How Safe Are Westar's Dividends

Nov.11.13 | About: Westar Energy, (WR)

The Company

Westar Energy, Inc. (NYSE:WR), is a $4 billion mid-cap company that is the largest electric power provider in Kansas. It owns coal, nuclear, natural gas/diesel, and wind facilities to generate electricity. Coal accounts for 74% of its production capacity.

Some of WR's five-year average growth rates are; 5.54% for revenue, 10.32% for net income, and 3.28% for earnings. It has increased its dividends for nine consecutive years, and has a current dividend of $1.35 per share (4.3% yield as of November 8, 2013), and a payout ratio that has averaged 65% over the last five-years. Its share price has gone from $19.86 on September 24, 2003, to its current price of $31.63 (November 8, 2013). Its 52-week high was $34.96, reached on April 30, 2013. Although these metrics are impressive, WR had negative free cash flow in four of the last five years, due in part to a consent decree entered into with the EPA in 2010, over environmental issues. Although WR is approaching the end of the costs associated with these environmental issues, the jury is still out on how much of these costs will be recoverable by rate increases. Negative rulings by the Kansas Corporation Commission (KCC), on future rate increases, could adversely effect WR's profits as well as its dividends.

2013 Third Quarter Results

WR recently released its 2013 third quarter earnings that, at $1.04 per share, beat Charles Schwab's mean analysts estimate of $1.00 per share. This is the 5th consecutive quarter in which WR has beat analysts estimates. Earnings for the nine months ending September 30, 2012 were $1.97, an increase of 10% compared to the $1.79 per share for the same period in 2012, . WR also increased its 2013 earnings guidance of $2.05 to $2.15 per share, to $2.20 to $2.30 per share. Charles Schwab's 2013 mean estimate for WR is $2.17. It therefore appears that WR is on track to exceed its 2012 earnings of $2.15 per share. WR has increased its earnings every year since 2009.

Free Cash Flow

Although WR's earning look decent, its free cash flow (operating cash flow minus capital expenses), which was negative in 2011 and 2012, is another story. In 2011 its free cash flow was a negative $2.01 per share and in 2012 it was a negative $1.67. The primary reason for the negative cash flow is high capital expenses that were caused in part by EPA environmental compliance issues. In 2010 WR entered into a consent decree and settlement that required a substantial amount of capital expenses for environmental equipment.

In its 2012 annual report, WR estimated capital expenses associated with environmental improvements as $311.2 million in 2013, $239.5 million in 2014, and $92.6 million in 2015. Since WR is a public utility, it hopes to recover these costs by increased rates to consumers, but this is subject to the approval of the KCC. Because the rate increases are normally applied for and approved after the improvements are made, there is a substantial delay in recovering the costs, which is why it is not unusual for utilities to have negative free cash flow. From the estimates submitted by the company, it looks like the costs of the EPA compliance issues have peaked and for the most part will end in 2015. This does not mean that additional environmental expenses will not be needed in the future, but hopefully they will be less expensive.

In its 2012 annual report, WR estimated its capital expenditures for 2013, 2014, and 2015, (in addition to the environmental expenses) at $2.3 billion, which is an average of $766.66 million annually. Even with a capital expense of $766 million in 2012, WR would have had a negative cash flow of $167 million ($1.31 per share). WR has only $10 million in cash and cash equivalents, which means that in the short term (until WR can obtain substantial rate increases), it is going to continue to have negative cash flow, and will need to borrow or increasing its capital to fund its dividends. So far it has done both. In 2011 its net issuance of stock was $295 million. In 2012 its net issuance of debt was $376 million. On September 23, 2013 WR announced that it was planning on making a public offering of eight million shares of its common stock with an option for underwriters to purchase up to an addition 1.2 million shares, to cover over-allotments. Eight million shares would be a dilution of approximately 6.2% of the company's 127 million outstanding shares of common stock.

Rate increase approvals by the KCC are a continuous process for WR, and are always hotly contested by consumer and business groups. Since 2008 WR has received approvals for eighteen rate increases which total approximately $470 million. WR does not always get what it wants. For example, on April 18, 2012 the KCC approved a $50 million increase, which was about half of what WR requested. A $30.7 million rate increase is currently pending before the KCC and is scheduled to be decided on or before December 2, 2013.


In conclusion, WR seems to be executing well on its revenue and earnings that continue to grow, although not by much in 2013. Its negative cash flow issue will hopefully be resolved by future rate increases, and the company should be better able to control its future capital expenses once it is out from under the burden of its EPA compliance issues. Although there is quite a bit of uncertainty in WR's future, I am of the opinion that WR will continue to increase its dividends as long as it sees any growth in revenue and earnings, and it looks like there will be some growth for 2013. Its outlook could change dramatically, however, if there are major difficulties with the company obtaining KCC approvals for its rate increases to cover recent and future capital expenses, especially those concerning environmental issues. Anyone investing in WR should monitor its rate requests closely.

Disclosure: I am long WR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.