WEC Energy Group

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

A utility company primarily engaged in the generation and distribution of electricity and natural gas to customers in Wisconsin, Illinois, Michigan and Minnesota with a growing presence in renewable energy.

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.

WEC Energy Group is a holding company with a complex operational structure, primarily operating through its subsidiaries, focusing on providing electricity and natural gas services to diverse markets.

Business Overview

WEC Energy Group (WEC) is a major player in the utility sector, operating primarily in Wisconsin, Illinois, Michigan, and Minnesota. The company’s operations are segmented into:

  • Wisconsin Segment: Generates and distributes electricity and natural gas. This segment is the largest contributor to WEC’s overall revenue.
    • Electric Operations: In this business line, they are authorized to sell power in designated territories of the state, primarily for residential, commercial, and industrial clients. They work within a regulated market. Their distribution network includes transmission, transformers, sub-stations, and related infrastructure.
    • Natural Gas Operations: Distributes natural gas to its customers via a distribution system and by purchasing and transporting gas via third parties.
  • Illinois Segment: Distributes natural gas to its customers via a distribution system. The company also purchases and transports gas for the delivery.
  • Other States Segment: Consists of the company’s operations in other states like Michigan and Minnesota. These segments primarily involve natural gas distribution to residential, commercial, and industrial users.
  • Non-Utility Energy Infrastructure Segment: Includes operations related to renewable generating facilities.

WEC’s regulated utilities business segments operate under a rate base established and approved by regulators, with limited competition.

The utility industry is undergoing significant transformation due to several factors:

  • Renewable Energy Transition: There’s a strong push towards renewable energy sources, driven by environmental concerns and government policies. WEC is actively investing in wind, solar, and battery storage projects, in response to the demand.
  • Infrastructure Modernization: Upgrading aging infrastructure and adopting smart grid technologies are critical for reliability and efficiency.
  • Regulatory Scrutiny: The regulatory environment is complex and evolving with increased scrutiny on capital expenditures and rate cases. This heavily influences the price and profitability of the business.

Competition varies by segment and geography. In regulated markets there is limited direct competition, whereas in power markets, it can be substantial. Competition can occur at the generation and retail level from incumbents and new entrants.

WEC has several direct competitors, depending on the region:

  • Edison International: Has similar utility operations and serves the Californian market.
  • Xcel Energy: Serves parts of Michigan and Wisconsin.
  • CMS Energy: Serves most of Michigan.
  • Other competitors: Are generally smaller companies operating in a certain jurisdiction.

WEC differentiates itself through its investments in renewable energy, its strong regional footprint, and its regulated business structure. However, management must navigate these strategies with an eye toward potential regulatory constraints, competition, and changing market dynamics.

Financial Analysis

Here’s an overview of WEC’s latest financial data and implications. Keep in mind that we are looking at earnings calls and reports from the last year (2023 and 2024).

Revenues:

  • WEC’s operating revenue in the first three quarters of 2024 decreased slightly year-over-year, driven by lower natural gas sales volumes (driven by weather-related effects), decreased sales related to transmission services, and a decrease in recovery of fuel and purchased power costs. Operating revenues were driven by the Wisconsin segment (electric and gas) and was roughly $1.16 B in the third quarter of 2024. The second quarter came in at $1.77B.

The company’s operating revenue is highly influenced by the state of the weather.

  • WEC’s revenue is affected by the regulatory landscape. WEC had rate increases approved in 2023 and 2024. In other jurisdictions, the company does have deferrals to recoup those costs.
  • Revenues have increased YoY and have been consistently growing due to increased electric rates, but can fluctuate due to weather, or economic conditions.

Profitability:

  • The company’s net income in the third quarter of 2024 was approximately $315 M. A significant impact came from the Wisconsin segment and specifically from the electric segment. In the previous 3 months, it was at $190 million, mostly driven by increased expenses that were only partially offset by increases in operating revenue.
  • WEC’s net income in the first 9 months of 2024 is $1.11B
  • WEC’s operating margins are impacted by the rising cost of operations, especially in the utility segment. There have also been increased fuel and purchased power costs that the company cannot recover from customers.

It can be assumed that WEC’s margins and ROIC could fluctuate based on the regulatory and economic climate, as well as the weather. They are also very sensitive to changing interest rates.

  • While they do have some cost-sharing mechanisms with customers, their business will be affected by a rising interest rate environment and increasing expenses, or the inability to pass costs through to customers.

Balance Sheet Health:

  • WEC’s balance sheet is relatively strong. Current assets at $2.4B against current liabilities of $3.4B. In general their assets outweigh their liabilities.
    • The company’s cash and cash equivalents at $479M.
    • WEC’s long-term debt amounts to $16.9B with a weighted average rate of 3.56% which is largely fixed.
  • The company has seen a large increase in goodwill, which is not necessarily beneficial to the company. They are also adding on to their lease agreements.
    • It would be interesting to see a change in the company’s balance sheet regarding reducing their debt-equity balance.
  • Overall, the balance sheet is healthy with manageable levels of debt.

Cash Flow:

  • WEC generated about $1.1B in cash from operations in the first nine months of 2024. They spent $2.2B in investing and $724M in financing.
  • They have a lot of capital expenditures coming up. However, there is also a projected increase in free cash flow as rates improve. WEC expects to spend at least $16.9 billion in their capital program for 2024-2028.

Moat Analysis

Based on the information available, including from recent earnings calls, and the analysis above, here’s a look into WEC’s economic moat.

  • Network Effects: Does not apply to WEC’s business. While transmission of electricity has a network-like effect, the company has no control over the “network” part. They are just a transport business.

  • Intangible Assets: Has some limited intangible assets in the form of its brand names and patents. While consumers generally prefer established providers, a strong brand is not a critical factor. However, it’s more of the customer stickiness that drives the demand. Regulatory approvals and certifications serve as a type of regulatory license moat, giving them a regional monopoly.

  • Switching Costs: There are some switching costs involved with changing utility providers. However, these costs are not very high. There may be some switching costs to commercial/industrial clients, as there is an opportunity to change providers, if not tied up by a contract.

  • Cost Advantages: WEC has scale, but its advantages are not meaningfully bigger than its peer competitors. However, since it is a highly asset-intensive business, the assets that WEC own that cannot be replicated, such as distribution networks, may contribute to a cost advantage. They operate on a regulated market, and this can allow them to have some control over pricing.

Based on these sources of competitive advantage, we can assign WEC a moat rating of 3/5. While they possess some advantages from economies of scale and regulation, they do not have a wide economic moat.

Risks to the Moat

The biggest risks to WEC’s moat come from regulatory changes, such as changes in allowed returns or the allowance of cost recovery, or technological disruptions to energy production/transmission. The risk of new entrants is low, but not impossible, should any technological advances prove viable.

The main threats to WEC’s business resiliency include:

  • Economic Downturns: These are extremely sensitive to the economic conditions of the region in which they operate. For example, a downturn may significantly reduce demand for electricity or gas.
  • Weather Volatility: Extreme weather conditions can disrupt the distribution networks, cause damage to plants or assets, and reduce demand in short periods.
  • Increased Capital Requirements: A lot of investment in renewables is needed, and a major hurdle will be financing these new projects.
  • Regulatory Changes: Since the business is heavily dependent on regulators, they could have their future returns capped or reduce their profitability.
  • Rising Interest Rates: This increases borrowing costs for future projects and increases debt payments, which may negatively impact net profits.
  • Technology Changes: While the transition to renewable energy sources is an opportunity, if these investments prove unprofitable or too expensive for the company to compete, or if technologies come in that allow new entrants to dominate, it may severely impact the long-term viability of WEC.

Understandability

WEC has a lot of moving parts, particularly when you consider its many subsidiaries, various business segments, and exposure to different regulatory and economic environments. On top of that, they are a regulated utility and operate with special accounting practices as a result. Therefore, it is not immediately understandable and deserves a rating of 2/5 for understandability.

Balance Sheet Health

While WEC’s debt levels are high, they are not unusual for the utility industry, which can often take on large amounts of leverage, and they are also well-established. However, their cash-flow generation, diversified operations across multiple states and a variety of assets, and stable revenue generation give it a rating of 4/5 for balance sheet health.