Utilities-01-Dividend growth investing

Should a dividend growth investor look at WEC energy?

Looking for steady utility income?

Yes, thanks – I do enjoy the income flowing in from utilities.

The sector often is characterized by government requirements (e.g., no ability to hike prices beyond a particular point) and high capital investments. Here, we look at WEC Energy’s historic approach to dividends and whether this may be a good entry point.

History and approach to dividends

When looking at their past – a simple question is how does the management team prioritize income for their shareholders? We can see (Figure 1) that there is a steady increase in the investors’ income with time. This is favorable and good to see.

WEC-2022-07-historical dividend growth investor
Figure 1. WEC-2022-07-historical dividend growth investor. Note the steady dividend increases (white) and the dividend yield (red-brown). Historical Graph – Copyright © 2011-2022, F.A.S.T. Graphs™ – All Rights Reserved

.So – it has the right general trend and a steady increase in earnings growth (Figure 1). We can see from about 2013 that the price (black line) seems to be pulling ahead of the 15x PE (orange line). It trades at a premium level of 23x PE. This is relatively high. What is the likely impact for me as an investor? Is it worth paying this price for a 2.91% dividend yield and long-term growth (approx 7% pa over the recent years)?

Valuation and risk I am looking at as a dividend investor

So – if it is trading at a premium, is that bad? What is the implication?

Personally, I prefer to buy undervalued stocks as it provides more upside and limits the risks of further falls. Paradoxically, it means I am often buying while others sell. This can be uncomfortable but looking at Figures 2 & 3 gives some indication of what worries me.

WEC-2022-07-optimistic near-term forecast for dividend growth investor
Figure 2. WEC-2022-07-optimistic near-term forecast for dividend growth investor. Historical Graph – Copyright © 2011-2022, F.A.S.T. Graphs™ – All Rights Reserved

If we assume that WEC continues to trade at a premium, we see we might expect 6.7% return pa running until the end of 2024. This looks good but is based on the assumption that we are not going to see any decline in this PE level; that prices will continue to trade at a premium while earnings grow slowly. Another feature to look at on Figure 2 is along the bottom – see how the analyst estimates have changed. They have held fairly steady, which is what I would expect with a utility. This is good. But – is it reasonable to expect the PE to hold constant at this elevated level? What happens if it decreases?

Risk management and downside potential with WEC

I do worry that the PE multiple may collapse to a more reasonable 15x. What is the impact for me, investing in these types of utilities? Well, that it would represent a sizeable decrease in the price (Figure 3.)

WEC-2022-07-realistic near-term forecast for dividend growth investor
Figure 3. WEC-2022-07-realistic near-term forecast for dividend growth investor. Historical Graph – Copyright © 2011-2022, F.A.S.T. Graphs™ – All Rights Reserved

If we look at the black box that calculates the potential total return here, we can see that if the PE ratio contracts to a more reasonable 15x by the end of 2024, even with dividends and the DGR, the annual return over the period would be -8%. To me, this represents a reasonable risk. The firm also has slow long-term growth prospects and so the recovery and steady increase in earnings might take many years to recover the potential losses if the PE ratio slips to 15x.

Thesis and my thoughts as a dividend growth investor

For me – Figure 3 worries me due to the potential near-term losses and downside risk. The current elevated multiple of 23x appears out of sync with the long-term growth rates and, therefore, represents a premium on this well-managed utility. I do like the company and management of the company. I do NOT like the current price and the potential for downside from my perspective as a dividend growth investor; it ticks the income box but it fails to meet my risk-management needs.

As a result, I’m keeping this on my watch list with the potential to invest in the future. At the moment, I would rate this as a HOLD for current investors. While there is downside risk, I do not see any immediate catalyst that would cause the decline.

Looking for steady utility income? Yes, thanks – I do enjoy the income flowing in from utilities. The sector often is characterized by government requirements (e.g., no ability to hike prices beyond a particular point) and high capital investments. Here, we look at WEC Energy’s historic approach to dividends and whether this may be a…

Looking for steady utility income? Yes, thanks – I do enjoy the income flowing in from utilities. The sector often is characterized by government requirements (e.g., no ability to hike prices beyond a particular point) and high capital investments. Here, we look at WEC Energy’s historic approach to dividends and whether this may be a…

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