OGE Energy Corp

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Oklahoma Gas and Electric Company (OG&E) is a regulated electric utility providing electricity to customers in Oklahoma and western Arkansas, operating in a sector characterized by stable demand but stringent regulatory oversight.

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.

OGE Energy is a holding company, the main operating unit is the Oklahoma Gas and Electric Company, a regulated electricity provider in Oklahoma and Western Arkansas. OG&E’s primary focus is on the generation, transmission, distribution and sale of electric energy. OGE has been an integral part of Oklahoma and Western Arkansas’s infrastructure since the 1930s, and as a regulated utility, it’s business operations are significantly governed by state and federal agencies.

Business Overview

  • Revenue Distribution: OG&E’s revenue is primarily derived from the sale of electricity to its customers. It’s operating revenue for the three months ended in September, 2024 came from: Residential (47.5%), Commercial (26.5%), Industrial (19.6%), Public Authorities and Streetlights (5%), Integrated Market (0.6%), and Transmission (0.3%). For the six months ended in June, 2024: Residential (45.6%), Commercial (25.7%), Industrial (20.3%), Public Authorities and Streetlights (5.1%), Integrated Market (0.5%), and Transmission (0.4%). Note that there are some “other operating revenues” which account for the rest. The relative stability in revenue distribution across segments can be a source of strength for this regulated utility, as it is not overly reliant on specific types of customers.
  • Industry Trends: The electric utility industry is undergoing transformation. The need for clean energy and grid modernization is a major trend, and also increasing regulation of operations and rate structures. The cost of materials is also rising while the need for resilient systems rises. The industry is also facing the challenge of balancing growth with sustainability to satisfy investors. OG&E, like its peers, is navigating these complex forces. A key trend that affects OGE is also the rise in renewable energy.

It is crucial to note that while these trends influence the company’s strategic direction, they also create opportunities for investment and growth, as discussed in the management discussion sections of its filings.

  • Competitive Landscape: OG&E operates in a regulated environment, thereby limiting direct competition from other retail electric providers. However, it faces some competition from other power sources and from new companies who may be more adept at adopting and deploying advanced technologies or renewable energy solutions. The company also faces competition from customers who may choose to use solar panels, and by the increasing energy efficiency of appliances.
  • Differentiation: OGE sets itself apart through its strategic emphasis on enabling growth, providing reliable and resilient service, and investing in the community. Moreover, it continues to emphasize operational excellence. The company is primarily a regulated utility so it benefits from a rate structure that guarantees it a certain rate of return on its investments and operation in its territories, as opposed to other companies which are exposed to intense competition.

OG&E is actively investing in infrastructure, grid modernization, and renewable energy projects. Also its focus on sustainability and reducing emissions make the company an attractive long term investment.

  • Margins: For the last quarters operating margins have been stable and strong. However, these margins can change depending on fuel costs, cost of transmission, rate regulations, and investments. As a regulated utility, these margins, though stable, may be kept within certain limits by regulators.

OG&E’s fuel purchase and power generation costs, have fluctuated, thereby causing variability in profits. However, these costs are often recoverable through regulatory mechanisms, but there can be a delay in those recoveries, creating a challenge in forecasting profits. The regulatory recovery mechanism also has a lag, meaning profitability suffers in short term while the company catches up.

  • Management’s Perspective: Management emphasizes on long-term growth in earnings per share (EPS). Management is focused on reliability and resilience, and has committed to being part of a solution for sustainable future. They have also given a strong focus on infrastructure improvements and are increasing grid digitalization to better serve their customers. They have mentioned that they will maintain a steady long-term dividend payout ratio of 60%-70%. Finally, management seems to believe they have a good relationship with regulators, and is working closely with regulators to recover costs.

Financials

  • Revenue Trend: OGE’s revenue from contracts with customers increased 5.1% year-over-year for the three months ended in September, 2024, and 3.7% year-over-year for the nine months ended September, 2024. This shows a relatively stable trend with growth. The company is expecting a 4%-6% growth in operating income for 2024.
  • Profitability: The company’s net income came down 47.3% for the three months ended September 2024 and net income increased by 34.4% year-over-year for the nine months ended September, 2024. The fall in net income for three months is primarily due to higher interest expense which is the result of increased investments. The YoY increase in profits was due to a gain on the sale of assets by the OGE Energy’s Natural Gas Midstream Operations.

OGE’s financial statements are often influenced by nonoperating items, which highlights that analyzing only net income can be misleading and investors need to analyze the different segments of their business to get an accurate picture of profitability.

  • Debt: The company has a significant amount of debt, which it uses to fund operations and investments, however, their target debt-to-equity ratio indicates they plan to deleverage in future. The company is seeing some pressure on the balance sheet because of interest rates and new debt issuance, which may impact their interest coverage and financial flexibility in the short term. Debt to capitalization ratio is around 40%, while debt-to-equity is 60%.

OGE’s average interest rate on short-term debt is approximately 5.5% and they are planning to issue $350 million senior notes in 2024, which indicates it is seeing pressure from higher interest expenses.

  • Cash Flows: Cash flows from operating activities fell in the latest quarters, but due to decrease in investments and capital expenditure, the net cash flow is still positive.

Moat Rating: 3/5

OGE’s moat is moderately durable and is primarily derived from its status as a regulated utility. Here’s a detailed justification:

  • Regulatory Moat (Strength): OGE benefits from a substantial regulatory moat, given its operation as a regulated utility in Oklahoma and Arkansas. The nature of these industries presents significant barriers to entry, as new entrants would need to navigate a web of regulations and approvals and would be limited in their service territories. This provides OGE with a strong degree of control within their region. It is important to note that the regulators also place limits on how much profit and returns are generated by OGE which are primarily based on the historical cost of investments. Also regulators ensure the company is able to recover costs, which increases resilience, though at the cost of a lag in profitability when fuel prices/interest rates increase. The downside for OGE comes from regulators who may not be willing to pass on the full burden of costs increases.

OGE operates with a cost-recovery rate model, which has historically allowed for recovering increases in its operating expenses. However, there is some lag in the recovery of those costs and as a result profitability may be adversely affected in the short term during periods of high prices.

  • Scale-Based Cost Advantages (Moderate Strength): OG&E also has a scale-based cost advantage due to its large scale of operations in its territories. It has access to existing infrastructure and has the ability to spread costs over a wider customer base. This, again, acts as a form of competitive advantage, however it is less durable than regulatory, because a competitor can still set up in different regions and not pay the same cost.
  • Customer Switching Costs (Low Strength): OGE’s customers have relatively low switching costs, which reduces the durability of their competitive advantage. Customers can purchase electricity from competitors (if available) by switching to more cost-effective alternatives (solar, etc) or simply by cutting their usage (increasing energy efficiency). However, OGE has a strong and loyal customer base, and that provides some resilience.
  • Intangible Assets (Low): Brand recognition, while present, is not a major driver of profitability for OGE. Regulatory approvals, like licenses to operate within its geographies, are a form of intangible asset; however these approvals are largely set, can be contested, and might be hard to get for the company’s new acquisitions.
  • Network Effects (Low): OGE’s business is not based on a network of users. Therefore, there is little benefit in having other customers use the same electricity provider.

Justification: OGE’s primary moat stems from regulations, but this doesn’t provide an absolutely unshakable moat, thus a 3/5 rating. Scale and some loyal customer base provide some competitive advantage that is quite consistent for the business. The relative consistency of returns and revenues also indicate this.

Risks to the Moat & Business Resilience

While OGE has several attributes that help maintain a decent moat, there are several important risks which can threaten their business and moat, as well as weaken their resilience.

  • Regulatory Changes: OGE operates under strict regulatory guidelines. Any changes in regulations-especially those relating to pricing and rate of return-can directly impact the company’s revenue, profitability, and its moat. Changes in the way renewable assets are treated would also directly affect OG&E. Furthermore, any unfavorable changes to the rate recovery mechanism can immediately affect OG&E’s earnings negatively. Also it is subject to various state and federal guidelines which are costly. Also, the company might be forced to pass on costs to customers.
  • Economic Downturns: A significant economic downturn can hurt OGE’s customer base. Reduced usage from commercial and industrial clients may significantly impact revenues and operating income.

OGE’s management has stated they have seen little slowdown of electricity sales even in times of economic downturns, and they expect to see a mild recovery in economy for their areas of operation in future.

  • Technological Disruptions: Technological changes in the energy market may hurt OGE’s ability to keep its customer base and maintain prices. A rise in distributed generation (like rooftop solar) might make it difficult for OGE to maintain consistent growth in demand. In addition, increase in electric cars and home batteries may also affect OGE’s future growth, and a fast pace of technology adoption could make the company’s old infrastructure and business less relevant. The company is trying to incorporate these new technologies, but faces an uphill battle because of high regulatory requirements.
  • Fuel price fluctuations: Fluctuations in fuel prices can affect the costs, and ultimately the profitability of the company. Though the company has fuel cost recovery clauses with regulators, any delays to that mechanism can harm cash flows and also make it difficult to plan future projects.

However, there are several factors that give strength to OGE:

  • Essential Services: Electricity is a basic necessity. Therefore, demand tends to be stable over a long period of time.
  • Strong Credit Ratings: Although they have a large amount of debt, the company has a BBB+ credit rating from Standard and Poor’s and Baa1 from Moody’s. This suggests that the company can withstand some short term shocks as long as they continue to maintain their rating.
  • Geographical Monopoly: The company largely operates in Oklahoma and parts of Arkansas. As a regulated company it has a monopoly within those jurisdictions, which gives it pricing and market power.
  • Investment in Green Energy: The company is focused on green energy and renewable initiatives. This focus should help the company mitigate some of the risks of technological disruptions.

Financial Analysis

  • Revenue Analysis:
    • OGE has shown stable growth in its revenues over the past years, owing to steady growth in its core business. Revenues are expected to grow at a modest pace in the future.
    • The company is slowly diversifying its revenue streams with investments into natural gas, but most of it is still from its core electricity business.
  • Operating Expenses:
    • Major expenses include fuel costs, operations and maintenance expenses, transmission, depreciation and amortization, and taxes.
    • It must be noted that some of these expenses, like fuel costs, are subject to regulatory adjustments. As a result there could be a lag in recovery of increased costs from regulators, which can lead to short-term dips in profits and cash flows.
  • Profitability Margins:
  • Operating margins have remained stable over recent years. However, increasing costs for fuel and other inputs, along with increasing regulatory burdens, could put some pressure on the margins.
  • Management is attempting to improve margins through efficiency initiatives and cost-cutting measures.
  • Balance Sheet:
    • OGE’s balance sheet reflects a highly capital-intensive utility with significant investments in property, plant, and equipment.
    • Debt levels are high, reflecting the company’s reliance on debt financing for large capital investments.
  • Cash Flow:
    • Cash flow from operating activities is variable due to swings in input costs and changes in the economy, but still remains positive.
    • OGE is reliant on external funding, such as debt and share issuance, to manage the large capital expenditure requirements.
  • Overall: The financial position of OGE is a mixed picture with stable revenues, moderate profitability, a large debt load, and reliance on external funding for capital intensive projects. However, the company has a reliable income stream due to its regulated status.

Understandability Rating: 2/5

  • The basic operation of OGE as an electricity provider is simple to understand.
  • However, the intricacies of valuation and business analysis come from understanding the complex regulatory environment, capital structure, long-term contracts, and debt obligations.
  • The regulatory aspects and the impact of government rules, along with many of the accounting aspects which are very specific to utilities can be difficult for an average investor to understand.

Balance Sheet Health: 4/5 OGE has a relatively healthy balance sheet, with moderate amounts of debt, and stable cash flows.

  • While there are large levels of debt, its regulatory and revenue model gives relative certainty to investors that this debt can be repaid. Furthermore, the company’s rating from agencies such as S&P and Moody’s are both investment grade and reflects its financial prudence.
  • The company also has adequate liquidity to carry its short-term obligations.
  • Though interest rate increases are affecting its finances, the company is attempting to pay back as much of its debt as possible in the medium term.

Recent Concerns/Controversies:

  • Rate Increases and Regulatory Challenges: OGE has recently proposed to increase rates with Oklahoma Corporation Commission (OCC). However, there have been public protests against the high rates for consumers, as they already believe their costs are very high. Also, the OCC has initiated numerous investigations on OGE in the past years, and the rate increases have been approved at a lower-than-expected value, which has often impacted the profitability of the company.

Management needs to continue to manage these complex regulatory issues, or their future returns may be negatively affected.

  • Debt and Interest Payments: The company’s debt levels and interest expenses have increased in the recent period. However, management stated that it will continue to maintain a strong balance sheet and use excess cash to deleverage. Management also stated they are using fixed interest debt to limit their exposures to interest rates fluctuations.
  • Investment in Unprofitable Renewable Projects: The company’s investment in renewable projects has been scrutinized. However, management has stated that it is committed to pursuing more clean energy solutions.
  • Supply chain disruptions: The global supply chain issues have hurt the company’s ability to carry out their operational and capital expansion plans. However, the company is working closely with suppliers and expects the material issues to be resolved soon.

Conclusion

OGE Energy has a moderately strong moat based primarily on regulations, with a strong position in the Oklahoma and Arkansas utilities market. The company’s financial position is relatively stable, but future performance may be affected by changing regulatory requirements and rising interest rates. The company’s ability to handle and mitigate these risks, while executing a sound strategy for the future, will decide the long-term investment value of the company.