Alliant Energy´s Earnings Growth Prospects

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Dec 03, 2014

In this article, let's take a look at Alliant Energy Corporation (LNT, Financial), a $7.07 billion market cap company that provides electric and natural gas utility services, and also has various unregulated energy, freight transportation and other investments.

Key driver

The company planned a multibillion capital plan to reach a 5%-7% annual earnings growth rate off weather-normalized 2013 earnings. Operations in two of the most favorable regulatory jurisdictions, Iowa and Wisconsin, benefit the firm due to the healthy relations with the regulators.

To reach this, management has made implementations, like a new transmission cost rider in Iowa. Further, management is implementing environmental controls while implementing its capital plan.

Revenues, margins and profitability

Looking at profitability, revenues declined by 2.72% and led earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($1.40 vs $1.43). During the past fiscal year, the company increased its bottom line. It earned $3.28 versus $2.94 in the prior year. This year, Wall Street expects an improvement in earnings ($3.47 versus $3.28).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker Company ROE (%)
LNT Alliant Energy Corp 11.70
SCG Scana Corp. 11.23
AEE Ameren Corp 8.72
TE TECO Energy Inc 6.77
 Industry Median 8.76

The company has a current ROE of 11.70% which is higher than the one exhibit by Scana (SCG, Financial), Ameren (AEE, Financial) and TECO (TE, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

03May20171241451493833305.png

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 18.2x, trading at a discount compared to an average of 20.6x for the industry. To use another metric, its price-to-book ratio of 2.06x indicates a premium versus the industry average of 1.67x while the price-to-sales ratio of 2.09x is above the industry average of 1.65x.

As we can see in the next chart, the stock price has an upward trend in the five-year period.

03May20171241461493833306.png

Valuation

In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.

Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two- or Three-Stage growth model or the H-Model (which is a special case of a two-stage model).With the appropriate model, we can forecast dividends up to the end of the investment horizon where we no longer have confidence in the forecasts and then forecast a terminal value based on some other method, such as a multiple of book value or earnings.

To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.

This formula condenses to: V0=(D0 (1+g))/(r-g)=D1/(r-g)

where:

V0 = fundamental value

D0 = last year dividends per share of Exxon's common stock

r = required rate of return on the common stock

g = dividend growth rate

Let´s estimate the inputs for modeling:

Required Rate of Return (r)

The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium

Assumptions:

Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%. This is a very low rate because of today´s context. Since 1900, yields have ranged from a little less than 2% to 15%; with an average rate of 4.9%. So I think it is more appropriate to use this rate.

Beta: β =0.57

GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]

rLNT = RF + βLNT [GGM ERP]

= 4.9% + 0.57 [11.43%]

= 11.42%

Dividend growth rate (g)

The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.

g = b x ROE

b = retention rate

ROE=(Net Income)/Equity= ((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

The “PRAT” Model:

g= ((Net Income-Dividends)/(Net Income)).((Net Income)/Sales).(Sales/(Total Assets)).((Total Assets)/Equity)

Let´s collect the information we need to get the dividend growth rate:

Financial Data (USD $ in millions) 31/12/2013 31/12/2012 31/12/2011
Cash dividends declared 219,700 215,200 204,900
Net income applicable to common shares 376,200 335,700 321,900
Net sales 3,276,800 3,094,500 3,221,400
Total assets 11,112,400 10,785,500 9,687,900
Total Shareholders' equity 3,481,400 3,280,000 3,158,100
Ratios   Â
Retention rate 0 0,36 0,36
Profit margin 0,11 0,11 0,10
Asset turnover 0,29 0,29 0,33
Financial leverage 3,29 3,35 3,11
   Â
Retention rate = (Net Income – Cash dividends declared) ÷ Net Income = 0,42
   Â
Profit margin = Net Income ÷ Net sales = 0,11 Â Â
   Â
Asset turnover = Net sales ÷ Total assets = 0,29 Â Â
   Â
Financial leverage = Total assets ÷ Total Shareholders' equity = 3,19 Â
   Â
Averages   Â
Retention rate 0,38 Â Â
Profit margin 0,11 Â Â
Asset turnover 0,30 Â Â
Financial leverage 3,25 Â Â
   Â
g = Retention rate × Profit margin × Asset turnover × Financial leverage Â
   Â
Dividend growth rate 4,05% Â Â
   Â

Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.

Dividend growth rate (g) implied by Gordon growth model (long-run rate)

With the GGM formula and simple math:

g = (P0.r - D0)/(P0+D0)

= ($61.8 ×11.42% – $2.04) ÷ ($61.8 + $2.04) = 7.85%.

The growth rates are:

Year Value g(t)
1 g(1) 4,05%
2 g(2) 5,00%
3 g(3) 5,95%
4 g(4) 6,90%
5 g(5) 7,85%

G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).

Calculation of Intrinsic Value

Year Value Cash Flow Present value
0 Div 0 2,04 Â
1 Div 1 2,12 1,91
2 Div 2 2,23 1,80
3 Div 3 2,36 1,71
4 Div 4 2,52 1,64
5 Div 5 2,72 1,59
5 Terminal Value 82,48 48,04
Intrinsic value   56,67
Current share price   61,80

Final comment

When the stock price is higher than the intrinsic value, the stock is said to be overvalued and it makes sense to sell the stock. It is recommended a margin of safety, usually a 20%, and in this case is 10% above so we can say that the stock is fairly valued.

We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.

If you had invested $10,000 five years ago, today you could have $27,809, which represents a 22.7% compound annual growth rate (CAGR).

Hedge fund managers Paul Tudor Jones (Trades, Portfolio) and Jim Simons (Trades, Portfolio) have added the stock in the third quarter of 2014, as well as Pioneer Investments (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned.


[1] These values were obtained from Bloomberg´s CRP function.