Why Xcel Energy Could Be A Bargain Despite Wildfire Risks

seekingalpha04-14

Utilities are facing challenges including rising capital expenditures, expensive energy transition, inflation, and higher borrowing costs.Utilities are underperforming compared to low-risk government ...

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href=https://seekingalpha.com/article/4683668-why-xcel-energy-could-be-bargain-despite-wildfire-risks><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Utilities are facing challenges including rising capital expenditures, expensive energy transition, inflation, and higher borrowing costs.Utilities are underperforming compared to low-risk government ...</p>\n\n<a href=\"https://seekingalpha.com/article/4683668-why-xcel-energy-could-be-bargain-despite-wildfire-risks\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"IE00B3S45H60.SGD","symbol_name":"Neuberger Berman US Multicap Opportunities A Acc 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In January, The Wall Street Journal wrote an article titled \"Utilities Get An Inflation Shock.\" They are facing the perfect storm, including rising capital expenditures related to storm and fire-related damage, the super expensive energy transition, and inflation, which makes operations even more expensive. Even worse, elevated rates make borrowing more expensive as well, which pressures earnings power.  Many utilities are also investing in the energy transition by building out renewable energy and transmission lines. The cost of doing all these things has risen because of higher labor and material costs. Adding to the burden: Higher interest rates haven’t only increased debt-financing costs for utility companies but also raised the cost of capital that they are expected to deliver. - The Wall Street Journal  Bear in mind that utilities are often used as income-generating vehicles. They usually have slow growth but decent yields. In this case, this is connected to another problem. Because government bonds have been pressured by higher inflation as well, investors can now get a much better yield by buying low-risk government bonds. The chart below compares the yield on the Utilities Select Sector SPDR ETF (XLU) to the yield on the Vanguard Extended Duration Treasury ETF (EDV), which yields close to 4%. In fact, EDV yields roughly 80 basis points more than the XLU ETF. Data by YCharts As a result, it may not come as a surprise that utilities haven't performed this poorly compared to the S&P 500 since the year 2000. If you had bought utilities at any point since then, you would have underperformed the S&P 500 - including dividends. Data by YCharts All of this brings me to Xcel Energy (NASDAQ:XEL), a stock I haven't covered since December 12, 2022, when I called it \"A Wickedly Cool Dividend Stock.\" Back then, I wrote the following: I believe that XEL shares will continue to outperform the market on a long-term basis without exposing investors to above-average volatility. Looking at the chart below, we see the stock has returned 138% over the past ten years. This beats the XLU ETF by a decent margin. It also beat the market before inflation became an even bigger issue in 2022. Data by YCharts Even worse, the stock is now 30% below its all-time high, as it may have played a role in the most recent Texas wildfires. If it weren't for these headwinds, the stock would have been a great outperformer. Could have, should have, would have. Right? That said, in this article, I'll revisit the stock and explain why it's still one of my favorite utilities - thanks to a very favorable total return picture. The only problem is the huge risks related to wildfire litigation. So, let's get to it! The Real Risk Of Wildfires Warren Buffett has become very careful in the electric utility industry. This is what he wrote in his most recent letter (emphasis added): Other electric utilities may face survival problems resembling those of Pacific Gas and Electric and Hawaiian Electric. A confiscatory resolution of our present problems would obviously be a negative for BHE, but both that company and Berkshire itself are structured to survive negative surprises. We regularly get these in our insurance business, where our basic product is risk assumption, and they will occur elsewhere. Berkshire can sustain financial surprises but we will not knowingly throw good money after bad.  Unfortunately, Xcel Energy is now under pressure from wildfires, as one of its divisions may have been involved in the Texas wildfires. Xcel Energy On March 9, Bloomberg reported: \"A wooden utility pole owned by Excel Energy Inc. that toppled during high winds and sparked the worst wildfire in Texas history appeared to be decayed at its base where it broke and fell over.\" The Smokehouse Creek fire ended up burning more than 1 million acres and costing the lives of two people. While the company is cooperating in the investigation, it is disputing claims that it acted negligently. Xcel said it has been cooperating with investigations into the wildfires and conducting its own review of the incident since it started. However, the company disputed claims in the same statement that the company acted negligently in maintaining and operating its infrastructure. - Texas Tribune In this case, the homeowners who are suing Xcel Energy are represented by the same company that sued Hawaiian Electric (HE) and PG&E Corp. (PCG). Both of these companies got \"nuked\" the moment wildfires ended up in massive lawsuits. XEL has escaped the same fate - at least for the time being. Data by YCharts For now, it looks like XEL may be spared. However, I'm working with very limited info to make that claim, which means the next few months and the earnings call at the end of this month will reveal a lot more valuable intel. The XEL Core Business Remains Strong XEL has outperformed its utility peers despite the Texas headlines. This is due to its focus on consistent earnings growth. As we can see below, the company has a long-term target to provide 8-10% annual shareholder returns.  5-7% of this is expected to come from EPS growth. The dividend is currently 4.1%. The company aims for a 50-60% payout ratio. The current payout ratio is 61%. The five-year dividend CAGR is 6.4%.  Data by YCharts Ignoring any valuation changes, the stock could return 9-11% per year if it is able to stick to its EPS growth outlook. Xcel Energy What matters is that the company has a fantastic track record. Not only has it grown its dividend by 6.3% per year over the past ten years, but it has also maintained a healthy payout ratio, as EPS growth has averaged 6.1% since 2005. Even better, the company's actual EPS results have come in below its midpoint just two times since 2004 - in 2005 and 2008. Xcel Energy In its fourth-quarter earnings call, the company reiterated its long-term EPS growth objective of 5% to 7% and expects to deliver earnings at or above the top end of this range starting in 2025. However, due to significant capital investment opportunities and equity funding needs, they plan to grow the dividend at the low end of the current 5% to 7% range, with a target payout ratio of 50% to 60%. After all, by 2030, it wants the renewable share of its power mix to be 70%. In 2005, that number was 9%. Last year, it was 41%. Xcel Energy In 2023, Xcel Energy received approval for a groundbreaking clean energy portfolio, including over 5,800 megawatts of new generation resources. According to the company, this portfolio represented a significant investment of $4.8 billion in Colorado, aimed at driving the transition to a cleaner energy economy. Long-term growth is expected to be fueled by strong base-rate growth through at least 2028. Xcel Energy Despite these growth rates, the company maintains favorable rates for both electric and natural gas, as it is priced well below the national average. Xcel Energy That said, in its 2028 financing plan, the company expects to require $13 billion in incremental debt, as it lacks the operating cash flow to fund new investments (and the dividend). Xcel Energy This year, the company has issued roughly $1.5 billion in new bonds with a weighted average coupon of 5.5%, which is decent in a market where SOFR (short-term) rates are at 5.3% and the U.S. 10-year yield is 4.5%. These favorable rates are caused by healthy credit ratings. The corporation has an investment grade rating from all major rating agencies and a plan to even lower its leverage ratio through 2028. This is caused by new debt flowing into value-adding projects. This allows the company to reduce leverage despite taking on more gross debt. Xcel Energy So, what does this mean for its valuation? Valuation There's some good news here, as analysts agree with the company's guidance. Using the FactSet data in the chart below, the company is expected to grow its earnings per share by 7% this year, potentially followed by 8% growth in both 2025 and 2026. The average of that is slightly above the company's longer-term guidance range. Even better, the stock trades at a blended P/E ratio of 15.6x, which is below its long-term normalized P/E multiple of 17.4x. FAST Graphs With that said, while utilities certainly deserve to trade at a discount in this environment, it shows the recent stock price decline has resulted in a favorable total return picture. In the scenario where the Texas wildfire lawsuit risks remain contained and rates/inflation come down quickly, the stock is in a great position to potentially return north of 12% per year. All things considered, I believe XEL offers good value. However, risks persist, as I do not expect that inflation will come down quickly. As such, I also do not expect interest rates to turn into a tailwind anytime soon. On top of that, XEL deals with wildfire uncertainties. While I will rate XEL a Buy and believe its core business makes it one of the best utilities on the market, this is far from a high-conviction buy. Takeaway In a challenging environment for utilities, the recent Texas wildfires have added significant pressure to companies like Xcel Energy. Despite this, XEL maintains a robust core business and a track record of consistent earnings growth. While the threat of wildfire litigation looms, the company's focus on renewable energy, strong base growth, and favorable financing rates position it for long-term success. Meanwhile, analysts expect continued EPS growth, and with the stock trading below its historical P/E ratio, there's potential for strong returns. Pros & Cons Pros.   Strong Core Business: XEL has consistent earnings growth and a focus on renewable energy, positioning it for long-term success.  Favorable Financing: With favorable financing rates and investment-grade credit ratings, the company can fund growth initiatives while maintaining manageable leverage.  Potential for Growth: Analysts forecast EPS growth above the company's long-term guidance, presenting an opportunity for investors.  Valuation: Trading below its historical P/E ratio, XEL offers value for investors seeking discounted stocks in the utility sector.   Cons:   Wildfire Risks: The threat of wildfire litigation adds uncertainty and potential financial liabilities to XEL's operations.  Inflation and Interest Rates: Persisting inflation and uncertain interest rate trends could impact the company's profitability and financing costs.  Regulatory Environment: Changes in regulations or policies could affect XEL's operations and profitability in unforeseen ways.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2427031281"}