Wisconsin Energy Corporation (NYSE:WEC)
Presentation at 2012 Barclays Energy/Power Conference
September 5, 2012 3:05 p.m. ET
Gale Klappa - Chairman, President, and CEO
Thank you very much. Good afternoon everybody. Since I’m one of the last things standing between you and the margaritas, we’ll try to be crisp, and then answer any questions you’ve got. And obviously we pay our lawyers by the word.
Just to briefly refamiliarize you, we are the largest gas and electric utility system in the state of Wisconsin. We also serve in the upper peninsula of Michigan. 1.1 million electric customer, over a million natural gas customers. We touch about one out of every two customers in the state of Wisconsin.
A little bit of history on performance. We’ve been very fortunate in that we’ve established a pretty solid track record of performance. In fact, if you look back to the year 2003, we are the only company in the S&P Electric Index, the S&P Utilities Index, the Philadelphia Utility Index, or the Dow Utility Index, the only company, that has been able to grow earnings per share and dividends per share each year since 2003.
Now, I have a question for you straight off the campaign trail. Are you better off than you were three, five, seven, or ten years ago? And if you’re a Wisconsin Energy Customer, or if you were heavily weighted in Wisconsin Energy stock, the answer is decidedly yes. So for my own amusement, if not yours, we’ll walk through the three, five, seven, and ten year return numbers.
As you can see, if you look at all the major averages, pretty reasonable if modest returns over the course of the past three years through the end of 2011, but on a total shareholder return basis, over the last three years, ending 2011, Wisconsin Energy delivered a little better than an 83% total return.
Five years? Similar story. Even smaller returns. Of course we went through the great recession in that five-year period. So even smaller returns on the major indices. And just under a 70% total shareholder return for Wisconsin Energy.
Seven years? Very strong differential, with Wisconsin Energy returning 150% in total shareholder return over the past seven years. And then just in case you wanted to see the 10-year numbers, a 308% total shareholder return.
So, a reasonably solid track record of performance. Some of that track record of performance is due to the fact that we have improved the reliability of our service in our region. As many of you know, there’s a virtual cycle of customer satisfaction in a regulated industry and shareholder returns over time. And I’m really proud to be able to tell you that last year, for the seventh time in the past 10 years, our company was named the most reliable utility in the Midwest.
Our customer satisfaction numbers have had a dramatic upward improvement over the course of the past decade. In fact, in the second quarter of this year we achieved the highest customer satisfaction in the history of the company since we began measuring decades ago. Just to put the numbers in perspective, 88% in the second quarter of this year, 88.9% of our customers said they were very satisfied with the transaction. That’s any interaction they’ve had with the company. And almost 80% of our customers said that they were very satisfied with the company itself. Those are top quartile numbers, no matter how you cut it.
We, of course, have just completed the major infrastructure megaprojects that we’ve had underway since 2003. The first of those projects involved the completion of two very efficient next generation fired combined cycle units in Port Washington, which is a city north of Milwaukee.
And I’d like to call your attention to the bottom line on the slide, the cost per unit of capacity. We were able to complete the Port Washington units - and again, these are among the most efficient natural gas units in the Midwest and anywhere in the country - for $609 per unit of capacity. If you were to try to build comparable combined cycle units today, the cost would likely be in excess of $1,000 per unit of capacity. So these units will serve our customers very, very well and help us remain price competitive for decades to come.
And the same story with our major coal-fired units. We completed the first of the major units at Oak Creek in February of 2010. Unit two at Oak Creek was completed in January of 2011. This is, in total, a $2.3 billion project and we were able to bring these units in for just at $1,950 per unit of capacity.
If you look at other coal-fired units that are being completed around the country today - and a good example would be the Duke unit at Cliffside in North Carolina - using an exactly comparable technology, they are bringing that unit in for $3,000 per unit of capacity. So we’re very pleased with not only the efficiency of these units. These coal-fired units are among the three most efficient coal-fired units anywhere in the United States. But also, the price that we were able to complete these construction projects for.
There has been, as a result of the modern, new efficient capacity that we’ve put in place, a dramatic change in our environmental performance. And the slide really tells it all. We have added 50% to our power plant capacity of our fleet. And at the same time, emissions of nitrogen oxide, sulfur dioxide, and mercury are down 70%. We do not face any significant exposure to the new environmental rules that the EPA is now trying to mandate.
In fact, our customers are already paying, in their electric rates today, for the cost of the environmental technologies that the EPA is trying to put in place, particularly on coal-fired power plants across the country. So we’re very, very well positioned, both in terms of the modern, efficient capacity of our fleet, but also in terms of an increasing cost competitiveness going forward.
Now, speaking of environmental controls, this picture you see here is the state of the art emission controls that we are just now completing, and bringing into commercial service, at our older coal-fired units on our Oak Creek site. These are units five, six, seven, and eight. These are 1960s vintage units, but we received approval from the Wisconsin Commission to invest about $900 million on nitrogen oxide controls and sulfur dioxide controls at this site, because those older Oak Creek units were still among the most efficient baseload units in the Midwest.
The air controls on units five and six went commercial in the first quarter of this year, and we are just about to bring into commercial service any day now the emission controls on units seven and eight. This is the second-largest construction project in the company’s history. It is on time and it is slightly under budget at just under $900 million.
We’re also, as many of you know, adding renewable capacity to our fleet. Wisconsin and Michigan both have renewable portfolio standards. In the state of Wisconsin the mandate is to reach 10% of our total retail sales from renewable sources by the year 2015. We’ve already completed the two largest wind farms in the state of Wisconsin, and our latest effort to try to reach the statewide mandate by 2015 is the building of a biomass-fueled power plant in northern Wisconsin.
And let me back up for a second and talk about the renewable portfolio standard. The lesson of history in general is that you can best, most competitively serve your customers with a diverse portfolio - diverse technologies, diverse fuel sources. Because you simply cannot tell what’s going to happen to any particular fuel source in terms of price or availability in any given year.
So a diverse portfolio makes a tremendous amount of sense, and as I say, the lesson of history is that a diverse portfolio serves our customers very, very well over the long term. The same concept, I believe, applies in the renewable portion of our portfolio. Many of the state legislators wanted us to meet the renewable portfolio standard by using only wind. But I will give you an example of why that is not a prudent strategy, and why building a unit like this biomass unit that we can dispatch actually makes tremendous sense.
And you only have to look back to July 5 of this year. July 5, where many of our industrial customers were still off on holiday vacation. So we didn’t have full industrial load on our system. But we did have 103 degrees and no wind in the Midwest. We were getting about 6 megawatts out of our wind farms. And we have over 300 megawatts of wind farms.
A number of power plants in other parts of the Midwest went into forced outage. Luckily, the Wisconsin units operated very well, but the Midwest operator ran our new power of the future units between 103% and 105% of their rated capacity for hours on the afternoon of July 5. For the first time in Midwest history, the hour ahead price in the MISO market went over $1,000 a megawatt hour. It was have the ability tight. But we were getting zero capacity. We were getting almost nothing out of the wind farms, because it was one of those hot, sultry, afternoons where the wind just wasn’t blowing.
With the biomass plant, when it’s complete, we can dispatch the unit at our will. This is like any other power plant, only it’s a little bit smaller - a 50 megawatt power plant. And what you see there is the boiler, under construction now. We’re about 40% complete today on the construction of this biomass plant.
It’s in Rothschild, Wisconsin, just on the edge of the northern Wisconsin woods. We will be using wood waste from the northern Wisconsin forest. We’ll be using treetops, tree trunks, sawdust, other forms of wood waste from logging operations in northern Wisconsin. Investment of about $255 million - again we’re about 40% complete. We’re on time, on budget. And we’re scheduled for completion and commercial service by the end of 2013.
So where do we go from here? Well, our story is evolving from one where we’ve grown earnings per share, because of all these investments in the megaprojects, at about 10% a year since 2004. Now, as the major part of our megaproject program is behind us, we’re really focusing on our delivery networks, and on renewing and upgrading our delivery networks.
We have a plan to spend about $3.5 billion between now and 2016, some of it on renewable construction like the biomass plant that we’ve just talked about. But the bulk of it will be on what we call delivering the future.
And let me give you some very specific examples. We will rebuild almost 2,500 miles of electric distribution lines, all of which are more than 50 years old today. We’ll replace about 28,000 power poles. And we actually have power poles in the ground that are 100 years old and need replacing. We’ll replace over 28,000 transformers, and hundreds of substation components. And that’s on the electric distribution side of the business.
On the gas distribution side of the business, a very similar plan. We’ll replace over 1,250 miles of aging fiberglass, plastic, or steel gas mains. We’ll replace 83,000 individual gas lines. Those would be the distribution lines that come off the street to your house. And we’ll replace over a quarter of a million meter sets.
So we’ve gone from the megaprojects to what one of my associates calls the singles and doubles. Much more manageable projects, smaller projects, that still require significant investment and will add very strong value in keeping our networks reliable for customers as we move forward.
We also just announced that we will convert what we call our Valley Power Plant. The Valley Power Plant is located just south of downtown Milwaukee, and it is a critical energy resource for the city. It is the last operating power plant inside the city limits. It’s an older power plant built in the 1960s that has historically burned coal. It provides two critical functions.
First, downtown Milwaukee is heated by steam generated by the Valley Power Plant. All of the major downtown Milwaukee buildings do not have their own heating systems, ranging from Northwestern Mutual Life, to City Hall, to the Marquette University campus. They are all heated by steam supply from our Valley Power Plant. So one of the major functions of the Valley Plant is steam supply for downtown Milwaukee. The other is the generation of electricity for the grid and, as importantly, during high demand hours of the day and high demand seasons of the year, the Valley Power Plant provides voltage support for the downtown electric grid.
So it’s not a plant that we can walk away from. What we have decided to do is convert that plant from coal to natural gas. And on August 17, we announced our plans to convert that plant. Here are the details. It’s scheduled for completion in either late 2015 or 2016, depending upon the timing of our permits. And it will take that long because we can’t simply shut both units of the plant down at once. We’ll have to convert one unit of the plant and then move to conversion of the other unit of the plant as soon as the first unit is complete.
Our announcement to convert this plant follows approval by the Wisconsin Public Service Commission of a $26 million upgrade to an existing gas pipeline operated by our gas distribution company. We don’t have, today, the capacity on the existing natural gas system in downtown Milwaukee to deliver enough natural gas to fuel this converted plant, so step one was to get approval to actually have an upgraded natural gas pipeline that could actually fuel the plant sufficiently. We received that approval a month or so ago.
So if you put this together, it’s about a $100 million investment project - $26 million to upgrade the existing gas pipeline in the city center, and the conversion itself of the Valley Power Plant will be between $60 million and $65 million.
So when you put it all together, as I mentioned earlier, for 2012 through 2016, the five-year period, we plan to invest about $3.5 billion in infrastructure projects that will meet one of three goals: renew and modernize our grid and keep us the most reliable utility in the Midwest, meet new environmental standards, and add clean, renewable energy to our fleet.
We also, with our positive free cash flow - and Dan has reported on this in many forums - we are one of the rare utilities that has significant positive free cash flow, after our capital spending program and after our dividend policy, which we’ll talk about in a minute. So we’re looking, also, for additional investment opportunities beyond the projects that we just talked about that would add to the $3.5 billion of capital spend over this five-year period.
And there are a couple that I would like to highlight. The first would be the second bullet point, which is divestiture of energy assets by the state of Wisconsin. The state of Wisconsin owns and operates about 37 power generation or co-generation plants of some sort or some kind. Many of them meet the heating needs or the electricity needs of state college campuses, the state penitentiary, the state capital, many of the state facilities.
A number of those facilities are theoretically in violation of the federal Clean Air Act, and the state of Wisconsin has been sued by the Sierra Club for violations of the Clean Air Act. A number of these plants are fueled by coal. Many of them have not been upgraded with the most modern environmental controls. Our current governor would like to see the plants in private hands, in part because of the budget issues that every state faces, and the fact that he would have to spend hundreds of millions of dollars to upgrade these existing facilities.
So depending upon the outcome of the fall state elections, we may see legislation in 2013 - and this would take an act of the legislature to allow the plants to be sold to private investors. But we may see legislation in 2013 that would, in essence, put up for sale the 37 plants that the state now owns and operates around the state of Wisconsin. That could be a significant investment opportunity for us, and a significant follow on investment opportunity because of the moderate environmental controls, or the conversion from coal to natural gas that would be necessary.
So that certainly is one potential investment opportunity. We just announced on our second quarter call - and I don’t have it on the screen - that we’ve come to an agreement with NextEra to purchase a wind farm that NextEra has been operating and owning in the state of Wisconsin. We are the 85% off-taker of that wind farm.
Now, with the agreement that we have with NextEra, we’re able to turn that asset into an asset that will save customers money compared to the cost of the purchase power agreement today. So we will take ownership of the assets and we’ve asked the Public Service Commission to allow us to put that asset into our rate base.
So, the benefits would be we would earn a 10.4% return on an asset that is not now earning for us, but also, even under the highest or lowest case scenarios of wind output, the purchase price will save customers money. Those are the types of investment opportunities that we’re searching for, and trying to put into place.
Our criteria are two and very clear. The first is these additional investment opportunities would have to be more accretive than a share buyback, and secondly, would have to absolutely not, in any material way, change our risk profile. So that just gives you a sense of the additional investment opportunities that we’re working on.
I mentioned our financial flexibility. We do project that we will have about $600 million of free cash flow. And again, our definition here is cash after the capital spending program, and after our dividend policy is implemented. So $600 million of free cash over the five-year period, starting this year, through 2016.
So part of what we plan to do with that cash for shareholder benefit is to implement an aggressive dividend policy. For many years, our dividend payout ratio was among the lowest, if not the lowest, of any utility in the industry that actually pays a dividend. And that’s because we had such a significant use of the cash as we invested in our power of the future assets.
Well, today, with that major construction program now behind us, we have the room and the desire to get to the efficient frontier on the dividend payout ratio, to have a dividend payout ratio that is competitive with our peers across the regulated sector.
So our goal that we have announced, and that our board has endorsed, is to raise our payout ratio to 60% of earnings by 2014. And, again, that’s a level that I think all of you will recognize would make us more competitive in terms of payout ratio with other regulated energy companies across our sector. We raised our dividend by 30% for 2011, by 15% for 2012, and we believe this policy should support average annual dividend increases of double digits for 2013 and 2014.
And just an additional comment on our dividend policy, I mentioned the real goal is to get to the efficient frontier, for a company like ours, on dividend payout ratio. Well, when we get to 2014 we’ll step back and say, is 60% the efficient frontier? Or is it something different? And we will revise our policy or keep our policy the same, depending upon what we see when we get to the 60% payout ratio in 2014. So we think we have a best-in-class dividend growth potential over the course of the next several years.
And on the subject of financial flexibility, we also retired $450 million of long term debt last spring at the holding company, as we deleveraged the holding company post our power of the future construction program. And as many of you know, the board also authorized a share repurchase plan.
And we implemented a portion of that share repurchase plan when the market dropped significantly last August. We were able to repurchase $100 million of our stock at an average purchase price last August, by and large, of $30.79 a share.
So, of the $300 million that’s been authorized by the board for the share repurchase plan, we’ve completed one-third of it. We have not repurchased any shares so far this year, certainly not through the second quarter. And we will watch and wait. We’re not in a big hurry. We’re looking for additional investment opportunities. We also know that we’ve been conservative in our cash flow projections, so we’ll watch and wait and take action as appropriate for the remainder of the program.
But there is not a gun to our head. There’s nothing that says if we don’t think it’s the most appropriate thing to do, there’s nothing that says we must complete that program by 2013. We could ask the board for an extension, or we could move forward, and it really all depends upon what we see as additional investment opportunities. One way to look at this is that a share buyback is the worst you will see from us for the remaining $200 million that’s on the table in terms of the repurchase authorization.
So, a few final thoughts and key takeaways on our company. I think the track record shows we’ve been consistently one of the top-performing companies in our sector. I really believe that we’re positioned to deliver among the best risk-adjusted returns in our industry. Our goal is to consistently deliver, with low risk, 8-10% total shareholder return.
We have positive free cash flow and great financial flexibility that few companies in our industry ever have the luxury of being able to employ. I think we have a best-in-class dividend growth story, and our goal is very simply stated - to borrow a phrase from Tina Turner - to be simply the best.
Unidentified Audience Member
The power of the future was preapproved by the commission. Have any of the projects that you have described, particularly the hardening of the distribution system, do you go to the commission in advance and ask them, can you do this? Or is this something that you’re going to do and then go back to them with the rate case thing, and put this in the rate base?
Very good question. There are a couple of the projects that we have talked about here that have also gotten preapproval. The upgrade of the gas distribution pipeline that we talked about, that would allow us to convert Valley, that’s been preapproved by the commission. The biomass plant that we’re building in northern Wisconsin has been preapproved by the commission, exactly the same way that the power of the future plans were preapproved.
There is a threshold, a dollar threshold, that the Wisconsin Commission applies to whether or not you need preapproval. Many of the distribution projects, like replacement of substation transformers, for example, as individual, discrete projects, are small enough where they don’t meet that threshold. However, we have put those projections of the spending on those particular items in our rate case filing, where we project our capital spending and our O&M expenses going forward for two years. So in that way, once the rate case is decided, many of these projects will have tantamount to preapproval.
Unidentified Audience Member
Second question relates to the political climate in Wisconsin, and given the governor’s history of where he is, what he believes in, I wonder if you could get the legislature to introduce capital punishment so that you could have electric chairs around the state, and get those preapproved too. [laughter] And maybe that would help him sell the penitentiary electricity to somebody.
Well, he’s got a ready workforce. The inmates actually do run the power plant at the penitentiary. And, as Pat said, very little turnover. [laughter] But I’m not sure electric chairs are a great sense of demand growth, but we’ll work on it.
Unidentified Audience Member
You certainly have a great record and great improvement in shareholder value during the last five, ten years. However, as you look beyond this thing as you present it, there has to be some risks. So what keeps you awake - and not the Green Bay Packers, I can assume, or somebody else - in terms of where do you see the biggest challenge for the company.
Clearly you worry about a lot of things. But probably for us, right now, our risk profile is so substantially reduced. It’s a very different company than it was 8-10 years ago. And one of the things we didn’t mention, of course, because it’s a bit of ancient history, we were able to sell our nuclear units and lock up the energy from those nuclear units under a power purchase agreement for the remaining life of those units. So we have shed nuclear operating risk. We no longer have nuclear operating risk. In fact, I think, of the 20 largest utilities in the country, we’re probably the only one that does not have direct nuclear operating risk.
Clearly the construction program, with the megaprojects, was a huge risk. So what I continue to worry about is continuing to focus and execute. On paper, all of the projects we just mentioned to upgrade and renew the distribution network should be lower-risk projects, and on paper they are. But you have to execute. You have to focus. And so we want to make sure that the same kind of rigor, and the same kind of focus that we’ve had on the larger projects is applied to the smaller projects. So that’s something that we’re really very laser-like focused on at the present time.
And then you worry about things that you just can’t predict. Things that just come out of the blue. And I wouldn’t be too thrilled about a punitive dividend tax rate, but I can’t control that. [laughter]
Unidentified Audience Member
Would that change your dividend policy?
The answer is, I don’t think so. We’ve talked to so many of you, and kind of the theme we hear back is don’t particularly worry about our individual tax rate. Pursue a dividend policy that makes sense, and does get you to the efficient frontier for a company like yours. So unless they were to go to, like, 70% tax on dividends - I mean, we’d run the numbers, but unless there was to be a truly punitive tax rate, I don’t think it would change our policy.
Unidentified Audience Member
Does the share buyback against dividend, as that kind of plays out in that scenario with the higher tax rate…?
We would look at it, but, again, I think given our position right now we have the flexibility to pursue the right dividend policy and still either do share buybacks or find appropriate incremental investments. In our case, I think we’re in a fortunate, flexible position where it’s not either or.
Unidentified Audience Member
If the sale of the state assets were to make it through the legislature, what would you expect the competition for those assets would be? And what would the timeline be in terms of it going up for sale, and then the sales being completed, and then getting into the rate base?
I can’t give you a precise answer on the timeline, but my guess is, assuming the elections turned out where the Republicans had majority control of the state assembly and the state senate, that there probably would be legislation introduced in early 2013 and then debated during 2013 and probably decided in the second half of 2013. That’s my best guess.
There would be, I am certain, some sort of auction. That would be something I think the state would probably want to go through. But I do know that there is a strong desire on the part of the current administration that the assets be, if they are sold, that they be sold to entities that have clear operating experience with utility or utility-like assets, and entities that are standalone investment grade. So I think there would be a clear preference to have an operator and an owner with a solid track record and investment grade credit ratings as the new owners of the assets if they were sold.
And then on your question of whether or not they would be in rate base, that’s still to be decided. Many of these assets provide service to individual state campus sites, or individual sites. So there may well be just a continuation or a revision of the existing contracts between the state agencies.
Unidentified Audience Member
Do you have, or do you plan to have, a smart meter program?
We do have a form of a smart meter program. We have not moved, yet, to the very latest smart meter technology, but we’ve actually got over a million new meters in place with some smart meter technology today. And I mentioned on the gas side, we’ll have the latest technology on the meter sets we replace on the gas side in place as well. We do not have full two-way communication among our meters yet. That’s to come.
Unidentified Audience Member
That’s a part of reliability that seems to make a lot of sense, and it’s also an investment.
Absolutely. It makes sense for customers, it makes sense as an investment.
Unidentified Audience Member
The 37 plants, how big are they? What are we talking, 1,000 megawatts? 3,000?
On the state plants? Many of them are very small. Many of them are like co-gen units, 30 megawatts, 20 megawatts. There a couple of larger, north of 200 megawatt plants, but many of the 37 are quite small, because they’re sized to serve the needs of one particular site.
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