Xcel Energy Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Xcel Energy is a major U.S. utility company engaged in regulated electricity and natural gas operations, serving millions of customers across eight states.

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.

Xcel Energy is a large utility with a market capitalization of $30.7 Billion. It mainly provides electricity and natural gas to customers in eight states: Colorado, Michigan, Minnesota, New Mexico, North Dakota, South Dakota, Texas and Wisconsin.

Business Explanation

Xcel Energy operates through several segments:

  1. Regulated Electric: This segment generates, transmits, and distributes electricity in the aforementioned states. They produce power through a diverse mix of nuclear, coal, natural gas, and renewables, reflecting a trend toward cleaner sources.
  2. Regulated Natural Gas: This segment purchases, distributes, and transports natural gas to customers. They serve customers mainly in Minnesota, North Dakota, and Wisconsin.

Xcel Energy has made large strides in renewable generation and aims to transition to carbon free electricity by 2050.

Xcel Energy has plans to provide 100% carbon free electricity by 2050. The primary focus is on maintaining reliability while integrating renewable energy. They also have a commitment to keeping customer costs affordable.

The utility sector is currently in a state of transition due to several trends:

  • Renewable Energy Transition: Increased adoption of renewable energy sources (solar, wind) due to environmental concerns and falling costs.
  • Regulatory Changes: Stricter environmental regulations and increasing oversight by regulatory bodies like state public utility commissions.
  • Infrastructure Modernization: Upgrades needed to grids and transmission lines to manage the flow of energy from diverse, including intermittent sources.
  • Demand for Electrification: Increased demand for electricity as opposed to fossil fuels due to consumer and government mandates.
  • Technological Innovation: Rapid innovations in power production as well as distribution and management.

Xcel Energy’s competitive landscape includes both other large utilities and new entrants such as renewable-energy providers and distributed generation. Competition also arises from the growth of alternative energy sources, which may take market share from large utilities. However, due to the complexity, scale, and regulation involved, competition in the industry is usually limited. The geographical monopoly given by local and state regulations also increases the barriers to entry for other companies.

In the 2024 Q1 earnings call, management discussed how they will continue to invest in clean energy and technology that will lead to low-cost and reliable energy transition.

Profit Margins

Xcel’s financial margins are dependent on the regulatory environment and the cost of fuel/power purchased. The company often operates under a set cost structure with revenues determined by state-level regulatory bodies and prices passed on to end customers.

Xcel energy’s gross profit margins from 2022 and 2021:

  • 2022: 19.3%
  • 2021: 23.1%

The net profit margin from the same time period is:

  • 2022: 9.7%
  • 2021: 11.3%

The gross profit margin has decreased a bit, while net profit has fallen more, indicating increasing expenses.

These metrics can also fluctuate significantly with changes in regulation and with fluctuations in natural gas and coal prices.

Competitive Advantage (Moat)

Xcel’s primary source of competitive advantage comes from the economic moats created by:

  1. Regulated Monopoly:

They operate in a regulated industry, meaning that they have a protected area of operations and are often the sole providers of power/gas in those regions. This regulation allows them to make a stable and predictable revenue that is guaranteed by the regulatory authorities.

  1. Economies of Scale: The costs of expanding the infrastructure required for electrical grids or natural gas lines are extremely high. Due to the large infrastructure, it is extremely difficult for smaller companies to compete and requires economies of scale for a profitable business. Existing players enjoy a significant cost advantage due to its massive scale of operations.
  2. Infrastructural Investment: Xcel has existing network infrastructure which gives them cost advantages and makes it difficult for a competitor to take away their market.

Moat Rating

Based on above facts, I assign Xcel Energy a Moat rating of 3 out of 5.

  • 3/5 is Narrow Moat with potential to grow:
    • Xcel benefits from a solid moat due to the regulatory nature of the utility business, providing geographical monopolies and relatively secure returns. Their cost advantages stemming from scale and unique resources give further support to this moat.
    • However, the ongoing energy transition and increasing competition from newer companies may erode at least part of their moat in the long term. In particular, the possibility of future regulation limiting return on equity or investment creates risks for the company. The shift to cleaner energy, although a positive in general, also implies substantial investment in infrastructure which could be very costly. The technology that is being used to make cleaner energy a more affordable and stable alternative will come under constant scrutiny. The company may need to be on the leading edge of new technology development to maintain and grow their moat.
    • Also, as stated above, other newer players entering into the market, especially in the renewable energy space, pose a threat to this business. Thus, the company is not immune to competition and needs to continue to create cost-cutting and differentiating technologies and business practices to maintain their moat.

Legitimate Risks that could harm the Moat and Business Resilience

Xcel’s moat faces some legitimate risks:

  1. Regulatory changes: Changes in regulation, for example, reduction in return on equity or changes in pricing models, would affect the profitability of the company.
  2. Fuel Costs: Fluctuations in fossil fuel prices can materially impact costs of operation, thus impacting both profitability and balance sheet health.
  3. Technological Changes: The utility sector is rapidly innovating, and Xcel needs to ensure its technology remains modern and efficient. Failure to adapt to this and incorporate new technology can leave the company behind competitors.

In the 2024 Q1 earnings call, management highlighted that volatility in natural gas and oil prices and increased interest rates still create uncertainty. They expect to manage these macro headwinds with their ability to operate efficiently and pass on regulatory costs. However, they admit that new regulatory requirements and weather conditions create an additional risk.

  1. Macroeconomics: Inflation may significantly increase operating costs as raw materials and other overhead costs will increase. In addition, rising interest rates will greatly affect companies such as XEL who are highly debt financed, as interest expense will significantly rise. These will greatly impact profitability and potentially also market value.

The company’s resilience:

  1. Essential Service: Energy is a basic and essential need. That makes the demand for XEL’s services very inelastic, especially for the residential segment. This ensures there is still a market for the company even if prices increase or market conditions turn sour.
  2. Long Term Contracts: Long term power purchase agreements with various producers limit volatility and increase predictability of revenue streams for the company.
  3. Price Changes Passed on to End Customers: XEL is also mostly able to transfer changes in costs to the end-consumer through rate increases approved by the state regulators, further minimizing the effects of inflation and unforeseen factors on the company’s financials.
  4. Diversified portfolio: the company has a diversified portfolio of energy sources. Thus, they are not overly reliant on any single source of energy and will also benefit from growth in renewable generation.

Financial Analysis

The company generates revenue by providing electricity and natural gas to end users. In 2023, regulated electricity accounted for 79% of revenues, whereas regulated natural gas accounted for 17%. The remaining part of the revenues comes from other services that the company offers.

Xcel’s financials show a stable business, but also some vulnerability to fluctuations:

  1. Net income: In the 2023 annual report, they reported a net income of $1.72 Billion, whereas net income for 2022 was $1.67 Billion.
  2. Cash from operations: Xcel also reported Cash from operations (CFO) for 2023 as $5.12 Billion. This is up from $4.44 Billion reported in 2022.
  3. Debt: The company is heavily financed by debt. As of Q3 2024 the company had total long term debt of $21.8 Billion, which was used to finance the infrastructure and growth. This greatly increases the risk for the company in a rising interest rate environment.

From the 2024 Q1 call we learn that as of March 31, 2024, Xcel Energy issued $2.25 Billion of senior notes to fund repayment of existing loans and other debt.

Understandability

Based on the complex business operations and regulatory environment, XEL’s understandability is rated at 2 out of 5.

  • The utility business involves a lot of moving parts and may be very difficult for a regular investor to completely grasp. This includes a lot of jargon such as rate base, authorized returns, tariffs, and so on.
  • The heavily regulated nature adds more layers of complexity to the overall business operation.
  • The technical operations and different types of energy and their respective infrastructure may be too technical for a non-engineer to grasp.

Balance Sheet Health

The company’s balance sheet is somewhat worrisome due to the high amount of debt. The balance sheet health is rated as 3 out of 5:

  • The company has significant amounts of assets and its working capital situation looks ok. However, high debt levels coupled with rising interest rates are a risk.
  • The current ratio is a decent 1.2, which shows its ability to pay back current debt obligations.
  • The company also has a fair amount of cash at hand which can be used as an emergency buffer.