the shortfall against guidance was due to Regulated Operations related to rate case reserves. My analysis in Fig. 2 below, based on Allete published data, tells a very different story.
Figure 2
From Fig. 2 it would appear Regulated Operations 2022 EPS of $2.68 was only slightly below midpoint of guidance of $2.70. The shortfall against midpoint of guidance in 2022 appears to be entirely due to Non-Regulated Operations with Clean Energy the overwhelming contributing factor. While dilution due to share issues in March 2022 has impacted EPS this would have been known and included in guidance estimates.
Outlook -
Both Clean Energy and Regulated Operations contributed to a decrease in earnings in March quarter 2023 versus corresponding period in 2022 as shown in Fig. 3 below from page 6, Q1 2023 earnings call presentation .
Figure 3
Comments excerpted from Allete Q1 2023 earnings call transcript,
ALLETE's Regulated Operations segment recorded first quarter 2023 net income of $40.6 million, compared to $51.5 million in 2022. Earnings for 2023 reflect lower net income at Minnesota Power, primarily due to the timing of interim rate reserves previously mentioned and lower kilowatt hour sales due to milder winter weather conditions as compared to last year. Also impacting 2023 was higher operating and maintenance expense.
ALLETE Clean Energy was below our expectations for the quarter by approximately $0.05 per share, primarily due to weather impacts causing more wind resources and availability across much of the fleet. However, the $160 million profitable sale of the Red Barn build transfer project in April will be a positive impact to our second quarter financial results.
New Energy is on track to achieve full year earnings of $16 million to $17 million as reflected in our initial guidance. Considering these items in total, we remain on track to achieve our full-year 2023 earnings guidance of $3.55 to $3.85 per share.
Figure 4 below is an attempt to put all of the foregoing into context in regard to Allete's actual performance against and ongoing guidance for, "Accelerating clean energy trends drive 5% to 7% EPS growth".
Figure 4
In Fig. 4 above, I have used 2020 as the base year for comparison of achievement against objectives. Excerpted from SEC 8-K dated Feb. 13, 2020 ,
Allete... today initiated its 2020 earnings guidance range of $3.40 to $3.70 per share on net income of $180 million to $190 million. This guidance range is comprised of our Regulated Operations segment earnings within a range of $2.75 to $2.95 per share, and ALLETE Clean Energy and Corporate and Other operations earnings within a range of $0.65 to $0.75 per share. We reaffirm our long-term objective of achieving average annual earnings per share growth of 5 to 7 percent. (bolding by author)
Expectations as reflected in EPS guidance -
- 2022 guidance - Fig. 4 shows, compared to expectations in 2020 per guidance at that time, expectations for total EPS in 2022 reflected an EPS growth rate of just 2.78% average per year, with expected negative growth of (2.66%) per year for Regulated Operations almost entirely offsetting anticipated 22.47% per year growth in Non-regulated Operations. This 2.78% is far short of the 5 to 7 percent objective.
- 2023 guidance - Fig. 4 shows, compared to expectations in 2020 per guidance at that time, expectations for total EPS in 2023 reflected an EPS growth rate of just 1.39% average per year, with expected negative growth of (3.01%) per year for Regulated Operations almost entirely offsetting anticipated 16.25% per year growth in Non-regulated Operations. This 1.39%% is far short of the 5 to 7 percent objective.
Actual EPS growth rates compared to objectives -
- 2022 actual - Fig. 4 shows average growth rate of 0.35% per year, with growth rate of 1.02% for Regulated Operations almost completely offset by negative growth rate of (2.09)% for Non-regulated Operations. Clean Energy, included in Non-regulated Operations, is stated as the driver of the objective for 5-7% EPS growth, so it is surprising to see negative growth while Regulated Operations shows positive growth over the two years 2020 t0 2022.
- 2023 Projected Net Income - The projections included in Fig. 4 for 2023 are based on the midpoint of guidance for 2023. On this basis, average yearly Net Income growth rate for the three years 2020 to 2023 is 6.43%. While this falls within a 5 to 7% band, it is for Net Income rather than EPS.
- 2023 Projected EPS - The projections included in Fig. 4 for 2023 are in line with the midpoint of guidance for 2023. On this basis, average yearly EPS growth rate for the three years 2020 to 2023 is 3.77%. This is lower than projected Net Income growth rate of 6.43% due to increasing share count from share issues. While well above the 0.35% for 2020 to 2022, this 3.77% average yearly growth rate for three years 2020 to 2023 is still well short of the 5-7% objective. And the projections have yet to be met.
Summary and Conclusions
As discussed at the beginning of this article, total returns since my 2020 article linked above have been limited by low share price growth. This is not surprising given the 0.35% per year growth in EPS from end of 2020 to end of 2022 as shown in Fig. 4 above. The saving grace for Allete is the 4% dividend yield. The current dividend is well covered by current earnings, and continuation of payment of dividend at the current rate does not require EPS growth. On that basis, a DGI investor could buy Allete stock at the current share price and reasonably expect to continue to receive dividends at a yield on cost of ~4% per year. If management is able to achieve their objective of 5% to 7% EPS growth in the long term, then total returns of 9 to 11% could be possible. Unfortunately, based on my detailed analysis above, the jury is still out on the matter of 5-7% EPS growth. For DGI investors Allete is a hold, if only for the fairly assured 4% dividend yield. If management is to progress towards its EPS growth objectives, there is a need in the remainder of 2023 for a reversal in the trend of negative EPS growth for Clean Energy, evidenced through end of 2022 and into Q1 2023. In this regard, it is possibly wise to adopt a wait and see approach for those seeking share price growth in addition to a solid dividend yield.
For further details see:
Allete: Magic Of DGI But Clean Energy A Drag On Earnings Growth