Rating: BUY
Current Price: $39.92
Price Target: $46.48
Thesis:
We own Westar Energy because it offers shareholders a growing dividend and opportunities for capital appreciation. We also appreciate the company’s diverse energy generation mix, including its growing renewables capacity. Lastly, as a utilities company, Westar adds important diversification to our Blue Harbinger 15 portfolio.
Westar Energy is the largest electric energy provider in Kansas. The company provides generation, transmission and distribution to approximately 687,000 customers. Westar maintains a flexible and diverse energy supply portfolio. In doing so, they continue to make environmental upgrades to their coal-fired power plants, develop renewable generation, build and upgrade their electric infrastructure and develop systems and programs with regard to how their customers use energy. The following chart shows Westar’s mix of energy generation capacity:
The diverse sources of energy, particularly renewables, are important and valuable because Westar faces significant environmental regulation challenges. Some companies throughout the US generate almost all of their energy from coal, and this exposes them to heightened regulatory risks as coal is the dirtiest form of energy. Westar acknowledges this risk in their annual report as follows:
“Our costs of compliance with environmental laws and regulations, including those relating to greenhouse gas emissions, are significant, and the future costs of compliance with environmental laws and regulations could adversely impact our operations and consolidated financial results.”
Because Westar has significant renewables capacity, it keeps the company out of the direct cross-hairs of federal regulators who often have little regard for the economic impacts of expensive regulations on the well-being of the surrounding communities. Additionally, Kansas is a strongly republican state which means it tends to be less extreme with regards to the imposition of expensive environmental regulations.
Important for future growth of the company, Westar operates in economically healthy regions of Kansas including the cities of Topeka, Lawrence, Manhattan, Salina, Hutchinson and Wichita. Unemployment is low in these areas, and Westar is a large employer. The strong economy helps ensure Westar also remains strong. The following chart shows the breakdown of Westar’s customer base:
In March 2015, Westar requested approval from the Kansas Corporation Commission to increase the rates it charges by 7.9% or $152 million to recover Environmental Protection Agency (EPS) costs as well as increased service reliability. And in August they reached an agreement for a $78 million rate increase. The approved rate increase demonstrates the region’s support for Westar Energy.
Valuation:
We value Westar at $46.48 per share by discounting its $2.44 expected 2015 earnings per share using a required rate of return of 6% (weighted average cost of capital) and a growth rate of only 0.75% per year which is the long-term rate Westar expects (annual report p.28). If the growth rate ends up being higher than 0.75% then the stock is worth even more. Our $46.48 price target gives the stock more than 16% upside, with potential for further increases depending on the company’s future growth and profitability.
Dividends:
In addition to potential gains via capital appreciation, Westar offers shareholders an increasing dividend. Dividends are common for stable utility companies like Westar, and in this case Westar offers and attractive 3.62% dividend yield. And the amount of Westar’s dividend payments has increased over time (see graph below), and the company expects this trend to continue.
Conclusion:
Westar is a diversified electric utility company that rewards shareholders with a growing dividend and opportunity for capital appreciation. Additionally, this electric utility company investment adds important sector diversification to our Blue Harbinger 15 portfolio. It is important to invest across a variety of market sectors (e.g. utilities, consumer discretionary, technology, etc.) to reduce exposure to sector specific risks and to minimize overall volatility in the value of your investment portfolio.