ALLETE Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

ALLETE Inc. is a diversified energy company, primarily operating in the regulated utilities and clean energy sectors, with operations mainly in the Upper Midwest. Its primary business is to provide electricity generation, distribution, and transmission services to both retail and wholesale customers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

ALLETE’s moat stems from its regulated utility operations and its involvement in renewable energy, but these advantages are not ironclad due to the nature of the utility industry. I have given its moat a 3 out of 5.

Moat Analysis:

  • Regulated Utility Operations: ALLETE’s core strength lies in its regulated utility operations, primarily through Minnesota Power. This provides a stable revenue stream and a degree of protection from competition due to its position as the primary provider of electricity in its service areas. These operations have a local geographic monopoly with high barriers of entry, but these are not as powerful as other moats.
  • Renewable Energy Assets: ALLETE is expanding its presence in renewable energy, particularly through ALLETE Clean Energy. While this is a growing market, its renewable assets are not as well developed as its regular operations.
  • Long Term Power Agreements: ALLTE signs PPAs with long durations, which provide an avenue of stable cash flow and help to generate positive ROIC.
  • Intangible Assets: The company has an intangible asset in the form of brand recognition, since it has been around for a long time, but this isn’t significant as those with well established brands such as coca-cola or nike.
  • Lack of Economic Moat: The absence of other powerful moats, such as network effects, switching costs, and cost advantages, prevents ALLETE from achieving a higher moat rating.

Risks to the Moat and Business Resilience:

  • Regulation Risk: As a regulated utility, ALLETE is subject to regulatory scrutiny and policy changes that can affect its revenue and profitability. The regulatory landscape is constantly changing, and these changes could significantly impact its business.
  • Commodity Price Volatility: As a utility company, ALLETE is exposed to fluctuations in commodity prices, especially natural gas and coal, which are used to fuel many of its plants. These price fluctuations affect the earnings in the short-term.
  • Economic Slowdown: Any macroeconomic issues and slow down will impact the operations and customer demand for their utilities, which can impact the revenues and profitability.
  • Competition in Clean Energy: Though ALLETE is expanding in the clean energy market, it faces competition from established players who can pose a threat. Also, because it’s still an early-stage business segment, there may be unexpected challenges.
  • Technological Disruption: Changes in technology like distributed generation and energy storage could disrupt the centralized utility business and threaten ALLETE’s moat.
  • Environmental Regulation ALLETE is subject to a wide variety of federal, state, and local environmental regulations, regarding all aspects of their business, which may increase their overall costs of operations.
  • Cybersecurity: As a utility company, it is subject to cyber attacks and a disruption in operations could have a large negative impact.
  • Natural disasters and weather events: All the assets that are included in providing electricity, are often at risk from weather events and natural disasters.

Business Explanation:

  • Revenue Distribution:
  • The majority of ALLETE’s revenue comes from its Regulated Operations segment, primarily through electricity sales to retail customers in Minnesota and Wisconsin. The revenue is also generated through wholesale sales to other utilities, cooperatives, and power marketers, largely through transmission services.
  • ALLETE Clean Energy business generates revenue through the sale of electricity from its renewable energy generation facilities. These facilities are often coupled with long-term PPAs to provide a stable revenue stream.
  • Industry Trends:
    • The electric utility industry is undergoing a significant transformation with increasing adoption of renewables and storage and increasing regulation.
    • There is also increasing volatility in the power prices, and in demand.
    • Growth in the utility segment is expected to remain muted, but growth in renewables is expected to be high in the coming years.
  • Margins:
    • Regulated utilities typically operate with a steady and consistent profit margins due to their regulated nature.
    • The renewable energy operations may have volatile margins depending on power prices, and new technology costs.
  • Competitive Landscape:
    • Regulated utilities typically do not face competition from similar businesses in their service areas, however face competition from alternative energy providers and from distributed generation.
    • Renewables segment is more competitive than the regulated utilities, with numerous players looking to make gains in the growing industry.
  • Differentiation:
    • ALLETE’s long time history in providing a reliable supply of electricity is certainly a differentiating factor.
    • The transition from legacy generation to renewables, combined with the stability of its core business may provide a differentiator, which may not be true for all utility companies.

Financial Analysis:

  • Revenue Growth: ALLETE’s revenues have historically been consistent, showing moderate annual growth of around 1-3 percent. This is as expected since it is a regulated utility, and the company’s expansion into renewable operations are still in early stages. A large percentage of their profits are tied into fixed contracts.
  • Profitability: The profitability of ALLETE is fairly stable, in line with similar companies in the utility sector. The return on invested capital (ROIC) for ALLETE has been fluctuating between 8 and 12 percent and has been in a downtrend recently due to higher expenses.
  • Debt and Leverage: The total debt of ALLETE is about $3.5 billion, but in context of its size, that seems manageable, and the company maintains an investment-grade credit rating. A significant part of their assets are also considered to be low risk as they are for utility customers. Also, it’s unlikely for high leverage to hurt them due to a stable revenue flow.
  • Dividends: ALLETE has historically paid a reliable dividend with a yield of 4-5 percent, which is attractive to income investors. The dividend payout ratios are a significant factor in investor confidence.
  • Future Outlook: The company is focused on transforming its operations to greener operations, and is focused on growing its clean energy business, all while supporting its existing utility assets. The company hopes to reduce its carbon footprint in the coming years.
  • Recent Developments: ALLETE has been consistently building upon its investments in the clean energy sector and is building out a plan for a more sustainable power supply for the future. ALLETE has also been working to improve its operating costs.

Understandability Rating:

I have given ALLETE a 2 out of 5 for understandability. Here’s why:

  • Core Utility Business: The core business of regulated utility operations is understandable—generating and distributing electricity.
  • Complexity of Operations: However, the increasing complexity surrounding the transition to renewables, combined with the financial instruments used to hedge against fuel prices, makes the business more difficult to understand.
  • Accounting Issues: For someone without knowledge of financial statements, the accounting is difficult to understand. Furthermore, there are constant legal hurdles, and regulatory approvals to consider.

Balance Sheet Health Rating:

ALLETE’s balance sheet is relatively healthy, earning it a 4 out of 5. My justification is below:

  • Stable Assets: The core infrastructure of the utility sector has long useful lives. Therefore the long-term assets are considered stable.
  • Debt Management: The company is somewhat leveraged, but its debt is generally for funding long term assets, and are generally covered by long-term contracts. The company also has a high investment grade credit rating from S&P and Moody’s, implying a well managed debt.
  • Working Capital: Their current assets have a similar or slightly higher ratio to their current liabilities.
  • Financial Strength ALLETE does show a strong financial position and has historically been able to maintain returns on capital.
  • Off Balance Sheet Items: Although manageable, ALLETE has a large amount of unrecorded liabilities in leases, employee benefits, and other post-retirement benefit plans, making the analysis a little more difficult.
  • Long Term Assets: Many of the company’s investments are long-term, and so there is a potential of the value depreciating over time.