2023-11-07 18:02:48 ET
Summary
- Ameren Corporation is a regulated electric and natural gas utility serving Missouri and Illinois with a large customer base.
- The company's recent market performance has been disappointing, but it is primarily due to utilities being treated as bond alternatives.
- Ameren's financial stability and high dividend yield make it an attractive investment, despite potential challenges from population decline and slower coal exit.
- The company is less dependent on leverage than some of its peers, which is a positive in a high-rate environment. It is still suffering rising financing costs, though.
- The company is a bit expensive compared to its peers, but it might be worth it for more risk-averse investors.
Ameren Corporation ( AEE ) is a regulated electric and natural gas utility that serves the states of Missouri and Illinois. This company’s service territory is fairly heavily populated, especially around the city of St. Louis, Missouri. This has resulted in the company having a fairly high customer count that places it among the largest utilities in the United States. However, as I have pointed out in various previous articles, the overall size of a utility company is irrelevant to its possession of certain innate characteristics. Among these is the fact that utility companies tend to have relatively stable cash flows and high dividend yields regardless of the conditions of the broader economy. It is this overall stability and 3.22% yield that forms the bulk of the investment thesis that I laid out in my previous article on this company.
Much of the thesis remains intact, although the company’s market performance since the date that the previous article was published has been quite disappointing. As we can see here, shares of Ameren Corporation are down 2.54% since August 26, 2023 (the date that my prior article was published), which is a worse performance than that of the S&P 500 Index ( SP500 ) or the U.S. Utilities Index ( IDU ):
This overall underperformance seems quite certain to be a bit of a turn-off for many investors, but it should not be. After all, the biggest reason for this performance shortfall is the fact that utilities like Ameren are frequently treated as bond alternatives by the market. In short, the stock goes down when interest rates rise. This is due to the general stability of the company’s finances as well as the high yield that it pays out.
A few months have passed since the date that we last discussed this company. This has naturally brought about some events that may force us to revise our thesis, so it would be a good idea for us to revisit this company and determine if our original thesis is still valid.
About Ameren Corporation
As stated in the introduction, Ameren Corporation is a regulated electric and natural gas utility that serves the eastern half of the state of Missouri and most of the state of Illinois:
Ameren Corporation
There are parts of this territory that are very heavily populated, especially the area around St. Louis, Missouri. As a result, Ameren Corporation has approximately 2.4 million electric and 900,000 natural gas customers purchasing its services every single day. That is sufficient to make this one of the largest utilities in the United States.
Unfortunately, it is questionable how long the company will be able to maintain its customer base at its current level. After all, Illinois has been one of the most rapidly shrinking states in the nation since 2020. In 2020, the state had a population of 12.8 million but the U.S. Census Bureau projects that it will only be home to 11.9 million people by 2029:
We can debate a number of reasons why this might be the case, but I have little interest in such a debate. This population decline could have an impact on Ameren’s top-line revenues going forward, as naturally the fewer people that are living within its service territory, the fewer people who will be paying their monthly utility bills. With that said though, a significant portion of the population decline is occurring within the city of Chicago, which has seen its population fall by 1.65% annually over the past three years. Ameren does not service the city of Chicago so it would be unaffected by this. In fact, it would benefit if people were leaving Chicago and settling in southern Illinois, but the statewide population decline suggests that this is not the case.
Fortunately, Missouri fares somewhat better than Illinois. The U.S. Census Bureau projects that its population will increase at a 0.18% rate over the 2020 to 2023 period:
However, that is nowhere close to enough to offset the overall population decline in Illinois. Thus, it seems likely that Ameren’s customer base will shrink somewhat over the remainder of this decade. That will naturally be somewhat of a headwind on the company’s revenue growth, as it will have fewer customers using electricity or paying their monthly utility bills. As we will see later though, the company will probably still be able to deliver some revenue and earnings growth over the period.
As mentioned in the introduction, one of Ameren’s core characteristics is that it exhibits considerable financial stability regardless of the conditions in the broader economy. We can see this quite clearly by looking at the company’s revenues and operating income over time. Here are Ameren’s revenues during each of the past ten years, along with the trailing twelve-month period:
Here is the company’s operating income over the same period:
As we can clearly see, neither measure of financial performance was affected by events such as the pandemic, the incredible shift in monetary policy that took place last year, the inflation that existed during 2021 and 2022 (and continues to this day), and really any other economic event that took place over the timeframe. It is almost a shame that there was no real recession in that period as that would be useful to show that even a recession has minimal impact on the company’s financial performance.
I explained the reason for this stability in my previous article on this company:
The reason for this is that Ameren provides a service that is generally considered to be a necessity for our modern way of life. As such, people prioritize paying their utility bills ahead of discretionary expenses during periods when money gets tight.
During a recession or other economic shock, many people will cut back on their discretionary spending and other leisure activities. They also begin spending a greater proportion of their time at home. In such an environment, nobody will want to risk having their electric or natural gas service shut off. They will therefore cut back on just about anything else in order to ensure that their utility bill gets paid. This is perfect for Ameren, for obvious reasons. It should also work out well for investors in such a climate, as a company with that characteristic should be able to weather challenging economic conditions than a company that is much more dependent on consumers' willingness to engage in “free spending” activities.
As is the case with most electric utilities right now, Ameren Corporation is very actively working on developing its renewable energy generation capacity. The company states that it expects to construct or otherwise acquire approximately 2.8 gigawatts of renewable energy generation capacity by 2030, 4.7 gigawatts of capacity by 2040, and achieve net-zero carbon emissions by 2045. Naturally, one of the things that it will be doing to accomplish this goal is to retire its remaining coal generation capacity. However, the company is going to take longer to accomplish this task than some of its peers. Ameren states that the Labadie coal plant will continue to operate in at least some capacity through 2042. There are some other utilities that are planning to completely exit coal by 2030 or even earlier.
The fact that Ameren Corporation will be taking longer to completely exit coal generation than some peers may cause it to fail to appeal to the environmental, social, and governance funds that control a substantial amount of money. That may cause underperformance relative to its peers. With that said though, I pointed out in a recent article that these funds are less powerful than they were a few years ago as environmental, social, and governance investing has been failing to live up to the demands of investors in a high-interest rate world. They have pulled their money out of these funds, effectively reducing their power. As such, a company does not have to worry about its ESG scores as much as it used to, and it can make smarter investments and financial decisions as a result.
The fact that Ameren is taking longer to exit coal than some of its peers could be a good thing. This is because renewable generation technologies today are nowhere near capable enough to maintain a stable grid. I pointed this out in a blog post from earlier this year. In short, the problem with both types of generation is that they are intermittent and unreliable. Utilities are either forced to construct a substantial amount of excess generation capacity or supplement the renewable generators with fossil fuels anyway. Batteries, at least those using any formulation technology available today, are nowhere near capable of solving this problem. It is certainly possible that new technologies will eventually overcome these challenges, especially if humanity manages to discover something other than wind and solar power, which would actually render a substantial amount of the current investments in deploying these technologies wasted money. Ameren seems to be taking a measured approach here, which is good for the risk-averse and conservative investors who tend to purchase stocks in utility companies.
Growth Opportunities
A look at Ameren’s revenue and operating income, as presented earlier in this article, reveals that the company tends to grow both over time. This is something that is very nice to see since investors normally like to see the companies in which they are invested grow and prosper with the passage of time. After all, without such growth, Ameren Corporation is merely a very low-yielding bond with all the risks of common equity. That is certainly not an appealing proposition.
The usual way in which a utility company like Ameren generates growth over time is by increasing its rate base. This alternative method of generating growth is particularly important for Ameren because, as we have already seen, the company may not be able to count on a growing customer base. I explained the concept of rate base in my previous article on this company:
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 to the rate base allows the company to positively adjust the prices that it charges its customers in order to earn that specified rate of return. The usual way through which a company increases the size of its rate base is by investing capital into upgrading, modernizing, and possibly even expanding its utility-grade infrastructure.
Ameren Corporation is currently executing a five-year capital investment plan for the 2023 to 2027 period. Under this plan, the company will invest $19.7 billion into infrastructure upgrades and new construction. These projects will increase the size of its rate base at an 8.4% compound annual growth rate over the period.
Unfortunately, the company’s earnings per share will not grow at the same rate. There are a few reasons for this, including the fact that the company will need to finance this capital investment through the issuance of both common stock and debt, and today’s high-rate environment has made both types of financing more expensive than they were over most of the past decade. In addition, the company may face delays with respect to regulatory rate reviews and various other things that create a time lag between when it invests in its infrastructure and when it is able to start getting payback on that infrastructure. Due to these factors, the company projects that its earnings per share will only grow at a 6% to 8% compound annual growth rate through 2027.
When we combine this projected earnings per share growth with the company’s 3.22% current yield, we get a projected total return of 9% to 11% over the period. That is in line with what most of the company’s peers deliver, and it is generally a reasonable total return from a utility stock.
Financial Considerations
As of June 30, 2023, Ameren Corporation has a net debt of $16.000 billion compared with a shareholders’ equity of $10.826 billion. This gives the company a net debt-to-equity ratio of 1.48 today. This is actually pretty low compared to many of the company’s peers:
Company | Net Debt-to-Equity |
Ameren Corporation | 1.48 |
Entergy Corporation ( ETR ) | 1.92 |
DTE Energy ( DTE ) | 1.89 |
Eversource Energy ( ES ) | 1.58 |
CMS Energy ( CMS ) | 1.91 |
(all figures as of June 30, 2023, as those are the most current figures that are currently available for Ameren and allow for more accurate comparison.)
As we can see, Ameren Corporation is somewhat less dependent on debt than many of its peers. This is overall a positive sign, as it should indicate that the company is somewhat less exposed to rising interest rates than some of the other companies in the sector. However, Ameren Corporation is certainly not immune to rising rates, as its interest expenses have been rising over the past few quarters:
As I pointed out in a recent article , rising interest rates are a headwind for growth. This is because the more money that a company spends on interest, the less that is available to make its way down to earnings per share. It also means that there is less money available to pay out to the investors in the form of dividends, which will undoubtedly disappoint anyone who is interested in buying a stock like this. While the rising interest expenses will probably not prevent the company from delivering dividend growth, the dividend may not be increased as rapidly as it otherwise would. In short, the company’s leverage is reducing its ability to generate the earnings and dividend growth that investors would like to see. However, Ameren does not appear to be as bad as many of its peers in this respect because it is less leveraged.
Dividend Analysis
One of the biggest reasons why investors purchase shares of utility companies like Ameren is because of the high dividend yields that these companies tend to possess. This is necessary because of their low growth rates. After all, we have already seen that Ameren Corporation is only expected to grow its earnings per share at a 6% to 8% rate over the next five years. That is not enough to attract investors away from other sectors unless the company provides some additional incentive to purchase its shares. The dividend provides that incentive, although at 3.22%, it is lower than a bond or other fixed-income investment.
Ameren Corporation has a long history of growing its dividend over time:
This is very nice to see in any environment, but it is especially attractive right now. This is because the high inflation that has been prevalent over the past two years has been reducing the purchasing power of the company’s dividend. This is an especially big problem for anyone who is dependent on the company’s dividend to pay their bills, which would include many retirees. The fact that the company raises its dividend annually helps to offset this effect and maintains the purchasing power of the dividend, at least to a certain extent.
As is always the case though, it is critical that we ensure that the company can actually afford the dividend that it pays out. After all, we do not want to be the victims of a dividend cut that reduces our incomes and almost certainly causes the company’s stock price to decline.
The usual way that we judge a company’s ability to pay its dividends is by looking at its free cash flow. During the most recent twelve-month period for which data is currently available, Ameren reported a negative levered free cash flow of $1.401 billion. That is obviously not enough to pay any dividends, but the company still paid out $635.0 million to its shareholders during the period. At first glance, that is quite concerning as it suggests that the company may not be able to afford the dividends that it pays out. After all, it is certainly not generating enough cash internally to cover its expenses, capital expenditures, and dividends.
However, it is very common for a company like this to finance its capital expenditures through the issuance of debt and equity. I mentioned this earlier in this article. The company will then pay its dividends out of operating cash flow. During the most recent twelve-month period, Ameren reported an operating cash flow of $2.502 billion. That is more than enough to cover the $635.0 million dividend with a substantial amount of money left over.
Overall, it does not appear that we need to worry about the company’s dividend very much. It should be able to maintain it going forward as well as deliver an increase during the early part of 2024 just like it normally does.
Valuation
According to Zacks Investment Research , Ameren will grow its earnings per share at a 6.61% rate over the next three to five years. This fits in pretty well with the company’s own projections based on its rate base growth. Thus, this figure seems to be pretty solid. This earnings-per-share growth rate gives the company a price-to-earnings growth ratio of 2.71 at the current stock price.
Here is how Ameren’s current valuation compares with that of its peers:
Company | PEG Ratio |
Ameren Corporation | 2.71 |
Entergy Corporation | 2.50 |
DTE Energy | 2.71 |
Eversource Energy | 2.60 |
CMS Energy | 2.37 |
This is not exactly what we wanted to see. It is apparent that Ameren is a bit expensive relative to its peers, even when considering the share price decline that the company experienced over the past few months. However, Ameren is also a bit less risky than some of these other companies due to its lower debt load. Thus, it appears that it is a bit of a trade-off here and the decision will ultimately depend on how much risk you are willing to assume. I personally doubt the market’s current predictions that rates will be cut significantly in the near future, so it might be best to assume a risk-off position.
Conclusion
In conclusion, Ameren continues to deliver on the overall stability and yield thesis that we have presented in previous articles on this company. Ameren is somewhat less aggressive with its peers with respect to both its financial structure and its net-zero ambitions, but that could be a good thing as today’s high rates have made both stances much more appealing than they were a few years ago. Unfortunately, investors do have to pay a bit more for Ameren Corporation than some of its peers, but that may be worth considering for a particularly risk-averse investor.
For further details see:
Ameren: A Bit Expensive, But May Be Worth It