This Utility Is an Overlooked, Low-Risk Shale Play

Regions with shale drilling activity are quickly becoming the most dynamic areas of the country. Investors looking for a very low-risk way to play the shale should not overlook regional utilities. This one is a place to start.

May 28, 2014 at 4:57PM

I believe the shale revolution in the United States is one of the best growth stories of this generation. Many investors, however, are hesitant to participate in this story because it is deemed too risky. Even the bigger shale players are upstream companies that many retail investors have never even heard of. Investing in unknown names can seem like a frightening prospect.

But the horizontal drilling story has gotten so big that it has outgrown just one sector. Defensive investors should consider utility companies operating in areas with major shale activity.

Consider Wisconsin Energy (NYSE:WEC). Wisconsin may not be home to any fracking activity, but the state is the biggest provider of fine, northern white sand, a necessary ingredient in the process of rock fracturing. New sand mines are going up all over Western Wisconsin, and Wisconsin Energy is providing most of these new facilities with the power they need. Wisconsin Energy is also a compelling dividend growth play, with one of the lowest coverage ratios in the sector. 

Wisconsin Frack Conveyer

Conveyer belt near frack sand mine, Western Wisconsin
Source: Carol Mitchell

Western Wisconsin expansion
Like a number of utilities these days, Wisconsin Energy is a benefactor of the conversion to natural gas from other, typically non-utility heating methods such as heating oil and propane. Western Wisconsin has been a heavy user of propane. As the natural gas supply has risen, the resulting low natural gas price has given many customers an impetus to switch to both natural gas and Wisconsin Energy.

Also in Western Wisconsin is frack sand mining, which will likely also be powered by natural gas energy. The company plans on converting its Valley Power Plant from coal to natural gas in order to meet increased future demand and comply with state pollution regulations. 

More maintenance, less renewables
Wisconsin is one of the more "progressive" states regarding green energy; in the last few years, Wisconsin Energy has had to increase its proportion of renewable energy sources in order to comply with state regulations. As a result, a good chunk of the company's past capital budgets has gone to solar and biomass infrastructure in several high-profile projects. 

Thankfully, much of that is done, and management can now focus additional capital spending on infrastructure, much of which is about 50 years old. The company will spend between $3.2 billion and $3.5 billion to modernize its grid, reduce operating costs, and continue to meet new environmental standards. Most of the work will be in replacing pipes, poles, wires, and substations. 

Growth and valuation
Considering all of this, management expects 4%-6% per-share earnings growth until at least 2017. This puts Wisconsin Energy in the top growth tier for utilities along with names such as American Electric Power (NYSE:AEP) and Duke Energy (NYSE:DUK).

It gets better, though. Wisconsin Energy is actually a late-stage dividend growth play: Its dividend per share is only 58% of earnings per share, whereas most utility companies pay between 70% and 80% of earnings in the form of dividends. By 2017, management expects the dividend to be around 70% of earnings. All things considered, we should expect 7%-10% dividend growth. Not bad for a boring utility. 

Unfortunately, Wisconsin Energy's story is no secret. The price-to-earnings ratio is now an expensive 17.7 times trailing earnings, well above that of most other utility companies.

Bottom line
Wisconsin Energy is a unique, low-risk dividend growth play in the utilities space. And it's not hard to see why: a low payout ratio and solid earnings growth backed by two secular trends. However, Wisconsin Energy is also one of the most costly utilities around, and so risk-averse investors might want to wait until shares reach a more reasonable valuation.

The top income plays from America's energy boom
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Casey Hoerth has no position in any stocks mentioned. The Motley Fool recommends Wisconsin Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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