Entergy Corporation: Good Potential In Renewables But Debt Is A Risk

May 17, 2022 7:26 AM ETEntergy Corporation (ETR)D, DTB, DTE, DTP, DTW, EIX, ES, EXC, SPY1 Comment2 Likes

Summary

  • Entergy serves a varied group of customers, boasting a well-balanced mix of industrial, residential, and commercial users.
  • The company is positioned to grow its EPS at a 5-7% rate over the next three years, giving it a potential total return of 9% to 11%.
  • Entergy is highly focused on renewables, which could ultimately endear it to the ESG crowd and the enormous amounts of money that they control.
  • The company is much more leveraged than its peers, which potentially exposes it to a high level of risk.
  • The stock appears to be relatively undervalued right now so it might deserve a place in your portfolio.
  • 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

peterschreiber.media/iStock via Getty Images

Entergy Corporation (NYSE:ETR) is an electric utility that provides service to customers in Arkansas, Louisiana, Mississippi, and Texas. The utility sector, in general, has long been a favorite among conservative investors due to the general stability of these companies and the fact that they tend to deliver earnings growth every year. Entergy's first quarter 2022 earnings generally reflect this, although the company's earnings per share were down year-over-year. The earnings decline may not be as big a problem as may be thought, though. Overall, Entergy does have quite a few things to like about it, including growth potential and an attractive 3.45% current yield that is likely to grow over time. The company also boasts an incredibly attractive valuation, which only adds to its appeal. This company may be worth considering for anyone looking to add a utility to their portfolio.

About Entergy Corporation

As stated in the introduction, Entergy Corporation is one of the largest utilities in the United States, serving more than three million customers in four states. These four states are Texas, Arkansas, Louisiana, and Mississippi. These are not often considered to be particularly progressive areas of the United States, which may explain why Entergy has seemingly not benefited as much as utilities in other regions from the recent market love for environmental, social, and governance investing. However, as we will see later in this article, Entergy has surprisingly devoted a great deal of attention and money to the development and deployment of renewable sources of power over the past few years. One of the defining features of much of Entergy's service area is that it is highly developed, with a very attractive mix of residential, commercial, and industrial users of electricity:

Sector

Energy Consumption (GWh)

% of Total

Residential

8,454

30.40%

Commercial

6,271

22.55%

Industrial

12,496

44.94%

This is nice because each of these different users represents a different type of user with somewhat different fundamentals. Perhaps the most notable of the differences between the markets is that residential sales are much less likely to be affected by a recession or other economic event. This is because most people consider electricity to their homes to be a necessity in today's world so they will typically prioritize paying their electric bills over other discretionary expenses during times when money gets tight. However, we might see commercial and industrial users reduce their electric consumption dramatically during an economic slowdown. This was certainly noticeable during 2020 when many businesses shut down or transitioned their employees to home-based work in response to the government-mandated coronavirus lockdowns. In contrast, though, commercial and industrial users will typically use substantially more electricity during normal times than residences do. Thus, Entergy's reasonably balanced mix of all types of users positions the company quite well to perform in any economic climate. This is something that may have gained importance in recent months due to a growing number of predictions that the United States will enter a recession by the end of the year.

One of the defining characteristics of utilities is that they tend to increase their earnings per share every year. However, Entergy failed to do this in the first quarter of 2022 as the company only earned $1.32 per share compared to $1.47 per share in the first quarter of 2021:

Entergy EPS Growth Q1 2021-Q1 2022

Entergy

This does not disprove the overall thesis of steadily growing earnings, though. This is because Entergy's first quarter 2021 results were artificially boosted by a one-time gain due to the reversal of a regulatory provision in Arkansas. That event added $0.16 per share to the company's earnings during that quarter. If we were to back that out, then Entergy would have earned $1.31 in the year-ago quarter versus $1.32 per share in the most recent one. Admittedly, a penny per share is not very much growth but it is still growth.

Entergy is quite likely to continue this growth trajectory going forward. That is because the company is actively growing its rate base. The rate base is the value of the company's assets upon which it is allowed by regulators to earn a specified rate of return. As this rate of return is a percentage, any increase in the rate base allows the company to adjust the rates that it charges its customers in order to make more money. The usual way that a utility increases the size of its rate base is by investing money into upgrading, modernizing, or even expanding its utility infrastructure. Entergy is planning to do exactly this as the company intends to invest $11.7 billion into this process over the 2022 to 2024 period:

Entergy Capital Spending Plan

Entergy

This will unfortunately not increase Entergy's rate base by $11.7 billion. This is because things such as depreciation and asset retirements will decrease the rate base over the same time period. Entergy's plan should still be sufficient to overcome these effects and ultimately result in earnings per share growth for the company. Management has guided for the company's earnings per share to grow at a 5% to 7% compound annual growth rate over the 2021 to 2024 period:

Entergy Projected EPS Growth Rate

Entergy

I will admit that I would prefer a much longer time horizon for management's planning and guidance. Nearly every other utility that I cover has provided this information for the 2022 to 2026 period. This longer time horizon is overall much more attractive for long-term buy-and-hold investors, which is a category that would likely include most people that would be interested in purchasing shares of Entergy. With that said though, this earnings per share growth combined with the stock's current 3.45% dividend yield should allow the company to reward its investors with a 9% to 11% total return over the 2021 to 2024 period, which is very respectable for a utility company.

As stated earlier, the area of the country in which Entergy operates is not often considered to be progressive. After all, Texas and to a lesser extent Louisiana is at the center of the nation's oil and gas industry. Despite this, Entergy has a number of renewable projects under construction, most of which are either wind or solar projects:

Entergy Extensive Renewable Projects

Entergy

As we can see, the company has numerous projects that are scheduled to come online prior to the end of 2026, although most will be in service somewhat earlier than that. In total, the company has 5.350 gigawatts of capacity under construction, which, when added to the 660 megawatts of generation that the company already possesses, is sufficient to make it one of the largest producers of renewable energy in the United States by the middle of the decade. This is something that may ultimately make Entergy somewhat appealing to the managers of the numerous environmental, social, and governance funds that have emerged over the past several years.

Attracting the attention of environmental, social, and governance funds is something that could prove to be a bullish catalyst for Entergy's stock price. This is due to the sheer amount of money that these funds control. As of December 31, 2021, environmental, social, and governance funds control approximately $2.7 trillion globally and $357 billion in the United States alone. This size is the result of several years of remarkable growth:

ESG Fund AUM Growth

Sustainfi.com/Data from Morningstar Direct

According to Bloomberg, these funds may control more than $53 trillion by 2025. This is an almost unfathomable amount of money that could easily have a significant impact on the price of any stock in the market. The popularity of this style of investing is likely the reason why so many companies have been devoting a great deal of effort to promoting their environmental, social, and governance credentials in recent investor presentations. As Entergy expands its renewable generation capacity, it may begin to attract some of this capital, which could work to either drive the stock price up beyond that of what more traditional utilities are able to return or at the very least put a floor under the stock price to protect it from a market collapse.

Entergy may have some advantages over many of its peers when it comes to the deployment of renewable sources of energy such as wind and solar. This is due to the geography and climate of the region in which it operates. Texas in particular tends to receive a great deal of sunlight, which helps to improve the efficiency of solar power, particularly when compared to solar panels deployed in areas that are more subject to rainy or cloudy conditions. In addition to this, several parts of the company's service territory are reasonably flat. Wind power tends to perform best in areas with flat geography because of the lack of hills or trees to break up the wind. As a result, winds in these areas tend to be somewhat stronger and more stable than winds elsewhere. This is why offshore wind tends to be superior to other forms of renewable energy. Overall, this makes wind turbines more efficient and reliable, which is the biggest problem with increasing the nationwide prevalence of renewable power. These advantages possessed by Entergy should allow it to keep building up its renewable generation infrastructure well beyond the middle of the decade, which could further increase its appeal to certain investors over time. That is something else that could bode well for the long-term performance of the stock.

Financial Considerations

In previous articles on Entergy Corporation, one of the biggest concerns that I expressed about the company is its fairly high debt load. This is because debt is a much riskier way to finance a company than equity is because debt must be repaid at maturity. As few companies actually have enough cash to do this, the debt is usually repaid by the company issuing new debt to pay off the maturing debt. Depending on the market and economic conditions, it may not be able to do this at the same interest rate so the company may see its costs increase as a result. This risk is particularly relevant today due to the Federal Reserve's plans to raise interest rates over the course of this year. In addition, a company must make regular payments on its debt if it is to remain solvent. As a result, an event that causes the company's cash flows to decline could push it into financial distress if the company has too much debt. Although an electric utility like Entergy typically boasts remarkably stable cash flows, bankruptcies are certainly not unheard of in the sector.

One metric that we can use to evaluate a company's debt load is the net debt-to-equity ratio. This tells us to what degree the company is financing its operations with debt as opposed to wholly-owned funds. This ratio also tells us how well the company's equity will cover its debt obligations in the event of a bankruptcy or liquidation, which is arguably more important. As of March 31, 2022, Entergy Corporation had a net debt of $27.857 billion against total shareholders' equity of $11.9962 billion. This gives the company a net debt-to-equity ratio of 2.32. Here is how that compares to the company's peers:

Company Net Debt-to-Equity
Entergy Corporation 2.32
DTE Energy (DTE) 2.08
Eversource Energy (ES) 1.39
Exelon (EXC) 1.57
Dominion Energy (D) 1.51
Edison International (EIX) 1.69

As we can clearly see, Entergy has a much higher net debt-to-equity ratio than many of its peers. This is a clear sign that Entergy may be utilizing too much debt in its financial structure. This ultimately indicates that the company is likely somewhat riskier than its peers. Unfortunately for Entergy, it seems to be getting worse in this aspect of its business since the company's net debt-to-equity ratio was only 2.02 at this time last year. This is certainly not a good sign and is something that any investor should keep a very close eye on going forward.

Dividend Analysis

One of the biggest reasons why investors purchase shares of utility companies like Entergy Corporation is the exceptionally high yields that these companies tend to pay out. Entergy is certainly not an exception to this as the stock's 3.45% current yield is substantially higher than the 1.45% yield of the S&P 500 index (SPY). Entergy also has a history of increasing the dividend on an annual basis:

ETR Dividend History

Seeking Alpha

A consistently growing dividend is always an attractive thing, particularly during inflationary times such as what we have today. This is because inflation is steadily reducing the number of goods and services that we can buy with the dividend that we receive from the company. This can make an investor feel as if they are getting poorer and poorer. The fact that the company keeps increasing the amount that it pays us helps to overcome this effect because the higher amount of money helps ensure that the dividend will purchase the same things over time and thus help us to maintain our lifestyles. 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 Entergy to suddenly be forced to reverse course and cut the dividend since that will reduce our incomes and almost certainly 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. The free cash flow is the money that is generated by the company's ordinary operations that is left over after it pays all of its bills and makes all necessary capital expenditures. This is the money available for tasks such as reducing debt, buying back stock, or paying a dividend. In the first quarter of 2022, Entergy reported a negative leveraged free cash flow of $1.6993 billion. This is obviously not enough for the company to afford any dividend, let alone the $205.1 million that it actually pays out.

With that said, it is not unusual for utilities to finance their capital expenditures via the issuance of equity and especially debt while financing their dividends out of operating cash flow. In the first quarter of 2022, Entergy reported an operating cash flow of $538.0 million. This was easily enough to cover the $205.1 million that was paid out to the investors with a good deal of money left over for other purposes. Overall, the company's dividend is probably reasonably safe but I will admit that I would feel more comfortable if the coverage was a bit higher.

Valuation

It is always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate a suboptimal return from that asset. In the case of a utility like Entergy Corporation, one metric that we can use to value it is the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes the company's earnings per share growth into account. Generally, a price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to its forward earnings per share growth and vice versa. However, very few stocks have a ratio that low so the best way to use it is to compare the company's valuation to that of its peers in order to determine which stock has the most attractive relative price.

According to Zacks Investment Research, Entergy Corporation will grow its earnings per share at a 6.07% rate over the next three to five years. This is very much in line with the figure that we used earlier to calculate the potential total return so it seems like a pretty good estimate. This gives the stock a price-to-earnings growth ratio of 3.05 at the current price. Here is how that compares to some of the company's peers:

Company

PEG Ratio

Entergy Corporation

3.05

DTE Energy

3.59

Eversource Energy

3.50

Exelon

3.32

Dominion Energy

3.23

Edison International

3.77

As we can clearly see here, Entergy appears to be trading at a much lower valuation than its peers. As such, the company looks to be somewhat undervalued today. This may be a result of the company's high debt load, which exposes it to some risks not faced by these other firms. However, the stock could certainly offer an opportunity here, particularly for an investor that is willing to take on a bit more risk.

Conclusion

In conclusion, Entergy appears to have a lot to offer to many investors. The company's high yield and attractive valuation, in particular, make it a nice pick in the utility space, although its relatively high debt load does make it a bit riskier than many of its peers. The company's heavy devotion to the deployment of renewable energy seems somewhat surprising given its location in the Deep South but that could also endear it to the managers of the various wealthy environmental, social, and governance funds that have become a force in the market over the past several years. Overall, this company may be worth a slot in your portfolio.

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