OGE Energy: Strong Renewable Credentials And A 4.22% Yield

Mar. 11, 2022 12:54 PM ETOGE Energy Corp. (OGE)DTB, DTE, DTP, DTW, ES, ETR, EXC, NEE, XOM11 Comments6 Likes

Summary

  • OGE Energy is an electric utility serving Oklahoma City.
  • Oklahoma City has very attractive demographics that are resulting in the company seeing customer base growth along with solid EPS growth.
  • The stock is positioned to deliver a 10% to 11% total return over the next year.
  • The company's 4.22% yield appears quite safe and its historical growth over time should help offset the impact of inflation.
  • The valuation might be somewhat stretched at the current price.
  • Looking for a helping hand in the market? Members of Energy Profits in Dividends get exclusive ideas and guidance to navigate any climate. Learn More »

Electricity transmission towers with red glowing wires

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OGE Energy Corp. (NYSE:OGE) is a regulated electric utility that serves customers in Oklahoma and Arkansas. These are admittedly not the first states that most people would think of when considering an investment in a utility due to their largely rural nature, but in fact, there is a great deal to like about the overall demographics here that benefits this company in a very large way. OGE Energy also shares many of the characteristics that endear them to more conservative investors, most notably their general stability and relatively slow but consistent growth. The company's most recent results certainly bear out this thesis, which I discussed in a previous article on the company. The utility sector, in general, tends to have somewhat higher yields than most other things in the market, which OGE's 4.22% yield also bears out. Unfortunately, the company appears to be somewhat overvalued relative to its peers but there may still be some reasons to consider it.

About OGE Energy

As stated in the introduction, OGE Energy Corp. is a regulated electric utility that serves customers throughout the state of Oklahoma, although it also has a relatively small operation in Arkansas:

OGE Energy Service Area

OGE Energy Fact Sheet

Admittedly, this service area is almost entirely rural except for Oklahoma City, and rural areas are not exactly known for producing strong customer growth. This is unfortunate because customer growth is one of the only ways by which a utility can generate growth. Fortunately, though, Oklahoma City is much more favorable in this regard. The city had one of the lowest unemployment rates in the nation at 1.6% compared to 3.8% for the nation as a whole. This has resulted in population growth for the region since people have begun to migrate to it in search of work. The city also has a fairly reasonable cost of living compared to some other areas, which also could be attractive to migrants. We certainly do see this as OGE's customer base increased by 1.4% over the past year:

OGE 2021 Customer Growth

OGE Energy Investor Presentation

This trend is expected to continue going forward. It should be obvious how this would result in growth for OGE Energy. After all, the more people live in an area, the more people are drawing power from the grid and, of course, paying their electric bills and thus providing the company with revenues. In fact, though, the consumption of electricity tends to increase more rapidly than the population in general. This is because a growing population of people tends to spur business creation, particularly if those people are skilled or have disposable income. As a business, in general, uses more electricity, the draw on the grid increases more rapidly than the population. We can see this quite easily in the fact that OGE Energy saw the consumption of electricity increase by 2.4% over the course of 2021. The company expects to see demand increase by 3% to 5% this year as fears of the coronavirus subside and people return to their pre-pandemic lives. Naturally, increased consumption of electricity benefits OGE Energy for the same reason that a rising population does since the company bills based on the amount of electricity consumed.

A 3% to 5% growth rate is unlikely to greatly attract investor dollars, however. Fortunately, OGE Energy has other ways to grow its earnings. The most important of these is to increase its rate base. The rate base is the value of the company's assets upon which it is able to earn a specified rate of return. As this specified rate of return is a percentage, any increase in the value of the company's rate base allows it to increase the prices that it can charge its customers in order to earn that specified rate of return. The usual way that a company increases the value of its rate base is by investing money into constructing, upgrading, modernizing, and potentially expanding its infrastructure. OGE Energy, like most utilities, is constantly doing this. OGE Energy has a particularly necessary reason to do this as the firm needs to support the growing demands of its customer base. Over the 2022 to 2026 period, OGE Energy plans to invest $4.75 billion into its utility infrastructure. This will grow the company's rate base from $7.554 billion to $10.369 billion during the period:

OGE Rate Base Growth 2020-2026

OGE Energy Investor Presentation

There may be some readers that notice that this projected rate base growth is less than the amount of money that the company is investing into it. There are a few reasons for this. The first of these is depreciation. The value of any newly-purchased capital asset declines the moment that it is purchased. Thus, the things that the company buys today will be worth far less in 2026. In short, the rate base will steadily decline if the company does not keep investing money into it. There are also certain parts of this investment capital that will be spent on replacing other assets. Naturally, when an asset is retired, then its value immediately drops to zero and thus decreasing the size of the rate base.

One thing that anyone looking at the above chart will notice is that OGE Energy's rate base increased over the 2020 to 2021 period. This is one reason why the company was able to increase its earnings per share by 5.88% in the full-year 2021 period:

OGE Energy 2021 EPS Growth

OGE Energy Investor Presentation

OGE's management has guided for about the same growth rate in 2022. If it can accomplish this, then investors should be looking at a 10% to 11% total return over the period when the earnings per share growth is combined with the current dividend yield. This is certainly not an unattractive return for a conservative utility stock. In fact, it is one of the more attractive potential total returns out of all of the utilities that I have discussed in recent weeks.

One of the areas in which OGE is investing heavily is renewable energy, particularly wind and solar power. This may seem surprising considering that Oklahoma and Arkansas are not generally considered to be the most progressive areas of the country. This does make a certain amount of sense though, and not only because nearly every electric utility is investing in the development of renewable power, this is due largely to the geography and climate of Oklahoma. First of all, Oklahoma, in general, is relatively flat, which lends itself exceptionally well to the development of wind power plants. This is because the lack of hills to break up the breezes results in stronger and more consistent winds than what would be found in other areas. This is one of the reasons why offshore wind farms are superior to onshore ones. This trait overall makes these facilities somewhat more reliable than a wind farm that we might find in a more mountainous region. Oklahoma also tends to get a great deal of sunlight, which works quite well for solar power.

One of the major trends that we have seen in the capital markets recently is a great deal of interest in renewable energy companies. This was particularly evident in the months following the outbreak of the COVID-19 pandemic and was epitomized by NextEra Energy (NEE) briefly surpassing Exxon Mobil (XOM) as the largest energy company in the world by market cap. This may be explained by some as young and idealistic investors pouring their government-issued stimulus checks into the capital markets but there are certainly other causes. In 2021, a record $649 billion poured into environmental, social, and governance funds, causing them to now account for 10% of all worldwide mutual fund assets. These funds invest heavily into renewable power, and when we consider the sheer quantity of these assets, it should be obvious how this could push up renewable stock prices. The reason that this could be important here is that OGE's investments into renewable power could attract these funds to the stock. They may begin buying if the stock price falls and thus put a floor under the stock price. This fact may thus interest investors that are concerned with principal preservation.

Fundamentals Of Electricity

Electric utilities have been in the media an abnormal amount lately, which is largely due to the electrification trend. This is something that has been widely promoted by various government officials and futurists that refer to the conversion of things that are historically powered by fossil fuels to the use of electricity instead. The most commonly cited things are transportation (electric cars) and space heating but there are other things that could be converted. This can be expected to massively increase the demand for electricity. In fact, I detailed the impact of electric cars alone in a previous article. It should be fairly obvious why this would be a good thing for electric utilities since the increased consumption of electricity would result in substantially higher revenues across the utility sector.

Unfortunately, the United States Energy Information Administration does not believe that this scenario is likely to play out to the degree that electrification proponents expect. According to the government agency, the national demand for electricity will grow at a 1% to 2% rate over the next thirty years:

EIA Electric Demand Growth 2022-2052

EIA 2022 Annual Energy Outlook

This is nowhere close to the growth rate that we would expect were wide swathes of the economy to convert from the use of fossil fuels to the use of electricity. Thus, the agency appears to be suggesting that the progression of this trend and adoption of these technologies will be nowhere near as rapid as some predict. It is likely that this will indeed be true as the infrastructure investment that is needed would be highly cost-prohibitive and electricity is much more expensive to use as a heating source than fossil fuels. Until these factors charge, it is quite unlikely that the heavy use of electricity will become widespread. Thus, it seems most likely that electric utilities will deliver the same slow and steady growth that they always have.

Financial Considerations

It is always important to look at the way that a company finances itself prior to making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid. In addition, a company must make regular payments on its debt if it is to remain solvent. As a result of this, a decline in cash flows could push a company into financial trouble if it has too much debt. Although utilities tend to have relatively stable cash flows, bankruptcies are certainly not unheard of in the sector.

One metric that we can use to analyze a company's financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which the company is financing itself with debt as opposed to equity. The ratio also tells us how well the company's equity would cover its debt obligations in the event of a bankruptcy or liquidation, which is arguably more important.

As of December 31, 2021, OGE Energy had $5.0209 billion in net debt compared to $4.0563 billion in shareholders' equity. This gives the company a net debt-to-equity ratio of 1.24. Here is how that compares to some of the company's peers:

Company

Net Debt-to-Equity Ratio

OGE Energy

1.24

NextEra Energy

1.19

DTE Energy (DTE)

2.09

Eversource Energy (ES)

1.37

Entergy (ETR)

2.26

Exelon Corporation (EXC)

1.22

As we can clearly see here, OGE Energy appears to have a very similar overall financial structure to its peers. This is quite a good sign as it provides us with confidence that the company is not using too much debt to finance itself, and thus, its debt should not pose any particularly outsized risk.

Dividend Analysis

One of the reasons that many investors purchase stock in utilities is because they will frequently boast a higher yield than many other things in the market. The biggest reason for this is their generally slow earnings growth, which causes them to deliver a higher proportion of their total return in the form of the dividends that they payout as opposed to the capital gains of more rapidly growing companies. OGE Energy is certainly no exception to this as its 4.22% current yield is substantially higher than the 1.34% on the S&P 500 Index (SPY). As is also often the case with utilities, OGE Energy has a history of slowly growing its dividend on an annual basis:

OGE Dividend History

Seeking Alpha

A company that consistently grows its dividend over time is particularly attractive during inflationary environments, such as the one that the American economy is in today. This is because the rising prices that we see in such an environment are steadily reducing the amount that we can buy with the dividend as time goes on. If the company is increasing the size of the dividend, then it helps to offset this impact. As is always the case though, it is critical that we ensure that the company can actually afford the dividend that it pays out. After all, we do not want it to reverse course and be forced to cut the dividend since that would reduce our income and most likely cause the stock price to decline.

The usual way that we judge a company's ability to pay its dividend is by looking at its free cash flow. A company's free cash flow is the money that is generated by its ordinary operations that is left over after the company pays all of its bills and makes all necessary capital expenditures. This is, therefore, the money that is available to do things such as reducing debt, buying back stock, or paying a dividend. During the fourth quarter of 2021, OGE Energy reported a negative levered free cash flow of $106.8 million. This is obviously not enough to pay any dividend, let alone the $82.1 million that the company actually paid out during the quarter.

With that said, it is not uncommon for a utility to finance its capital expenditures via the issuance of both debt and common equity and use its operating cash flow to pay the dividend. This is due largely to the incredibly high costs of constructing and maintaining utility-scale infrastructure over a wide geographic area. During the fourth quarter, OGE Energy achieved an operating cash flow of $180.8 million. This is more than enough for the company to pay out the $82.1 million in dividends and still have a great deal of money left over to partially fund other things, such as its capital expenditures. Overall then, this dividend does appear to be sustainable and investors should not have to worry about a potential cut.

Valuation

It is always critical to ensure that we do not pay too much for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate suboptimal returns off that asset. In the case of a utility like OGE Energy, one metric that we can use to value it is looking at the price-to-earnings growth ratio. This is a modified form of the familiar price-to-earnings ratio that takes a company's earnings per share growth into account. A price-to-earnings growth ratio of 1.0 could be a sign that the stock is undervalued relative to its forward earnings growth and vice versa. It is, however, exceptionally rare to find a stock with a ratio this low in today's market, particularly in the slow-growing utility sector. Thus, it is best to compare the stock to its peer companies in order to determine which one has the most attractive relative valuation.

According to Zacks Investment Research, OGE Energy will grow its earnings per share at a 3.47% rate over the next three to five years. This is admittedly quite a bit lower than what the company's own management has guided for, although admittedly management's guidance was only for 2022. The Zacks estimate would give the company a price-to-earnings growth ratio of 5.15 at the current stock price. Here is how that compares to the company's peer group:

Company

PEG Ratio

OGE Energy

5.15

NextEra Energy

3.27

DTE Energy

3.51

Eversource Energy

3.29

Entergy

17.06

Exelon Corporation

2.88

With the notable exception of Entergy, OGE has by far the highest ratio here. This could be a sign that the stock is significantly overvalued at the current level. However, it is important to note that if we use management's approximately 6% estimate for the earnings per share growth rate, then the ratio drops to 2.75, which makes OGE appear significantly undervalued compared to this peer group. I am hesitant to go that far since we used Zacks' earnings growth estimate for every other company here, but it is quite possible that OGE Energy is not as overvalued as it appears.

Conclusion

In conclusion, OGE has quite a bit to offer a potential investor. In particular, the company is based in one of the more attractive cities in terms of demographics, which allows it to grow by adding new customers somewhat easier than other utility companies. The stock price may incorporate that though as it does not appear to be significantly undervalued relative to its peer group. The company does have a great deal of renewable credentials, however, and a very attractive dividend, so it could certainly be quite appealing to an investor interested in the utility sector.

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