Some utilities are advantageously situated in service territories that boast strong renewable resources. With constructive regulatory relations, these utilities may be able to add wind and solar power to rate base without going the competitive route, suggests Ari Charney, editor of Investing Daily's Utility Forecaster.
Of course, few utilities are fortunate enough to have this kind of set-up. But one that does is longtime Income Portfolio holding Xcel Energy (XEL).
The Minnesota-based utility giant has an impressive footprint that spans eight states across the Southwest and Upper Midwest. But the vast majority of earnings is derived from regulated electric and gas utilities in just two states: Minnesota (43% of earnings) and Colorado (41%).
These geographies have enabled Xcel to become the biggest wind-power supplier among U.S. regulated utilities, with 6,700 megawatts (MW) of wind accounting for 21.3% of the utility’s electricity supply last year.
However, most of Xcel’s wind generation came courtesy of wind farms owned and operated by third parties under power-purchase agreements. Xcel’s own facilities only generate about 850 MW of wind power.
But that’s about to change in a big way. With one of the most ambitious capital plans in the utility sector, Xcel hopes to invest $18.5 billion in infrastructure over the next five years, with $4.2 billion allocated to develop its own wind generation and other renewables. Cash flow from operations (net of dividends) will fund about two-thirds of this spending.
In particular, the utility is looking to build or acquire more than 3,000 MW of wind capacity. That would boost renewables to around 25% of Xcel’s overall rate base.
Of course, these ambitions depend in large part on whether regulators go along with Xcel’s plans. In recent years, the utility has made great strides toward improving its overall regulatory environment, particularly with regard to reducing lag.
Regulatory lag occurs when a state public service commission (PSC) is slow to let a utility recoup its investment after upgrading and expanding its infrastructure. Such delays, which sometimes last years, can be a drag on earnings growth.
The good news is that Xcel has won a number of concessions from regulators, with mechanisms in place that allow it to earn a return on these investments shortly after it makes them. That augurs well for its five-year plan.
And while tax reform has been a mixed bag for utilities, lower taxes do mean lower rates. That gives utilities like Xcel more room to grow the parts of their business where they can actually earn a return, which also bodes well for its capital plan.
However, tax cuts offer utilities more of a long-term benefit than a near-term one. At present, utilities are under pressure to pass along tax savings to ratepayers as quickly as possible. And that’s creating a bit of a headache for some.
That’s because while utilities collect their full potential tax liability from ratepayers up front, they typically defer paying significant cash taxes until much later. Consequently, tax cuts have actually dampened many regulated utilities’ near-term cash flows, forcing them to take action to keep credit raters happy.
In response, some utility giants plan to issue significant equity to raise capital and keep a lid on their leverage metrics.
Fortunately, Xcel believes that it will only have to issue $300 million of new equity incrementally over the next couple of years, a relative pittance compared to its peers. That should mean minimal disruption of its growth plans.
Whether it comes in the form of wires or renewables, the resulting increase in rate base across Xcel’s utilities is expected to drive earnings and dividend growth of 6% annually over the next five years. With a forward yield of 3.5%, Xcel is one of our top picks for long-term growth and income and remains a buy below $46.