We continue to be amazed with the performance of Gale Klappa and his management team since they took over the executive leadership of Wisconsin Energy (WEC) from Richard Abdoo and his team. We even had the pleasure of interviewing Gale Klappa and the new CFO Pat Keyes in October, with regards to the factors that have led to Wisconsin Energy's resurgence since 2003. Our interview has reinforced our position in Wisconsin Energy. Although we are drastically underweight with regards to traditional utilities relative to the benchmark, we maintain our 1% position in WEC because of the culture of reliability that has been fostered with Klappa and his team. We also see a potential resurgence in the Wisconsin economy now that the controversy over the Wisconsin Budget Repair Bill has subsided and that there is political stability and a unified government in the state's legislative chambers.
Source: Milwaukee's Business Journal
We believe that WEC will continue its recent record of reliably delivering power dividend growth to investors' portfolios due to its industry leading reliability achievement enabling it to steadily increase its payout ratio from 36% in 2007 to 60% in 2014, and 65-70% in 2015-2017. We were surprised that Barclays picked Northeast Utilities (NU) as its top regulated utility earlier in the year but not surprised that Wisconsin Energy was one of its top six utilities for income-oriented investors. Although Northeast Utilities has seen a major improvement in its operations in relation to where it was standing in 2001 (when it was suing Consolidated Edison (ED) because ConEd backed away from merging with NU), we believe that Wisconsin Energy offers a better long-term opportunity than NU because WEC operates in a more favorable macroeconomic environment. We don't say that simply because we're long time WEC shareholders but because Wisconsin's population growth and renewable energy portfolio standard requirements is more favorable than the population growth and RPS requirements of Northeast Utilities states (Connecticut, Massachusetts, and New Hampshire)
- Wisconsin's RPS is 10% by 2015, versus 15% by 2020 for Massachusetts (NU's NSTAR and Western Massachusetts Electric Company subsidiaries), 23.8% by 2025 for New Hampshire (NU's Public Service of New Hampshire Subsidiary), and 27% by 2020 for Connecticut (NU's Connecticut Light and Power and Yankee Gas operations).
- Wisconsin's Population Growth since 2000 was 6.8%, versus 5.42% for Connecticut, 4.68% for Massachusetts, and 6.9% for New Hampshire.
- Wisconsin's Governor Scott Walker recently proposed a tax cut package whereas Connecticut's Governor Dan Malloy, Massachusetts Governor Deval Patrick and New Hampshire Governor Maggie Hassan are either pushing tax hikes or have a history of pushing tax hikes.
- Wisconsin was rated the 20th friendliest place to do business in 2012 by CEO Magazine, versus 26th place for New Hampshire, 44th for Connecticut and 47th for Massachusetts
- Wisconsin was rated the second most improved place to do business from 2008 to 2012 by CEO Magazine, while New Hampshire's business friendliness rating was the third biggest decliner during that period.
In our interview with Klappa, he confirmed our thesis that Wisconsin is seeing a steady influx of residents from the Chicagoland/Northern Illinois suburbs due to the higher quality of life and low costs of living in the Milwaukee suburbs and exurbs versus Chicagoland. This has helped WEC pick up 3,200 new electric customers and 5,800 new gas customers on a year-over-year basis.
So far in 2012, we can see Wisconsin Energy continuing its strong absolute and relative performance. WEC generated 7.8% in year-over-year EPS growth from continuing operations in FY 2012 versus FY 2011, despite facing the warmest winter in over 122 years at the beginning of the year. WEC also had to deal with a $24M year-over-year headwind in the form of reduced Allowances for Funds Used during Construction. This decline in AFUDC primarily related to the Glacier Hills Wind Park, which went into service in December 2011, as well as the Oak Creek AQCS project, for which emission control equipment went into service in March 2012 for units 5 and 6 and September 2012 for units 7 and 8. We expect WEC to see another reduction in AFUDC in 2013 as it expects to have fewer major construction projects. We believe that is part of the reason why WEC's EPS in FY 2013 is expected to only increase by 3.3% year-over-year (which is less than the 7.8% achieved in 2012).
In Q1 2012, WEC earned $.74/share, which beat analyst expectations by $.01/share and represented 2.8% year-over-year growth. In Q2 2012, WEC followed that up by growing its EPS by nearly 11% on a reported basis and 25% on a continuing operating basis. WEC's Q2 EPS of $.51 exceeded the $.44 estimate by the analyst community for Q2 2012 and WEC's Q3 2012 EPS was $.67 versus the $.57 analyst consensus estimates. Although WEC's Q4 2012 EPS from continuing operations declined by 12.2% year-over-year, at least it beat the consensus expectations by $.02. WEC's Q4 2012 operating income increased by 4.35% and the decline in EPS was due to reduced AFUDC allowances from ongoing construction projects. Revenue declines for the quarters and the full year of 2012 were offset by lower operating costs, increased earnings from its 26% owned transmission affiliate ATC and a 1.5% reduction in average outstanding shares. Operating costs were sharply lower due to reduced fuel and gas costs, as well as operations and maintenance expense savings.
Wisconsin's Unemployment rate was 6.6% in December, which continues to be well below the national average. This was an improvement from the 7.3% in September and the 6.8% in March. During the FY 2012 period, residential electricity use increased by 50bp year-over-year. Energy Sales to WEC's largest commercial and industrial users declined by 2.8% versus the prior-year period due to a planned outage at a major iron ore mine. The mine returned to normal operation in September. Sectors showing strength in the year included food products, chemical manufacturing, metal fabrication and plastics.
Natural gas prices have bounced off the historical lows achieved in April 2012. Spot prices closed at $4.33 per MMBTU on April 22, up from April's 2012 low of $1.89. The extended low price environment for natural gas has hurt WEC competitor to the south Exelon, which generates the majority of its revenues and operating income from the wholesale power market. With natural gas prices coming back, this will help Exelon catch its breath and WEC had received approval of gas price increases for its gas distribution subsidiary. WEC's Power the Future Program called for the company to reduce its 70%+ reliance on coal to an expected 50% in 2012. The new capacity that WEC added was almost equally balanced between natural gas and coal. WEC reduced its coal burn by about 22.5% in 2012, and increase its natural gas burn by 94.6%. WEC's Port Washington natural gas units increased its capacity factor utilization from 23% last year to 46% this year.
Source: Bloomberg LP
Wisconsin Energy's board has authorized a $300M share repurchase program last year. Since the program began, WEC has repurchased approximately 4,650,000 shares at a cost of $151.8 million. That equates to an average purchase price for the program so far of $32.63 a share. Wisconsin Energy's share price has seen strong performance this year partly because of its strong operating performance and because of the demand for dividend-paying securities as income-bearing alternatives to the poor interest rates on fixed income securities. As we previously noted, Wisconsin Energy adopted a dividend policy that seeks to reach a 60% payout ratio in the year 2014, and 65-70% in 2015-17. This will enable double-digit dividend growth over the next few years and enable its dividend yield to catch up with its regulated utility distribution peers.
Wisconsin Energy's capital investment budget for 2013-2017 is expected to remain at $3.2B-$3.5B, which is less than the $4.8B spent during the last five years of the Power the Future Program (2007-2011). This reduction is due to the fact that capital investment needs have declined due to the conclusion of the Power the Future Program. We reiterate that WEC is in a good position to take former Exelon ConEd customers and make them into We Energies customers. WEC reported that new services installed for electric customers were up 8.7% in 2012 as compared to 2011. Connections of new natural gas customers rose by more than 13.2% in 2012 compared with 2011.
Source: Wisconsin Energy IR Dividend History Section
In conclusion we are pleased with the performance of Wisconsin Energy. We expect continued EPS and dividend growth from the company. We believe utilities are fairly valued but Wisconsin Energy is our utility of choice. We can see why its performance has significantly exceeded the SPDR S&P 500 Utilities Index ETF (XLU) since the XLU's inception in 1998. While we expect WEC to outperform the utility sector overall due to the favorable macroeconomic environment created by Scott Walker, we believe that investors should not expect WEC to repeat its 290% outperformance against the XLU that it achieved from December 1998 to April 2013. Still, Wisconsin Energy is our top choice in the utility sector because it has been widely recognized for reliability amongst Midwestern utilities and we believe that the Midwest will see an improved economic environment. WEC has been reliably paying dividends to its shareholders since 1942 and we expect another 70 years of dividends.
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.