Investment Thesis
Ameren Corporation (NYSE:AEE) continues to be a reliable earner with steadily increasing dividends for the past decade. As a utility company, it’s no surprise that investors have caught on to the stability and predictability of the earnings stream and have priced it accordingly, at around 15x FWD earnings. I believe the stock is thus fairly valued and will likely match the SP 500 performance with lower volatility. I view this company as suitable for retired investors who are looking for a relatively safe place to invest as utilities are known for being a recession-proof, defensive play in my view.
Company Overview
Headquartered in St. Louis, Missouri, Ameren is a “public utility holding company” with subsidiaries Ameren Missouri, Ameren Illinois, and Ameren Transmission, a “rate-regulated electric transmission business” according to the annual report. The company is a major electricity and natural gas provider that is “working hard to provide more reliable energy, reduce outages, and restore power faster than ever before” according to their website.
The subsidiaries together collectively ensure that residents of Illinois and Missouri get the power they need at an affordable price. They have over 2.4 million electric customers, 900,000 gas customers, and 10,000MW of electric generation capability according to their investor presentation.
Like most utilities, the company is regulated in regard to the rates they can charge, emissions, and overall energy reliability standards. These include the Clean Air Act, Cross State Air Pollution Rule, and other regulations from the EPA. Overall, the company has successfully complied with the regulations set by the Federal Energy Regulatory Commission, which allows it to earn a satisfactory return on capital to shareholders safely.
It’s not a surprise that the financials indicate a steady stream of earnings, showing that utilities like Ameren continue to be known for their consistent dividend payout. However, I am relatively surprised to see that Ameren Corporation has been able to grow its top line successfully from $5.5 billion in 2020 to $7 billion TTM, translating to a CAGR of around 8%. Management wants to continue this growth track and indicates a target of “6% to 8% compound annual earnings growth rate from 2024 through 2028” according to their earnings transcript.
With growing emphasis on renewable energy these days, Ameren has shown to be no different. Their integrated resource plan “targets net-zero carbon emissions by 2045 while meeting customers’ rising needs and expectations for reliable, affordable, and clean energy sources”. By 2045 management plans to lean into renewable sources such as wind, solar, and hydroelectric power. In conclusion, Ameren is a reliable earner with steady growth that is leaning more into renewables to power the citizens of Missouri and Illinois.
6-8% Earnings Growth Is Reasonable
Ameren announced Q1 2024 earnings on May 2, 2024, with the following results:
- First quarter diluted Earnings Per Share were $0.98 in 2024 vs. $1.00 in 2023.
- Guidance range for 2024 affirmed at $4.52 to $4.72 per diluted share.
They attribute this solid performance in earnings to “increased infrastructure investments driven by strong execution of the company’s strategy”. Overall, the company has been focused on upgrading their power grid to strengthen reliability for customers, improving their reputation for powering the quality of life.
However, not all subsidiaries performed equally well, with Ameren Missouri and Illinois having earnings come in lower than last year. For Missouri, the company cites “increased infrastructure investments” that resulted in some higher expenses for the quarter. Ameren Illinois Electric has “a lower allowed return on equity for 2024 under the new multi-year rate plan”, which lowered their earnings a bit year over year.
Going forward, I expect the results in Missouri to be superior to Illinois as it looks like the regulatory environment in Missouri is more business-friendly. Illinois has shown that they are willing to limit how much money utilities can make, with a track record that shows they are against unreasonable rate increases. For instance, they recently rejected Ameren Illinois’s integrated grid plan in order to protect Illinois ratepayers, citing they “failed to sufficiently incorporate customer affordability into their proposals”.
Nonetheless, I still think Ameren as a whole can meet their 6-8% earnings growth forecast due to the relatively stable population in Missouri and Illinois, strong renewable investments, and the ability to earn acceptable returns on equity that are rate-regulated. Although the regulators may cap how much the utility earns, this actually gives the company a level of predictability which suggests management’s guidance can be trusted in my view.
New Ameren Filing May Be Approved
As stated earlier, the integrated grid plan was rejected by the ICC for failing to consider affordability and justifying rate increases. Thus, Ameren had to re-file a new plan that the ICC is now going over and is expected to publish a decision by the end of December 2024.
The new filing shows an improvement in demonstrating how the plan is going to be affordable for all Illinois residents. This new plan has the following goals,
- Reducing capital investment in the refiled Grid Plan by over $400 million dollars, as compared to the Original Grid Plan.
- Targeting lower rate base growth under the Refiled Grid Plan, with an estimate at approximately 3.5% per year.
- Targeting keeping electric bills on a total bill basis over time at or near the rate of inflation, currently expected to be 3% on average.
Personally, I believe the massive amount of regulation is fair to protect consumers, but it can be quite frustrating for Ameren shareholders. Any rate increases, plans, capex, and emissions are all scrutinized carefully by politicians and regulators alike. This red-tape goes to show that investing in utilities has its own set of challenges, as investors have to deal with conflicting interests that cap profitability. Nonetheless, it looks like the refiling of Ameren’s integrated grid plan might finally be approved because it adequately accounts for customer affordability.
Renewable Investments Come At A Bad Time
The company’s operating cash flow remains relatively robust, but capital expenditures continue to be much bigger than cash flow, which leads to negative free cash flow. As the company continues to invest in renewable energy infrastructure to comply with environmental regulations, I think free cash flow will remain negative as these investments play out.
According to their annual report, the company says:
We estimate that we will invest up to $22.8 billion (Ameren Missouri – up to $13.5 billion; Ameren Illinois – up to $7.6 billion; ATXI – up to $1.7 billion) of capital expenditures from 2024 through 2028.
While I think this is a good idea long-term, it may come at a time when interest rates are still very high and can stress the balance sheet. I feel the timing of this investment can be risky because if the overall economy takes a sharp dive, it can make these investments tricky to fund. To fund increasing capex and overall business viability, the company has issued mortgage bonds to pay off short-term debt.
While this isn’t too alarming, I feel that having to issue more debt to pay off near-term debt shows they don’t have that much liquidity at hand to pay the bills. Thus, free cash flow seems to be limited right at a time when Ameren wants to invest billions in renewable energy, showing the timing is potentially unfavorable for investors.
Valuation – $75 Fair Value
A utility like this one is likely always fairly valued because everyone knows what the earnings are reliable and predictable, as the regulators set an approved return on equity. So, it’s going to be hard to find this stock mispriced as all the assumptions are already built into the consensus EPS estimates. Thus, I believe the stock will see low volatility because there shouldn’t be any major surprises in the fundamentals.
Using Seeking Alpha’s earnings estimates, I believe the company can reach an EPS of $5 by 2025. This is because the company believes it can reach a 6-8% earnings growth annually, which is believable given the historical steadiness of earnings. So, applying a sector median 15x P/E multiple to $5 EPS gets me around $75 per share, fair value.
Because regulators can cap the profitability, it’s very hard for earnings to surprise on the upside. People know the ceiling this company can make, so it’s unlikely that the stock will materially outperform the broader market. For a stock to do well in my view, the fundamentals must perform above market expectations. Unfortunately, regulators make it impossible for Ameren to exceed expectations because they set the rules on an ‘approved return on equity’.
Risks
As mentioned, regulators have a lot of control over a company like Ameren. They set the rules, the profitability, the emissions standards, and so on. So, an increase in regulatory scrutiny and tightness of standards could make Ameren’s profits worse off as they struggle to meet these requirements. They are a price taker, not a price maker.
The company has significant debts, and rising interest rates could make refinancing more expensive. As of the latest earnings, their balance sheet shows $1.15 billion in current portion of debts, showing that the debt is coming due. As time goes on, if interest rates remain high, the interest expenses may become larger as they refinance under less favorable terms.
A lot of red-tape, bureaucracy, and political gridlock can make things slow for Ameren. Recently, they appealed with the Illinois Appellate Court that challenged the ICC’s rejection of their multi-year plan. Unfortunately, the legal system can be very slow and according to their investor presentation the “court is under no deadline to address appeal”. So, utilities have their own set of unique challenges with the legal, regulatory, and overall political system.
Hold Ameren Corporation
The company is fairly valued as its earnings and fundamentals are entirely predictable by the market. Analysts can probably estimate earnings with close precision, which removes the uncertainty aspect for this company. However, I’ve always found that companies with the highest certainty often do not present mispricing opportunities as everything is always priced in. Thus, I think Ameren Corporation is a hold, despite its strong earnings streams and reliable dividends.
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