Unlocking Green Power: Allete Is A Gem In The Utility Sector (NYSE:ALE)

Introduction

The utility sector is currently interesting for investors, mainly due to its resilience in volatile markets and the growing emphasis on sustainability and clean energy transformation, which creates a new upside. Unlike sectors susceptible to economic cycles, utilities offer stable returns for essential services and are key players in the transition toward more sustainable energy sources. This stability and the sector’s critical role in addressing climate change make it a compelling area for investors looking for long-term growth opportunities with a decent income.

ALLETE (NYSE:ALE) is a noteworthy company within this sector. With its strong focus on sustainability and clean energy, ALLETE is not just a utility company. It’s a pioneer in the energy transition, making significant strides towards carbon neutrality. In this article, I will outline my BUY thesis for ALLETE. This recommendation is based on the company’s investments in sustainable energy projects, financial stability, and potential for long-term growth as the energy sector evolves towards a more sustainable future.

Seeking Alpha’s company overview shows that:

ALLETE operates as an energy company. The company operates through Regulated Operations, ALLETE Clean Energy, and Corporate and Other segments. It generates electricity from coal-fired, biomass co-fired / natural gas, hydroelectric, wind, and solar. The company provides regulated utility electric services in northwestern Wisconsin to approximately 15,000 electric customers, 13,000 natural gas customers, and 10,000 water customers, as well as regulated utility electric services in northeastern Minnesota to approximately 150,000 retail customers and 14 non-affiliated municipal customers. It also owns and maintains electric transmission assets in Wisconsin, Michigan, Minnesota, and Illinois. In addition, the company focuses on developing, acquiring, and operating clean and renewable energy projects; it owns and operates approximately 1,300 megawatts of wind energy generation facilities.

Fundamentals

Over the past decade, ALLETE’s revenues have seen a commendable increase of 81%, showing its robust growth trajectory. This growth has been driven organically, as consumption of energy among consumers has risen, and through strategic mergers and acquisitions. Acquiring U.S. Water Services expanded ALLETE’s business into the water sector, while New Energy Equity enhanced its capabilities in the growing solar energy market. As seen on Seeking Alpha, analyst consensus anticipates ALLETE will maintain a steady sales growth rate of approximately 4% annually in the medium term.

ALLETE’s EPS (Earnings Per Share) has experienced a 66% increase throughout the last decade, although its growth pace has been somewhat slower than its revenue growth. This gap can be attributed to share issuance and lower margins, reflecting the company’s substantial investments in new projects to spur long-term growth. Despite these challenges, according to analysts’ consensus, as seen on Seeking Alpha, ALLETE is expected to boost its EPS growth at an impressive annual rate of ~9% in the medium term. The company is scheduled to report its Q4 results on February 20th, where analysts expect it to show a 4% EPS growth QoQ to $0.96.

ALLETE has demonstrated a solid commitment to rewarding its shareholders, having consistently paid dividends for the last 17 years and increasing them for the past twelve. The company announced a 4% dividend increase in January 2024, offering investors a substantial yield of 4.7%. With a payout ratio of 62%, the dividends are well-covered, providing reassurance regarding their sustainability. This growth rate of 4% is in line with ALLETE’s historical five-year average of its EPS, signaling that we are likely to see a growth rate in line with the EPS growth.

Contrary to the common practice of share repurchases, ALLETE has not actively engaged in buybacks. Instead, the company has issued additional shares to fund mergers, acquisitions, and project developments. Over the last decade, this strategy has led to a 36% increase in the number of outstanding shares. This approach can be attributed to a higher net debt to EBITDA ratio of over 4.3, limiting debt issuance. It also underscores ALLETE’s strategic focus on growth and expansion into new markets. Although dilutive in the short term, this financing method indicates ALLETE’s ambitious plans to scale its operations.

Valuation

ALLETE’s P/E ratio, based on 2024 EPS estimates, stands at 14. This valuation is consistent with the P/E ratios observed over the past twelve months, though it marks an increase from figures seen several months prior. A P/E of 14 for ALLETE reflects a sensible valuation, especially considering the company’s growth trajectory, which is projected in the mid to high single digits. This level of growth, coupled with ALLETE’s strategic investments in renewable energy and sustainability initiatives, suggests that its current valuation is reasonable.

The graph below from Fast Graphs reveals an attractive investment profile. The company’s average P/E ratio over the last 20 years has been 18, with the current ratio standing at 14. This represents a more favorable valuation compared to its long-term average. Moreover, while the average growth rate over this period has been 3%, ALLETE’s current growth rate is projected at 9%, indicating an acceleration in growth potential. This mismatch between historical and current metrics shows the potential for ALLETE to offer value to investors. Moreover, the average P/E ratio of the utilities sector stands at 15.5. While ALLETE historically has been trading above the sector’s average P/E due to its long track record of growth and stability, today it trades below the sector valuation, implying it is attractively valued.

Opportunities

ALLETE is focused on modernizing its HVDC (High Voltage Direct Current) modernization and expansion projects. The company is building infrastructure and expanding its transmission capabilities to enhance grid reliability and access to renewable energy sources. The project, estimated to cost between $800 million and $900 million, is pivotal for providing direct access to premier wind resources and reinforcing grid resilience in the Upper Midwest. The company can increase sales and income to fund the projects. Moreover, the endeavor has secured significant government grants, reducing the financial burden on customers and underscoring its strategic importance.

“Our team has worked hard to advance this important project and to secure government grants to help reduce the project’s cost for customers.”

(Bethany Owen, Chair, President, and CEO, Q3 2023 Conference call)

Renewable energy RFPs (Requests for Proposals) for solar and wind power are a significant growth opportunity. ALLETE plans to issue (RFPs) for up to 300 megawatts of solar and 400 megawatts of wind energy by the end of the year. These RFPs underscore the company’s commitment to expanding its renewable energy portfolio, emphasizing community investment, local labor, and diversity in supplier and workforce. This initiative aligns with Minnesota’s clean energy objectives and ALLETE’s sustainability goals, promising long-term value for customers and communities.

“On October 2nd, Minnesota Power filed a notice with the MPUC of our plan to issue an RFP for up to 300 megawatts of solar later this month. We also plan to issue an RFP for up to 400 megawatts of wind by the end of the year.”

(Bethany Owen, Chair, President, and CEO, Q3 2023 Conference call)

Rate proposal filing for future investments is another opportunity for a regulated utility. ALLETE’s recent rate proposal filing with the Minnesota Public Utilities Commission aims to support the company’s Energy Forward goals, including transitioning to renewable energy sources and enhancing grid resiliency. This move addresses inflation and supply chain issues and ensures a fair return on investment to attract capital for future clean energy projects. It highlights the company’s proactive strategy in securing financial stability for its sustainability ambitions. The company’s investments in renewables make it more likely to gain these price hikes.

“This proposal will help ensure Minnesota Power can continue making the Energy Forward investments needed to meet the goals of this year’s Minnesota legislation requiring 100% carbon-free energy by 2040.”

(Bethany Owen, Chair, President, and CEO, Q3 2023 Conference call)

Risks

The execution of ALLETE’s strategic projects, including transmission upgrades and renewable energy expansions, hinges on timely regulatory approvals. Delays or unfavorable outcomes in these processes could impact project timelines, increase costs, and affect the company’s ability to meet its renewable energy and infrastructure modernization goals.

“Construction could begin on this $800 million to $900 million project as early as next year, pending regulatory approvals in North Dakota and Minnesota with an in-service date expected later this decade.”

(Bethany Owen, Chair, President, and CEO, Q3 2023 Conference call)

ALLETE’s financial outlook and ability to meet its clean energy commitments significantly depend on the successful execution and operational efficiency of its renewable energy projects. Unforeseen challenges, such as lower-than-expected wind yields or higher operating costs, could adversely affect ALLETE Clean Energy’s financial results and, by extension, ALLETE’s overall financial health.

“The ALLETE Clean Energy team has endured the historically low wind conditions that affected much of the nation this quarter and have worked hard to mitigate the effects.”

(Bethany Owen, Chair, President, and CEO, Q3 2023 Conference call)

Like many in the industry, ALLETE faces risks associated with inflation and supply chain disruptions, which can increase project costs and delay timelines. The company’s ability to navigate these challenges while maintaining financial stability and advancing its Energy Forward goals is critical to its success and growth prospects. Inflation and supply chain issues can delay projects and squeeze margins.

“Our rate case request supports Energy Forward goals by… addressing inflation and supply chain issues and by providing a fair return on investment to attract capital for continued investment in the clean energy future.”

(Steve Morris, Senior Vice President and Chief Financial Officer, Q3 2023 Conference call)

Conclusions

To conclude, ALLETE stands out as a solid player in the utility sector, particularly emphasized by its strategic focus on sustainability and clean energy transformation. The company has demonstrated robust growth in revenues and EPS over the last decade, underpinned by organic growth and strategic acquisitions such as U.S. Water Services and New Energy Equity. These moves have diversified ALLETE’s portfolio and positioned it at the forefront of the renewable energy transition. Furthermore, ALLETE’s consistent dividend payments and increases over the years prove its financial health and commitment to shareholder returns.

However, the risks associated with regulatory approvals and the execution of large-scale projects cannot be overlooked, as they present potential challenges to ALLETE’s growth trajectory and financial performance. Despite these risks, ALLETE’s current valuation, with a P/E ratio of 14 against a significantly improved growth rate and favorable comparison to its historical P/E average, paints a picture of an attractive investment opportunity. Considering the company’s strategic direction, growth potential, and current valuation, ALLETE is a BUY.