Xcel Energy: Requests For Higher ROE, Beneficial Guidance, And Undervalued (NASDAQ:XEL)

Xcel Energy Inc. (NASDAQ:XEL) recently delivered beneficial expectations with regard to 2024 EPS and relevant requests in Wisconsin or Minnesota to obtain double digit ROE. If we also take into account expectations with regard to lower use of coal, approximately $4.8 billion in generation resources, to promote clean investments, in my view, Xcel looks like a must-follow stock. There are some risks because the business model is highly regulated. In addition, interest rate increases, lower electricity prices, or lower incentives for clean energy could lower net income growth. With that, I believe that XEL does trade undervalued.

Xcel Energy

Based in Minneapolis, Minnesota, Xcel Energy is an electricity and energy company in the United States that currently operates in eight states, offering services and products related to the production and management of electricity.

This type of business forces the company to maintain subsidiaries within the regulated markets and outside them, being the ones that have requirements and rates set by state governments.

In addition, according to the last annual report, the company maintains open investment positions in different types of related businesses; for example, $325 million were invested in electric vehicle programs throughout 2021 and 2022.

On the other hand, the company seeks to be a pioneer in environmental commitment through carbon footprint reduction objectives toward the year 2050, where it will seek to eliminate energy sources generated by coal, for example.

In both cases, the company has decided to organize its business structure based on the regulatory obligations of the markets in which it participates, thus leaving two large segments: the regulated electricity market and the regulated gas market, along with another third party, which includes income from investments in other businesses or margins that are not part of the general analysis of its operations.

The regulated electricity segment includes electric power generation, transmission, and distribution activities within Minnesota, Wisconsin, Michigan, North Dakota, South Dakota, Colorado, Texas, and New Mexico. Likewise, this segment includes commodity and trading operations as well as the sale of energy to other entities within the United States. The gas segment transports, stores, and distributes natural gas in some of the regions where the company also distributes electricity.

The Charts From 2021 To 2024 Indicate That Xcel Energy Did Trade At A Significant Higher Price Marks

The most recent earnings were lower than expected, and recent EPS revisions for the next quarter were also lowered. EPS GAAP stands at close to $0.74, with quarterly revenue of $3.4 billion. In the next quarter, EPS GAAP is expected to be close to $0.83, and quarterly revenue estimate is close to $4.32 billion.

I think that the guidance given to market participants was beneficial. The company expects constructive outcomes in recent proceedings, retail electric sales close to 2%-3%, and an EPS guidance of close to $3.5-$3.6.

With that about recent earnings and expectations, I believe that Xcel Energy could be trading cheaper as it used to. In 2021 and 2022, the company touched the $77 price mark, and it is currently trading at a significant lower level. With others noting that Xcel is a bit undervalued, I ran my own financial model to understand a bit better where Xcel stands.

Balance Sheet, Capital Structure, Capex Expected For The Next Five Years, And Cost Of Debt

The most recent information obtained from Xcel Energy includes a total capitalization close to $43 billion, which appears significantly higher than the current market capitalization. Short term debt is close to $785 million, and long term debt is close to $24.9 billion.

The company also noted that it expects to use capital expenditures of about $39 billion, using new debt of about $13 billion and CFO of about $22 billion. With such level of capex expected from 2024 to 2028, I believe that the capacity increases will most likely bring net income growth.

Given the total amount of debt reported, it is worth studying carefully the interest rates and debt agreements signed. In the last quarter, Xcel noted bonds and senior notes including debt of about 5.1% and 6%. Given the current credit markets out there, I believe that Xcel Energy knows well how to negotiate with debt investors. In my view, if interest rates decline in the open market, Xcel will most likely renegotiate its debt agreements.

Assumptions Under My Base Case Scenario And Fair Price Obtained

Under this scenario, I assumed that Xcel will most likely manage to offer low-cost services to its customers through the transmission and distribution of clean energy, while continuing to provide a competitive return to its shareholders.

I also assumed that Xcel Energy will successfully manage to derive 8% to 10% of its liquidity toward the payment of dividends in the short term. As a result, demand for the stock may increase, which may diminish the cost of capital.

Furthermore, I assumed that subsidiaries in different states will successfully obtain rate increases in the coming years. In this regard, it is worth noting the Wisconsin rate, which could bring a ROE of 10.25%. Have a look at the forecasts offered by management with regard to NSP-Wisconsin or NSP-Minnesota.

In April 2023, NSP-Wisconsin filed a Wisconsin rate case seeking an electric increase of $40 million (rate increase of 4.8%) and a natural gas increase of $9 million (rate increase of 5.3%). The filing is based on a 2024 forecast test year, a ROE of 10.25%, an equity ratio of 52.5% and a forecasted average net rate base of approximately $2.1 billion for the electric utility and $284 million for the natural gas utility. Source: Quarterly Report In December 2023, NSP-Minnesota filed a request with the North Dakota Public Service Commission for an annual natural gas rate increase of approximately $8 million, or 9.4%. The filing is based on a ROE of 10.2%, a 52.5% equity ratio and a 2024 forecast test year with rate base of approximately $168 million. NSP-Minnesota requested interim rates, subject to refund, of approximately $8 million to be implemented on March 1, 2024. Source: Quarterly Report

Under this scenario, I believe that management will successfully develop its capital expenditures plans, which will bring sufficient capacity, and enhance net income growth. In addition, carbon reduction and reduction in the use of coal will most likely bring investors interested in ESG efforts. In this regard, investors may want to have a look at the Colorado Resource Plan noted in the last quarter.

In August 2022, the Colorado Public Utilities Commission approved a settlement for the Colorado Resource Plan, which provides for an expected carbon reduction and the retirement of PSCo’s remaining coal plant by the end of 2030. In September 2023 (updated in October 2023), PSCo filed its recommended Preferred Portfolio of resources, which proposed a total of 7,521 megawatts of generation resources, including 4,716 owned MW and 2,805 purchased power MW. Source: Quarterly Report

My income statement expectations include 2029 net revenue from electricity of close to $19989 million, with natural gas worth $8373 million, others worth $177 million, and total operating revenues of $28540 million.

In addition, with 2029 operating expenses, including electric fuel and purchased power, worth $9726 million, cost of natural gas sold and transported of about $6415 million, depreciation and amortization close to $4103 million, and taxes worth $975 million, total operating expenses stand at $24946 million.

My results also include 2029 operating income worth $3593 million. In addition, with interest charges close to $1406 million and total interest charges and financing costs close to $1406 million, 2029 net income would be close to $2251 million. The tables below offer more information about my assumptions in this case scenario.

Other companies operating in the same sector report a WACC between 5% and 6%, and the median cost of capital would be 5.6%. The WACC I used is, therefore, close to the median.

Now, with the discount of future net income at a rate of 5.6% and using a PE ratio of 19x, the implied market capitalization would be close to $41 billion. The forecast price would be about $75-$76 per share.

My Best Case Scenario, And Assumptions Made

Under this scenario, I assumed that Xcel Energy will successfully achieve the state’s clean energy goals, and investments in clean energy will successfully exceed the target of $4.8 billion reported in the last quarter. In addition, I assumed that energy prices will continue to increase, and government incentives to companies reaching clean energy goals will also increase.

PSCo expects to invest approximately $4.8 billion in generation resources under the alternative portfolio for the benefit of its customers and achieving the state’s clean energy goals. Source: Quarterly Report

In addition, under this scenario, I assumed that workforce reduction expenses seen in 2023 will bring net profit margin increases in the coming years. I believe that the company is making significant efforts, therefore I assumed that market participants will accelerate the demand for the stock. Hence, the cost of capital may lower in the near future.

For now, I believe that the company is not expected to expand to other states or maintain overly aggressive acquisition strategies, except for a sporadic possibility that responds to a particular need for the current business. With that, under this scenario, I think that in the coming years, Xcel’s debt levels may lower, and management could expand into new jurisdictions, and perhaps acquire assets. As a result, capacity increases could be larger than that in the base case scenario.

Under my best case scenario, I included revenue from electric services worth $22.187 billion, with natural gas of $9.072 billion, other of $196 million, and total operating revenues close to $31.456 billion.

My numbers also include 2029 operating expenses including electric fuel and purchased power of $10.703 billion, with cost of natural gas sold and transported worth $6901 million, 2029 depreciation and amortization of about $4545 million, and operating income of about $4014 million. In addition, with 2029 interest charges of close to $1571 million, 2029 income before income taxes would be close to $2404 million, and 2029 net income would be $2503 million.

Under this scenario, I assumed that we will see a decline in the cost of capital to close to 4% and an increase in the price of electricity, which may enhance the company’s PE ratio. Using a PE ratio of close to 25x, the implied market capitalization would be close to $60 billion, and the forecast price would stand at $110 per share.

Competitors, And Risks

Competitiveness in these markets has a series of particularities due to regulations that prevent the company from maintaining a free pricing strategy. Besides, residential consumers have the option of opting for another type of energy.

The appearance of solar panel promotion programs as well as the municipalization of the services that the company offers could generate significant increases over the current competition.

There is a risk that the company may not be able to derive 10% out of its income for the shareholder dividend, if it does not generate the necessary liquidity margins through its two regulated energy segments. On the other hand, there are currently no major competitive complications for Xcel Energy, but this panorama could change due to the emergence of new regulatory frameworks as well as critical situations in the economy due to the increase in distribution and generation prices.

Furthermore, regulated markets do not offer the company a free margin for its pricing strategy. So, in the face of a crisis in this sense, Xcel Energy’s ability to adapt is subject to the regulations that each state imposes on activity in the region.

Likewise, the option that Xcel Energy fails to meet its environmental objectives could be grounds for sanctions or regulations that delay the fulfillment of its financial objectives as well as prevent access to credits or sources of financing.

Conclusion

Xcel Energy is making impressive requests for its assets in Wisconsin or Minnesota, which may bring double digit ROE. Management appears to make significant efforts for reduction in the use of coal, and there are also expectations with regard to investments of approximately $4.8 billion in generation resources to promote clean investments. Under normal circumstances and given these expectations as well as guidance for the year 2024, I believe that Xcel Energy could be worth close to $75-$76 or more. There are obvious risks with respect to the fact that Xcel is well-regulated, potential decreases in the price of electricity, lower incentives to clean energy, and increase in the interest rate. With that, I believe that Xcel trades quite undervalued.