Alternative energy companies that promise investors a way to cash in on solar and wind energy (the purported "next energy revolution") are exciting to invest in, but the industry is fraught with peril. Solar companies are notorious for being highly speculative, trading at sky-high valuations and sometimes losing investors nearly all their capital. Wind energy is harder to invest in given that many wind companies are foreign companies that are not traded on U.S. exchanges. This article highlights two quality utilities whose large exposure to alternative energy gives investors a chance to cash in on the potential green energy revolution, while still earning generous and growing dividends as well.
Otter Tail Corporation (OTTR +0.95%) is a diversified company with two major operating divisions: manufacturing/infrastructure and regulated utilities. Its regulated utility division services 130,000 customers in Minnesota, North Dakota, and South Dakota. Its Varistar manufacturing/infrastructure division consists of six subsidiaries, divided into plastics, construction, and manufacturing sub-divisions.
The investment thesis for Otter Tale consists of three parts:
First, 80% of earnings are derived from the utilities division (with 17% of electrical generating capacity from wind.) This provides cash flow predictability. With a very favorable regulatory environment, the company was able to secure 10.1% CAGR growth in base rates from 2012-2018.
The second part of the investment thesis consists of Ottertale's manufacturing/infrastructure division, Varistar, and the upcoming infrastructure energy boom.
According to a recent study by Interstate Gas Association of America, America will need to invest $641 billion in its energy infrastructure by 2035. The Bakken/Three Forks shale formation in North Dakota is the largest continuous oil formation in the U.S. and is expected to greatly increase America's production in the years to come.
Otter Tale's Varistar division is poised to take advantage of this infrastructure investment. Specifically the company's Avenia subsidiary, a provider of high-voltage electrical solutions for industrial, utility, and telecommunications companies, has experienced increased contracts in the Bakken region. Other subsidiaries include BTD, manufacturing facilities located in nearby Minnesota that specialize in machining, stamping, and welding metal components and pipes. These are the kinds of manufactured goods necessary for increased energy infrastructure and represent the growth kicker to an already fast growing utility.
The final component to the Otter Tale investment thesis is the company's strong dividend. The current dividend (4.1% yield) hasn't been raised since 2009, when the financial crisis resulted in a high payout ratio of 218%. Today, the payout ratio has fallen to a sustainable 74%, a level that supported dividend growth in the past. With analysts projecting 7% EPS growth over the next decade that is backed by solid growth prospects in base rate and manufacturing/infrastructure, investors can likely expect a return to dividend growth (analysts are projecting 5.4% CAGR dividend growth through 2023).
NextEra Energy (NEE +0.88%) is one of the larger but fastest growing utilities in America. In total the company has 42.6 GW (gigawatts) of electrical generating capacity (52% natural gas, 27% nuclear, 16% wind.) It is composed of two subsidiaries: Florida Light and Power and NexrEra Energy Resources.
Florida Light and Power is a regulated utility with 4.7 million customers. It provides the stable, predictable cash flow that supports the company's 3% dividend.
NextEra Energy Resources, is a competitive wholesale energy generator with 18.3 GW of capacity throughout 24 states and Canada. It features the nation's largest wind and solar generating capacity. Whereas some wholesale electricity providers such as Atlantic Power and JustEnergy have struggled recently, NextEra enjoys much more consistent cash flows because of long-term contracts for its alternative energy output. In 2014, management is guiding for 64% of EBITDA to come from such contracts. This will decrease cash flow volatility and help the company achieve its 10% dividend growth target.
What makes NextEra a truly exciting investment (even more so than Otter Tale) is its strong emphasis on growing its wind and solar capacity. The company's 10.2 GW of wind capacity already represents the largest wind generation in America, and a 17% CAGR since 2002 makes it one of the fastest growing as well. The company continues to expand as well. The present backlog of wind projects for 2014 and 2015 stands at 1.641 GW, a 16% increase. The company also has an additional 0.8 GW expansion of solar capacity planned through 2016.
The fast growth of NextEra supports one of the fastest growing dividends in the industry, with an 8.2% CAGR over the last decade vs Avg Utility's 5.1%.Management is targeting a 55% long-term payout ratio and 5%-7% EPS growth through 2016. This implies continued strong dividend growth that should result in continued market outperformance, with a 13.2% CAGR over the last 21 years vs the market's 9.5%.
Foolish takeaway
Otter Tail and NextEra Energy represent conservative, quality utility plays on alternative energy. With yields of 4.1% and 3% respectively (and expected dividend growth rates of 5.4% and 6% respectively), these utilities offer income investors a chance to cash in on the green energy revolution without taking on lower risk. With decent income generation capacity and market beating potential, conservative investors who want to gain exposure to alternative energy should consider these excellent diversified utilities.
