By Simply Safe Dividends. Originally published at ValueWalk.
Regulated utilities have long been a core staple in dividend portfolios, courtesy of their high-yields, safe payouts, slow but steady dividend growth, and very low volatility.
But while most people focus on the biggest and well-known names in the sector, such as Duke Energy (DUK), Southern Company (SO), and Consolidated Edison (ED), there are a select few faster growing, less known gems hidden in this otherwise boring industry.
Let’s examine one such name, WEC Energy Group (WEC), to see if this fast growing utility has what it takes to be one of the top dividend growth performers in this steady, defensive industry.
More importantly find out whether or not now could be the right time to add one of America’s best utilities to your own dividend growth portfolio. WEC Energy is a company I am watching closely for our Conservative Retirees dividend portfolio.
Business Description
Originally founded in 1896 as The Milwaukee Electric Railway and Light Company, WEC Energy Group has grown through six major acquisitions over the past 120 years to become one of the nation’s largest electric and natural gas utilities.
After the last (and largest) merger, the $9.1 billion purchase of Integrys Energy Corp, which transformed it into the Midwest’s largest regulated utility and the 15th largest diversified utility in America, the company changed its name to Wisconsin Energy Corp (now WEC Energy Group).
Today the company operates through seven major subsidiaries: We Energies, Wisconsin Public Service, Peoples Gas, North Shore Gas, Minnesota Energy Resources, Michigan Gas Utilities, and Upper Michigan Energy Resources.
Source: Wisconsin Energy Corporation Investor Presentation
All told, WEC’s 9.5 GW of electric power generating capacity, 44,000 miles of natural gas pipelines, and 70,000 miles of electrical transmission lines serve 4.4 million customers in Michigan, Minnesota, Wisconsin, and Illinois.
It also owns W.E Power, which designs, builds, and owns power plants, as well as a 60% stake in the American Transmission Company (ATC).
ATC is America’s only multi-state transmission only utility and operates 9,540 miles of high-voltage transmission lines in Michigan, Wisconsin, and Illinois.
The utility’s power generation is heavily coal dependent. However, management is working hard to increase its generation capacity to cleaner (and cheaper) sources of power, specifically natural gas and renewables (wind, solar, and hydro power).
| Energy Source | Capacity (Megawatts) | % Of Capacity |
| Coal | 5,044 | 53.4% |
| Natural Gas | 3,753 | 39.7% |
| Renewables | 652 | 6.9% |
| Total | 9,449 | 100% |
Source: Wisconsin Energy Corporation Investor Update
As you can see, while the company has made great strides in diversifying its business in recent years, the vast majority of its sales, earnings, and cash flow still derive from its core electrical business in its home market of Wisconsin.
However, as we’ll soon see, the majority of the utility’s growth runway lies elsewhere.
By end user, 37% of WEC Energy’s retail deliveries are to large commercial and industrial (C&I) customers, 35% to small C&I customers, and 28% to residential and farm customers. The company enjoys a balanced sales mix.
Business Analysis
Regulated utilities are some of the most dependable businesses in the county. They have minimal competition in the regions they operate in, enjoy guaranteed rates of return on their capital investments, and provide essential services.
Take a look at WEC Energy’s stable, steadily growing earnings over the last decade, for example:
Source: Simply Safe Dividends
Note that the apparent decline in EPS in 2015 was a result one-time charges and a one-time share dilution involved with the acquisition of Integrys Energy.
By 2016, the purchase has become highly accretive for the company and margins have rebounded nicely.
Looking at WEC Energy’s long-term growth record, one can’t help but be impressed with the relatively long-term growth rates (for a utility) that the company has generated. More importantly, management has been disciplined in avoiding sacrificing margins for growth.
In fact, if we look back further to the last decade, we can see one of the best growth records in the regulated utility industry.
As seen below, WEC Energy’s sales and earnings per share (EPS) compounded by 6.3% and 8.1%, respectively, from 2006 through 2016.
| Year | Revenue | Operating Margin | Net Margin | EPS |
| 2006 | $3.996 billion | 14.2% | 7.9% | $1.33 |
| 2016 | $7.358 billion | 23.1% | 12.6% | $2.91 |
| Change | 84.1% | 62.7% | 59.5% | 118.7% |
| CAGR | 6.3% | 5.0% | 4.8% | 8.1% |
Source: Morningstar
In fact, WEC Energy’s management team has done an exceptional job of not just growing while defending its margins, but growing them by targeting new businesses with favorable regulatory relationships, as well as achieving impressive economies of scale.
For example, Wisconsin’s investment into ATC opened up a great long-term growth opportunity with very high returns on equity of 12.7%, among the most profitable regulated utility businesses in the U.S.
In fact, for such a small utility, Wisconsin Energy is amazingly profitable relative to its industry peers.
| Company | Operating Margin | Net Margin | Return On Assets | Return On Equity | Return On Invested Capital |
| Wisconsin Energy | 23.1% | 12.6% | 3.2% | 10.6% | 6.3% |
| Industry Average | 23.0% | 10.9% | 2.8% | 9.2% | NA |
Source: Morningstar.
Better yet, the recent moves into natural gas distributions and electrical transmission have opened up a vast growth market for WEC Energy, in terms of lots of profitable growth investment potential over the next decade.
The company plans to invest more than $1.5 billion per year on capital projects through 2025, with gas delivery accounting for roughly half of total capital expenditures.
Low-cost natural gas and continued pipeline development activity have made gas delivery a hot growth area for utilities, and WEC Energy’s business should benefit from this development.
Keep in mind that this ambitious growth plan doesn’t even include planned growth initiatives for ATC, which will further add another $2.3 billion or so to the company’s total growth backlog; which stands at $20.3 billion.
In addition, ATC’s growth plans could be expanded in the coming years thanks to WEC Energy’s 50/50 joint venture with Duke Energy on things like California’s PATH 15 transmission line, the Zephyr Transmission project, as well as other transmission projects throughout the US.
All told, management expects long-term earnings growth of 5% to 7%, and most analysts expect that to be to the higher end of that range.
Since management is targeting an EPS payout ratio of 65% to 70%, dividend growth should track closely with that impressive earnings growth (for a regulated utility).
Key Risks
Like all regulated utilities, there are a few important risk factors to keep in mind when considering WEC Energy.
First, in a rising interest rate environment, refinancing debt over time is likely to become more expensive.
That means a gradually rising cost of debt (and capital) that could increase margin pressure, as well as limit the amount of growth projects WEC Energy can invest in, given management’s disciplined approach of refusing to invest into less
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