2023-05-02 10:20:19 ET
Summary
- Over the past 6 years, Xcel has produced steady earnings growth, around 6% per year.
- In line with EPS growth, Xcel has increased dividends by an average of around 6% per year over the past six years.
- Share price average yearly growth of around 9.5% has exceeded EPS growth due to multiple expansions over the last 6 years.
- Possible multiple contraction is a risk, but not so much for investors prepared to hold for the longer term.
Investment Thesis
Earnings and dividend outlook -
Xcel Energy ( XEL ) has grown net income and dividends at a steady rate of around 6% per year over the last six years. Given that regulated utilities pricing to customers is strictly regulated, allowing for recovery of costs plus a reasonable return, this performance is likely to continue into the future. The main area of concern would be multiple contraction. Share price average yearly growth of 9.5% exceeded EPS growth over the last six years due to P/E expansion from 18.42 at end of 2016 to ~22.0 at present. Nevertheless, the current multiple is close to the average over the last six years and might be more representative of an appropriate multiple than the 2016 figure.
Potential impact of renewables -
One area for growth could be increases in capital spending on renewable infrastructure on which Xcel, along with other regulated utilities, is allowed to earn a regulated return on equity. This could generate additional return on equity for Xcel without increasing tariffs due to offsets from lower ongoing operating costs for renewables. New SA contributor, Blake Downer, recently published an excellent article, " Xcel Energy Is Solving Renewable Energy's Storage Problem ", bringing attention to the company's initiatives in the area of battery storage. I actually came across the article, not directly through Seeking Alpha, but through my ongoing research on advances in battery storage. Battery technology innovations and improvements and cost reductions are advancing at such a pace that I might have to ultimately change my views on any competitive advantages that HFCEVs might have over BEVs for heavy transport applications. I am not quite there yet. But for stationery storage, where battery weight and size are not the same issue, advances such as the iron-air battery technology currently being trialed by Xcel Energy, and a couple of smaller unlisted utility companies, are likely to be a tipping point for cost reduction and longer storage time capability for power utilities. Xcel operates wind and solar farms, generation from which is subject to curtailment at times of generation and demand imbalances, and battery storage could significantly improve economic performance. The technology has not been proven at scale, but that is the purpose of the current trials, and I, for one, will follow developments with great interest.
Summary and conclusions -
Xcel is making significant progress in decarbonising its operations, and solving the storage problem would remove a major potential obstacle to achieving its goals in that regard.
I believe most investors in Xcel are likely to be dividend growth investors seeking reliable, growing dividends in the long-term. Past history and analysts' future EPS projections show a picture of steady, stable growth in both EPS and dividends. Dividend payout ratio has also been held fairly constant with a small reduction over the last six years.
I rate Xcel Energy a hold for existing investors and a potential buy, particularly on any dip in the share price, for investors seeking security of investment and dividends, in the longer term. A more detailed financial analysis follows below.
A More Detailed Financial Analysis
Just because the operations of a listed business perform well does not mean buying shares in that business at any given point in time will result in that investment performing well. My main aim in this more detailed financial analysis is to analyse financial data with regard to -
Total Return, Dividends, and Share Price
The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price. It follows what really matters in share value assessment is the expected price at which a buyer will be able to exit shares, and expected cash flow from dividends.
Changes in Share Price
From a purely mathematical/statistical point of view, changes in share price are driven by increases or decreases in EPS and changes in P/E ratio. Changes in P/E ratio are driven by investor sentiment toward the stock. Investor sentiment can be influenced by many factors, not necessarily stock-specific.
"Equity Bucket"
Earnings are tipped into the "Equity Bucket" for the benefit of shareholders. It's prudent to check whether distributions out of and other reductions in the "Equity Bucket" balance are benefiting shareholders.
Summarized in Tables 1, 2, and 3 below are the results of compiling and analyzing financial data with the foregoing in mind.
Table 1 - Detailed Financial History And Projections
Table 1 analyses historical data from 2016 to 2022, including share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates. For the six years 2016 to 2022, Xcel Energy has grown both EPS and DPS at an average yearly rate of 6.2%. Average yearly share price growth of 9.5% exceeds the EPS growth rate of 6.2% due to P/E multiple expansion from 18.42 at end of 2016 to 22.12 at end of 2022.
The table also includes estimates out to 2026 for share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates (note - while estimates are shown for analysts' EPS estimates out to 2023 through 2026 where available, estimates do tend to become less reliable the further out the estimates go. These estimates are generally only considered sufficiently reliable if there are at least three analysts' contributing estimates for the year in question). Table 1 allows modeling for target total rates of return. In the case shown above, the target set for total rate of return is 7.5% per year through the end of 2025 (see line 12), based on buying at the May 1, 2023, closing share price level. As noted above, estimates become less reliable in the later years. In the case of Xcel Energy, I have decided to input a target return based on 2025 year, which has EPS estimates from 11 analysts. The table shows that to achieve the 7.5% return, the required average yearly share price growth rate from May 1, 2023, through December 31, 2025, is 4.33% (line 51). Dividends, including estimated dividend increases, account for the balance of the target 7.5% total return.
Xcel Energy's Projected Returns Based On Selected Historical P/E Ratios Through End Of 2025
Table 2 below provides scenarios projecting potential returns based on select historical P/E ratios and analysts' consensus, low, and high EPS estimates per Seeking Alpha Premium through the end of 2026.
Table 2 - Summary of relevant projections Xcel Energy
Table 2 provides comparative data for buying at closing share price on May 1, 2023, and holding through the end of 2026. There's a total of twelve valuation scenarios for the year, comprised of three EPS estimates (SA Premium analysts' consensus, low, and high) across four different P/E ratio estimates, based on historical data. Xcel Energy's P/E ratio is presently 21.72, based on TTM Q1 2023 non-GAAP EPS. For Xcel Energy, the present P/E ratio is close to the modified average of historical P/E ratios over the last six years. Table 2 shows potential returns from an investment in shares of the company at a range of historical level P/E ratios. This analysis, from hereon, assumes an investor buying Xcel Energy shares today would be prepared to hold through end of 2025, if necessary, to achieve their return objectives. Comments on contents of Table 3, for the period to 2025 column follow.
Consensus, low, and high EPS estimates
All EPS estimates are based on analysts' consensus, low, and high estimates per SA Premium. This is designed to provide a range of valuation estimates ranging from low to most likely to high based on analysts' assessments. I could generate my own estimates, but these would likely fall within the same range and would not add to the value of the exercise. This is particularly so in respect of well-established businesses such as Xcel Energy. I believe the "low" estimates should be considered important. It's prudent to manage risk by knowing the potential worst-case scenarios from whatever cause.
Alternative P/E ratios utilized in scenarios
- The current P/E ratio . This scenario provides a range of potential returns if the P/E ratio remained at the current level through end of 2025.
- A modified average P/E ratio based on 26 quarter-end P/E ratios from Q4 2016 to Q1 2023 plus current P/E ratio in Q2 2023. The average of these P/E ratios has been modified to exclude the three highest and three lowest P/E ratios to remove outliers that might otherwise distort the result. The present P/E ratio is close to the average so in this instance, this scenario shows indicative returns similar to if the multiple stayed around current levels through end of 2025.
- A modified historical low P/E ratio calculated using the same data set used for calculating the modified average P/E ratio, with the three highest and lowest P/E ratios excluded.
- A selected P/E ratio to provide an alternative P/E scenario to take into account other factors that might be relevant to assessing potential returns. For example, if analysts' forward estimates reflected EPS growth rates significantly higher or lower than historical EPS growth rates. In such cases the forward P/E ratio might be expected to trend higher or lower than the historical average. In the case of Xcel, the P/E ratio at end of 2016 was 18.42. This quarterly P/E ratio was treated as an outlier and accordingly excluded from historical calculations of the average and low P/E ratio. The market generally has experienced significant multiple expansion over the last six years. With the possibility of a recession adding to market interest rate concerns we could now see a reversal of this trend leading to significant multiple contraction. For this reason, I have set the selected P/E ratio at 18.42 to provide an idea of the potential effect on Xcel returns should multiple expansion over the last six years be reversed through end of 2025.
Projected returns per Table 2 above (lines 20 to 45)
Lines 25, 35 and 45 show if Xcel Energy's P/E multiple were to fall to the 2016 level of 18.42, returns of 2.3% to 5.4% could be expected through end of 2025, based on the range of analysts' EPS estimates. The 2.3% is based on analysts' low estimates and the 5.4% on their high estimates, with consensus 3.6%. On the other hand, if the multiple reverted to the historical average of 21.94, slightly above the current level of 21.72, returns of 8.7% to 12.0% are indicated, with consensus 10.1%. If the P/E ratio should fall to the level of the modified low of 20.11, returns of 5.5% to 8.7% are indicated, with consensus 6.9%.
Checking Xcel Energy's "Equity Bucket"
Table 3.1 Xcel Energy Balance Sheet - Summary Format
Seeking Alpha Premium & SEC filings
Table 3.1 shows Xcel Energy has increased net assets used in operations by $15,724 million over the last 6.25 years. The increase was funded by $5,797 million in equity and $9,927 million in net debt. Net debt as a percentage of net debt plus equity increased from 57.2% to 60.2%, over the 6.25-year period. Outstanding shares increased by 43.0 million from 507.2 million to 550.2 million, over the period. The $5,797 million increase in shareholders' equity over the last 6.25 years is analyzed in Table 3.2 below.
Table 3.2 Xcel Energy Balance Sheet - Equity Section
Seeking Alpha Premium & SEC filings
I often find companies report earnings that should flow into and increase shareholders' equity. But often the increase in shareholders' equity does not materialize. Also, there can be distributions out of equity that do not benefit shareholders. Hence, the term "leaky equity bucket." In the case of Xcel Energy, there are significant distributions in the form of dividends to shareholders and stock compensation levels are modest.
Explanatory comments on Table 3.2 for the period from end FY-2016 to end Q1-2023.
- Reported net income (non-GAAP) over the 6.25-year period totals $9,025 million, equivalent to diluted net income per share of $17.08.
- Xcel Energy reports on the basis of GAAP results, without the many non-GAAP adjustments seen with other companies, which almost invariably increase headline reported profits. The only adjustment was in 2017 related to the Tax Cuts and Jobs Act.
- Other comprehensive income includes such things as foreign exchange translation adjustments in respect to buildings, plant, and other facilities located overseas and changes in valuation of assets in the pension fund - these are not passed through net income as they fluctuate without affecting operations and can easily reverse in a following period. Nevertheless, they do impact the value of shareholders' equity at any point in time. For Xcel Energy, these items totaled to $33 million positive over the 6.25 years.
- There is share-based compensation for staff but amounts are not material.
- For most companies, by the time we take the above-mentioned items into account, we find the headline reported non-GAAP net income has considerably reduced, providing less funds from operations available for distribution to shareholders. For Xcel Energy we find the reported net income of $9,025 million for the 6.25-year period increases slightly to $9,038 million available for distribution to shareholders.
- Dividends of $5,612 million, and $5 million for share repurchases were adequately covered by the $9,038 million generated from operations, leaving $3,421 million increase in equity. This $3,421 million plus $2,313 million from shares issued to raise additional capital and $63 million from share-based compensation issues, resulted in the increase of $5,797 million in shareholders' funds per Table 3.1 above.
Summary and Conclusions
Xcel Energy stock is a "sleep well at night" investment. It can be seen from the analysis above, while there is downside risk for returns through multiple contraction, the company has grown EPS and DPS remarkably consistently around 6% per year over the last six years. Going forward, analysts' estimates reflect a continuation of these growth rates, with a very narrow range between low and high estimates. The dividend for this stock is very well covered by earnings. There is no reason to think the 18 years of unbroken dividend growth will not continue into the foreseeable future. Small but positive returns are indicated for a longer term hold, even if the multiple contracted to end of 2016 levels.
I believe most investors in Xcel are likely to be dividend growth investors seeking reliable, growing dividends in the long-term.
I rate Xcel Energy a hold for existing investors and a potential buy, particularly on any dip in the share price, for investors seeking security of investment and dividends, in the longer term.
For further details see:
Xcel Energy: Steady, Stable Returns