2023-10-20 10:16:23 ET
Summary
- WEC Energy Group is a quality large-cap utility with 4.6 million retail customers, serving Wisconsin, Illinois, Michigan, and Minnesota.
- The company is rapidly moving away from coal generation, by investing in renewables, and hopes to phase coal out entirely by 2035.
- WEC Energy has a strong dividend growth history and the current yield is 3.78%. Earnings are expected to grow 6.5-7.0% annually near term.
- There are two series of preferred shares, M and P, paying a 6.0% or higher yield, and these may be an attractive alternative for income investors.
WEC Energy Group (WEC) is a utility that has existed in various forms since it began in Milwaukee in the 1890s. The current version of the business emerged as a holding company in 1986. WEC provides electricity, natural gas, and renewable energy in several markets; it currently has 4.6 million retail customers. This is a large-cap stock with a total value of $26.0 billion.
In the states of Wisconsin and Michigan, WEC sells electricity and natural gas. Natural gas is also provided to portions of Illinois (including the city of Chicago) and Minnesota. A map of the service areas is presented below. WEC is the only utility choice in most of its markets and the Wisconsin operations generate about two-thirds of the company's business. The 2022 Annual Report has a full list of the company's utility subsidiaries and affiliates (I counted some 34), but the more recognizable names include Wisconsin Electric, Wisconsin Public Service, Wisconsin Gas, Upper Michigan Energy Resources, American Transmission, Minnesota Energy Resources and North Shore Gas of Illinois.
WEC shares are currently trading at $82.45 down 23.4% from a recent peak of $107.69 in August 2022, with a dividend yield of 3.78%. The current beta is 0.44, so the stock is significantly less volatile than the market. WEC is perceived as a premier Mid-Western utility and in my opinion, you are paying for perceived quality in addition to the dividend. This company in many ways reminds me of Consolidated Edison (ED) - it's a strong investment, but shares never seem to be as cheap as you'd like them to be. Below is a chart of the share price history over the last five years.
Performance in 2022 - 2023
In its Second Quarter 2023 report, WEC Energy reaffirmed its 2023 annual earnings guidance of $4.58 to $4.62 per share, assuming normal weather for the remainder of the year (i.e., no warm spells that would reduce energy consumption). That said, the 2023 Investor Presentation indicates that WEC exceeded its guidance for each of the last 19 years; as this appears to be consistent, I believe EPS will be closer to $4.65 or higher (a number I'll use to value the company's shares in a later section). During the last 20 years earnings per share have grown at a compound annual growth rate of about 9.0% as illustrated below. If that's true again this year, EPS would be $4.86. However, the company estimates current growth of 6.5-7.0%. If we use this number, 2023 EPS would be about $4.75. My estimate of $4.65 could be conservative, therefore.
According to 2023 Q2 results that were published, second-quarter earnings were $0.92 cents, $0.08 cents higher than the consensus. According to the CEO: "After a down first quarter marked by one of the warmest winters on record, we delivered solid results in the second quarter. And we're firmly on track for a strong 2023." Net income was $289.7 million for the second quarter of 2023, up slightly from $287.5 million or $0.91 per share in 2022. For the first six months of 2023, the company had a net income of $797.2 million, or $2.52 per share, down 6.6% from $853.4 million, or $2.70 per share in the first half of 2022, again due to a record warm weather last winter. Despite this short-term setback, WEC is still on track to meet or exceed its guidance.
In 2022, revenues were $9.59 billion, up 15.3% from $8.32 billion in 2021. In 2020 revenue was $7.24 billion. Net income was $1.41 billion in 2022, up 8.5% from $1.30 billion in 2021, and up 18.5% from $1.19 billion in 2020. The increase in net income in 2022 was partly achieved by a decrease in operating costs during the year. Another portion of the 2022 increase in income (a not insignificant $45.2 million) was created by higher government Production Tax Credits, from the company's Jayhawk Wind Park, which recently began operation, plus higher generation volume at other wind parks, per the 2022 Annual Report.
Capital Expenditures and Moving Away from Coal
WEC's "about us" page says the company currently has 7,700 megawatts of power generating capacity. In 2005, 73.0% of the power generated was done using coal; in 2021 that number dropped to 39.0%, with natural gas electric generation making up the difference and going from 7.0 to 33.0% between those years. The company's present goal is to meet the terms of the 2015 Paris Climate Accords, so it plans to reduce carbon emissions from its electric generation to "60% below 2005 levels by 2025 and 80% below 2005 levels by 2030." By 2050, WEC hopes to be "net carbon neutral." The near-term amount budgeted to achieve this goal is $20.1 billion, to be spent over the next five years, through 2027. A significant part of this is earmarked for creating renewable energy infrastructure. About $5.4 billion of the amount will be spent for new regulated solar, battery storage, and wind developments in the state of Wisconsin. Another $3.6 billion will be spent to replace outdated infrastructure, and another $2.0 billion will be invested in "unregulated renewable energy infrastructure, with higher returns than WEC's rate-regulated businesses."
Over the last five years, WEC has already retired more than 1,800 megawatts, or 23.4%, of its coal generation capacity. The goal by 2026 is to retire another 1,600 megawatts of coal, taking the percentage up to 44.2%. This lost capacity is expected to be replaced with solar and wind generation.
Notes on Rate Structures and Debt
The holding company WEC consists of a basket of regulated utilities. As of October 2023, the allowed return on equity ranged from 9.05% to 10.52% depending on the entity and the state, as outlined in the table below.
For 2024, Wisconsin rates are under review and there are proposed rate increases of between 0.5% and 1.3% for electric and between 2.9% and 4.5% for natural gas, per the September Investor Book . A final decision is expected in the fourth quarter of 2023. This adjustment addresses the recovery for new renewable costs. The Wisconsin Commission has already approved more than $1 billion of capital investment costs for these since the end of 2021. In Wisconsin, WEC rates are based on a "forward test and an earnings-sharing rate" over its allowed return on equity. The state is generally considered favorable for utility regulations.
Rising interest rates have had some impact on the company since the Fed began raising rates. Interest expenses for the Wisconsin and Illinois segments of the business increased during calendar 2022, mostly due to long-term debt that was issued in late 2021. Below is the ratio of total debt to capitalization since 2015, which you can see has been rising slowly, but steadily, not necessarily following the Fed's increases in rates but rather tracking increased capital expenditures.
Dividend History
In January of 2023, WEC raised its quarterly dividend by 7.2% to $0.78 per share from $0.728 per quarter. This is the 20th consecutive year of dividend increases. If it continues this trend, which I believe it will, WEC will be a member of the S&P 500 Dividend Aristocrats in 2028, where members have increased their dividends for a minimum of 25 years. Increases in the last few years have been in excess of 7.0%, so generally exceeding inflation, which is important: 7.4% in 2022, 7.1% in 2021, and 7.2% in 2020. Over the last 20 years, the dividend has grown at a compound annual growth rate of 10.8%. While it made healthy increases through the 2008-2010 financial crisis, it is also important to note that in 2000, WEC cut its dividend from $0.195 per quarter to $0.10 and left it there for three and a half years. At the time, the dividend was cut to finance $6.0 billion in infrastructure , including coal-fired electricity generating plants.
In recent years, the payout ratio for WEC has been in a narrow range of 65.0-68.0%. The exact payout ratio over time is presented below. This assumes 2023 income reaches the average (though, as previously stated, probably low) consensus number of $4.61 per share. The Edison Electric Institute cites the utility average 2022 payout ratio as 69.4%, but ratios do vary widely from companies like Xcel Energy (XEL) at 63.9%, to Alliant Energy (LNT) at 78.6%, Consolidated Edison at 45.9%, and American Electric Power (AEP) at 76.6%. The Institute also reports the average utility dividend yield for 2022 as 3.4%.
Utility shares have been trending lower lately, as interest rates have increased, boosting yields across the board. You can compare the current 3.78% yield at WEC to other utility stocks such as Xcel at 3.5%, PPL Corporation (PPL) at 4.0%, Southern Company (SO) at 4.17%, Consolidated Edison at 3.67%, American Electric Power at 4.42%, and Spire Incorporated (SR) at 4.9%. It is also worth comparing to an index like ProShares Ultra Utilities (UPW) with a current dividend yield of 2.89% (and down 32.8% from its peak price) or Utilities Select Sector SPDR Fund (XLU) at 3.6% (down 19.2% from its peak). But it is also important to note that WEC Energy has two series of preferred shares.
Two Series of Preferred Stock are Alternatives
There are two series of preferred shares outstanding at WEC: the M Shares (WELPM) and the P Shares (WELPP), also known as the 6.0% series and the 3.6% series, respectively. These both trade on the OTC Markets and are rated Baa1 by Moody's, or lower investment grade. I searched and could not find a prospectus online for either series, as apparently, both debuted before EDGAR, though Computershare is their transfer agent. I also called WEC's Investor Relations on this issue and have yet to hear back. Both series were issued at $100 a share. The 6.0% series, WELPM, pays $1.50 quarterly and currently trades at $97.50 , a slight discount from the original $100 issue price, with a yield of 6.1%. These are reportedly non-redeemable and with no stated maturity. The 3.6% preferred shares, WELPP, are currently trading at a discounted $60.00 per share and pay $0.90 quarterly for a yield of 6.0%. These are reportedly redeemable at any time, but I would think the 3.6% Series would be left outstanding by the company, given its now below-market rate. Volume on both of these is less than 1,000 shares per day. Perhaps a reader has access to these prospectuses.
Share Valuation by DCF and P/E Ratio
WEC Energy reaffirmed its 2023 annual earnings guidance of $4.58 to $4.62 per share, but as indicated in the 2023 Investor Presentation, WEC has exceeded its guidance for each of the last 19 years. This appears to be a consistency, so I have used $4.65 to value the company's shares, though this is likely low. WEC Energy also has a narrow 6.5%-7% annual earnings growth target.
I estimate the current value of WEC shares to be US $83.42, so at today's price of $82.45, shares are about fully valued. I used a discounted cash flow to value the stock, with my rounded-up earnings per share of $4.65, beginning in 2023, and then projecting forward. In this case, I have used a 5-year projection period. For the discount rate, I looked at the average annual return of the S&P 500. The long-term average is about 9.8% , while over the last 10 years it has been higher at 12.4% . I used a discount rate of 9.25%, just below the lower end of the range, and discounting beginning in the second year. As a regulated utility, I believe WEC deserves a lower risk premium.
Below are WEC's annual earnings since 2018. Between 2018 and 2023, the compound annual growth rate in earnings per share was 6.8%, within the company's stated range. Morningstar forecasts a median 6.0% annual EPS and dividend growth across the overall utility sector. This is also supported by Institutional Investor , which has projected 6.0% per year growth for utilities over the next three years.
I have valued the shares using my projected EPS of $4.65 in 2023, then a 6.0% growth rate in net income each year over the next five years and a 9.25% discount rate. I have estimated a reversion rate of 6.5%, to account for future growth.
Although much of the utilities sector is selling at a discount (Morningstar says the current median P/E of 16 is the lowest since exiting the 2008-09 recession), WEC shares appear to be fully valued. As a cross-check, I have valued the shares using a traditional P/E ratio calculation for gas utility companies. Gabelli Funds has a useful chart indicating that the average US Large Electric utility ratio for 2024 would be 16.3. Applying this to the estimated 2023 earnings per share, the value would be $4.65 x 16.3 = $75.80. At the 2023 P/E ratio of 17.0, shares would be $4.65 x 17.0 = $79.05. Given the current price of $82.45 and these two similar value estimates, shares appear to be fully valued.
Risks to Outlook
In its service areas, WEC Energy has no direct competition. Rate regulations seem favorable in the primary Wisconsin market it serves. It does seem that one of the major risks to income is unseasonably warm weather, as happened in the winter of 2023. Of course, a warm winter means less usage. However, this could be offset by the possibility of a warmer than usual summer, which would also boost demand for energy, just with different timing. The other risk is further increases in interest rates, which could create higher debt-carrying costs and make a 3.5-5.0% dividend-paying stock less attractive than a 5.25% paying money market fund. I believe WEC is unlikely to cut its dividend again, as it did in 2000.
Conclusion
WEC is a stable and growing utility with a cohesive plan to move away from coal. It is a quality business and that quality comes at a premium. The current P/E ratio ranges from 18 to 19.0 times earnings, depending on the day, while the average large electric utility currently has a P/E ratio of 16.0. I do think WEC is a strong long-term dividend play, with some potential share price upside. Again, like Consolidated Edison, the shares may never be as cheap as you'd like them to be. The key is buying under $80 per share, but even at a price of $75.00 per share, the dividend yield is only 4.2% (WEC shares only went as low as $74.00 in the March 2020 selloff). I would personally buy the stock under $80.00; it is appropriate for dividend investors who can accept the "decent" dividend, but with an annual growth rate of 7.0%, well above inflation. But the two series of 6.0% preferred shares are likely a stronger option for dividend investors, you just need to get a hold of the prospectuses.
For further details see:
WEC Energy: Fully Valued, Buy The Dip Or The Preferred For Higher Yield