Ameren Corporation: Following The Oracle Of Omaha's Advice

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About: Ameren Corporation (AEE)
by: Jenks Jumps
Summary

Ameren Corporation operates both electric and gas utilities in both Missouri and Illinois. But, its business models are not as straightforward as we expected.

Ameren is projecting earnings growth of 6% to 8% annually through 2023 based on rate base growth of 8% annually. Its dividend distribution should grow accordingly.

But, its shares are richly valued of late making its yield lower than hoped.

Combining these factors with a lack of understanding about the business models has us heeding Buffett's advice.

Abraham Lincoln is credited with saying, “Those who look for the bad in people will surely find it.” Apparently, he didn't actually say it. But, it's not any less true just because honest Abe didn't utter the words. Further, if it's true for people, it would have to be true for companies. I'm starting to wonder if the dynamic is clouding my research.

Back Story

A Seeking Alpha loyal asked me if I had an opinion on DTE Energy (DTE) or Ameren Corporation (AEE). My investment club has positions in Otter Tail (OTTR), Duke Energy (DUK) and Xcel Energy (XEL). It wouldn't hurt for us to add another from a diversification standpoint.

I looked at DTE Energy first and was impressed initially. I'll admit I start every analysis with a healthy dose of skepticism. I look for the anomalies. The inevitable question I face when I've found one is whether it's big enough to outweigh the positives.

I did find a “gotcha” with DTE Energy. When offering its 2019 guidance, it opted to compare to 2018 original guidance rather than 2018 actual results. That's because compared to 2018 actual results, there would be a decline rather than growth. On the other hand, DTE Energy has exceeded its guidance for ten consecutive years.

While my investment club does tend to favor companies that under-promise and over-deliver, we are also drawn to management teams that simply tell it like it is. It was my opinion DTE Energy missed an opportunity to be more upfront and forthright. Coupled with the fact it's trading at all-time highs, it doesn't appear an opportune time to start a position.

I subsequently looked at Ameren – with the same dose of skepticism and in search of anomalies. This time, the shortfall I found was with my club.

Ameren Corporation

Ameren operates both electric and gas utilities in both Missouri and Illinois. In operation for more than a century, Ameren Missouri, the state's largest electric utility and second largest gas distributor, serves 1.2 million electric customers and 100,000 gas customers. Ameren Illinois operates Ameren Illinois Electric Distribution and Ameren Illinois Natural Gas. Ameren Illinois Electric Distribution serves 1.2 million electric customers. Ameren Illinois Natural Gas, the state's third largest gas distributor, serves 800,000 gas customers. ATXI is responsible for the construction and operation of the electric transmission business in Illinois.

Ameren Corporation Geography Source

Earnings for a utility company typically increase when the company's regulated rates increase. Rate cases require regulatory approval by state governments. Rate cases are utilized for overall cost increases or large projects. Thus, as a utility invests in its infrastructure, its rate base should grow. From 2019 to 2023, Ameren expects to invest approximately $13.3 billion in capital infrastructure. Through 2023, Ameren expects its rate base to grow 8% annually from $15.3 billion to $22.7 billion. Subsequently, it expects earnings to grow 6% to 8% annually through 2023.

Ameren Corporation Rate Base Projections Source

Rate increases may be music to a utility company's ears but, they certainly wouldn't sound as sweet to the utility customers' ears. As such, it is comforting to know Ameren's electricity customers pay lower rates than most in the United States.

Ameren Corporation Electricity Rates Source

In November 2018, the ICC (Illinois Commerce Commission) approved an increase in formula rates for Ameren Illinois Electric Distribution customers that went into effect in January 2019. As well, it approved a base rate increase for Ameren Illinois Natural Gas customers that also took effect January 2019. The formula rate framework in Illinois for electricity customers has a sunset date of year-end 2022. But, there is legislation filed to extend the framework indefinitely.

Ameren Missouri's customers' base rates are frozen until April 1, 2020 and are capped at a 2.85% CAGR through end of year 2023.

Like most domestic utility companies, Ameren intends for renewable energy sources to help it keep rates low. It plans to reduce carbon emissions 35% by 2030, 50% by 2040 and 80% by 2050. Ameren Missouri has build-transfer agreements in place to add 557-megawatt hours of wind-powered energy by 2020. On March 6th, the Missouri Public Service Commission voted in favor of Ameren Missouri constructing and acquiring a facility for up to 157-megawatt hours of wind-generated energy. This is the second wind facility approved for Ameren Missouri. The first, approved in October 2018, will have capacity up to 400-megawatt hours. As well, it plans 100-megawatt hours of solar-powered generation by 2027.Ameren Corporation Renewables Source

Ameren Transmission

Ameren Transmission is composed of the aggregated electric transmission businesses of Ameren Illinois and ATXI. Unlike Ameren Missouri and Ameren Illinois, which are regulated by state governments, Ameren Transmission's rates are regulated by FERC for “the wholesale transmission and distribution of energy in interstate commerce.”

ATXI has two projects under construction – Illinois Rivers and Mark Twain. The line being constructed in the Illinois Rivers project spans from eastern Missouri across Illinois to western Indiana. It should be completed by the end of 2019. The line being constructed in the Mark Twain project is located in northeast Missouri and connects Iowa to the Illinois Rivers project. The Mark Twain project should also be completed by the end of 2019.

2019 Guidance

Like DTE Energy, Ameren Corporation estimates its 2019 earnings would decline compared to 2018 earnings. On February 14, 2019, Ameren reported 2018 full-year results for non-GAAP diluted earnings of $3.37 per share. But, for 2019, the utility expects 2019 earnings to fall in a range of $3.15 to $3.35 with a midpoint of $3.25.

But, unlike DTE Energy comparing to 2018 original guidance, Ameren compares its 2019 projection to a weather-normalized base for 2018. In 2018, a warmer summer and colder winter in Missouri accounted for positive earnings of $0.32 when compared to “normal” weather for the area. In that regard, the 2018 comparison base becomes $3.05 and the growth in 2019 then appears to be approximately 6.6% from the midpoint.

Ameren Corporation 2019 Guidance Source

There are other smaller additions to and subtractions from the bottom line expected in 2019. In total, they end up netting to an expected positive impact to earnings. But, due to anticipated capital investments, cash flow is expected to be negative in 2019.

“We expect to fund this year's negative free cash flow and debt maturities primarily through a combination of short and long-term debt borrowings and issuances.”

Ameren Corporation 2019 Cash Flow Projection Source

Our Hesitation About Investing

In early 2016, my investment club migrated from a GARP (growth at a reasonable price) strategy to a DGI (dividend growth investing) strategy. We developed an investing model using criteria we dubbed as GRAVY - “GR” owth “A”bility, “V”aluation and “Y”ield. We strive to invest in healthy, fairly-valued dividend-payers with clear potential for dividend growth.

Ameren does meet the growth ability factors of our GRAVY model. With its projection to grow earnings by 6% to 8% through 2023, it is reasonable to expect its dividend to grow accordingly. Ameren expects its dividend distribution to account for 55% to 70% of annual earnings.

But, like DTE Energy, Ameren shares are richly priced of late and trading near all-time highs. This means its dividend yield is lower at 2.65%.

Beyond these factors, I'd still be hesitant to invest in Ameren – not necessarily because of the company but because of the club's lack of understanding or experience with the business models of two of Ameren's segments.

First, the laws in Illinois are different regarding how Ameren Illinois Electric Distribution may operate.

To supply electricity to a customer, there are two components – the generation of the electricity and the delivery of the electricity. In Illinois, this has been divided into two businesses.

“In 1997, Illinois legislation restructured the utility generation and delivery model to establish Illinois utilities, including Ameren Illinois, as regulated, delivery-only companies.”

This means customers may purchase electric power from a third-party RES (Retail Electric Supplier). If they don't, the division means Ameren Illinois must buy electricity for its customers. This procurement process is managed by a separate agency which is overseen by the ICC (Illinois Commerce Commission).

This separation also means Ameren is not allowed to own facilities which generate renewable energy in Illinois.

Ameren Illinois Electric Distribution contributed approximately 17% of Ameren Corporation's total net income in 2018 ($139 million of $828 million).

Secondly, the business model of the Ameren Transmission segment is also unfamiliar to the club. In 2018, this segment contributed approximately 20% of Ameren's net income ($164 million of $828 million).

Thus, in total, we don't understand well enough how Ameren generated nearly 37% of its net income in 2018.

The combination of these factors, valuation, yield and lack of comprehension about the business models, generates a big enough question mark to warrant a pass for the club. Furthermore, at this point, the rich valuation and low yield don't warrant the pursuit of an education on the business models of Ameren Transmission and Ameren Illinois Electric Distribution.

Summary

Abraham Lincoln may not have actually shared the wisdom about looking for the “bad.” And, perhaps, when researching both DTE Energy and Ameren Corporation, my skepticism became my Achilles' heel.

Regardless, my investment club will be following Warren Buffett's advice.

“Never invest in a business you can’t understand.”

Disclosure: I am/we are long OTTR,DUK,XEL. 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.

Additional disclosure: I belong to an investment club that owns shares in OTTR, DUK and XEL.