On Monday, December 17, 2012, I was ready to initiate a partial position in Wisconsin Energy (WEC) at around $37.00, unfortunately the stock made a quick move up and added to gains yesterday so I am now waiting for a little pullback. In a previous article Think Long Term and Buy These 3 Stocks, I mentioned that Wisconsin Energy was one of three stocks I was looking at and gave a brief explanation why I liked the stock. I have been wanting to add a utility for some time and the more analysis I did, the more I liked Wisconsin Energy. I will start with a partial position as I believe the fiscal cliff and possible dividend tax changes may affect utility stock prices in the weeks ahead. If there is no agreement on the fiscal cliff and/or there is major dividend tax changes I can add to the position if prices fall.
Wisconsin Energy is the largest electric and gas company in Wisconsin with 1.1 million electric customers and 1 million gas customers. Wisconsin Energy also owns a 26% interest in American Transmission Company, a multi-state, transmission only utility. WEC has been named the most reliable utility in the Midwest seven out of the last 10 years and has very high customer satisfaction.
As I mentioned in previous articles, when I buy stock in a company, I am looking for Good Valuation, Dividend Growth, a Wide Moat, Well Managed Business and perhaps a Catalyst that may propel the stock higher. I believe Wisconsin Energy has all of these elements. Let's take a look at each of these elements and see why I think Wisconsin Energy is an excellent utility for long term appreciation.
Valuation - Wisconsin Energy currently trades at $37.86, which is approximately 9% off of the 52 week high of $41.48. WEC currently has a P/E of 15.66 and a PEG (price to earnings growth) of 2.81. That may look expensive, but let's compare WEC to some other popular utilities.
|Con ED (ED)||57.02||14.96||5.21|
Note - valuation information from Yahoo.
So in comparison to other utilities, WEC does not look as expensive. I do want to note, that Seeking Alpha contributor Chuck Carnival wrote a series of articles concerning utility valuation and in this article, named WEC as being overvalued. In fairness to readers, you may want to read that article to get another thought concerning valuation. I believe it is always good to be aware of varying opinions. It should be noted that when Chuck wrote that article, WEC was trading at over $40.00 a share.
In fiscal year 2011 Wisconsin Energy earned $2.18 per share, an increase of over 13% from the $1.92 a share WEC earned in fiscal year 2010 (here). For fiscal year 2012, WEC management has forecast earnings of $2.31 to $2.33 a share, approximately 6.5% increase over 2011. WEC management goal is 4% to 6% earnings growth a year.
Dividend Growth - Using David Fish's excellent The DRIP Investing Resource Center (here) we find that Wisconsin Energy is a Dividend Challenger having increased its dividend nine straight years, but will soon be moving to the Dividend Contenders list as it has just announced its 10th straight yearly increase for the first quarter of 2013. WEC will be increasing the dividend from $0.30 to $0.34, an increase of 13%. Having raised its dividend 17% on average over the last five years and having announced its intention to raise its payout ratio to 60% from the current 49%, investors can expect healthy dividend increases for the next several years.
Wide Moat - Being a regulated utility provides the utility in its service area a barrier against competition. Stay friends with the regulators and provide good service to your customers and you should keep competition away. Wisconsin Energy's high customer service scores and efforts to improve the reliability of their service should keep them in the good graces of the regulators.
Wisconsin Energy has a moat.
Business - When the current management team took over in 2003, Wisconsin Energy was in poor shape, the power generation capability was inadequate to meet the needs of the region and the utility had recently cuts its dividend in half to fund infrastructure improvements that were sorely needed. Under the leadership of CEO Gale Klappa, WEC invested $7.8 billion in infrastructure improvements including four state-of-the-art generating plants, two fueled by natural gas and two by coal. WEC also met Wisconsin's renewable energy mandate by building a wind farm and a biomass plant that will burn wood waste from the Northern Wisconsin forests. Having completed the power generation improvements WEC has enough generating capacity to provide adequate power to the region for years to come.
Despite the large investments that have been made, WEC managed to grow earnings briskly and has provided super-charged returns to investors. From 2007 to 2011 WEC returned 69.7% to investors and if you go back 10-years, WEC has returned 308.4%.
Many utilities lack growth, but Wisconsin Energy does have some growth prospects. Western Wisconsin has seen the development of frack sand mining, as Wisconsin has an abundance of the fine sand needed for fracking. The natural gas needs of the miners, along with residential customers in the area wanting to switch from propane to natural gas, has created a need for additional natural gas pipelines in that part of the state. WEC intends to invest an initial $150 million to expand the pipeline in that area.
The Southeastern area of Wisconsin has seen population growth as residents of Illinois flee that state for Southeast Wisconsin. Electric service connections are up over 9% for the first nine months of 2012 and natural gas connections are up 14%.
Finally, WEC management believes the State of Wisconsin may sell the state run power plants they own. If the State of Wisconsin sells the plants, WEC is interested in purchasing them.
Wisconsin Energy management has stated they intend to look for ways to invest their positive free cash flow while staying within their risk profile. Utilities that have free cash flow are relatively rare and utilities that can invest without taking on debt are even rarer.
Wisconsin Energy information can be found here.
The Possible Catalyst - I believe Wisconsin Energy could be a candidate for a merger with another utility or an acquisition target for a larger utility. I believe WEC is an attractive candidate for other utilities for the following reasons.
- Strong balance sheet
- Positive free cash flow
- Little additional investment is needed for power generation.
- Regulated utility with fair regulators that have allowed rate increases.
- A Republican controlled State Government that is not likely to object to a purchase of the company.
Before I go on, I want to make one thing clear, I will not purchase WEC hoping for a buy-out by some other utility, in fact, I would prefer WEC remain the well run utility it is and retain the outstanding management it has. If an acquisition is going to occur, I would prefer WEC purchase another utility and institute their excellent management skills to the expanded utility. However, I do recognize utilities have been consolidating for years in an effort to grow and get economies of scale. Since de-regulation, the number of utilities has shrunk from over 100 to approximately 50 publicly traded companies. As such, it seems to me WEC would be a good candidate for a larger utility.
Action - I will purchase WEC if and when the price falls back to around $37.00 and intend to own it until the company gives me reason not to. I will add to WEC as price movements allow me and will continue to add until I reach a full position.