Wisconsin Remains a Very Constructive Environment for Utilities

Strategist

Andrew Bischof

WEC Energy Group is the largest Midwest utility, with approximately $26.5 billion of rate base and derives most of its earnings derived from regulated operations. Nearly 75% of earnings come from constructive Wisconsin and Federal Energy Regulatory Commission regulation. Its regulated-like commercial renewable energy business accounts for the remainder of earnings.

We expect the company to invest more than $20 billion of capital through 2027, which includes its investment in American Transmission. This investment plan supports our forecast that the company will achieve management's narrow 6.5%-7% annual earnings growth target.

In Wisconsin, the company enjoys rates based on two-year forward test years and an earnings-sharing mechanism over its allowed return on equity. Its average allowed ROE tops 9.8% at the company's subsidiaries in the state and is consistently above peers'. In late 2022, the company's Wisconsin subsidiaries received a final rate case order that is consistent with our view that Wisconsin remains a very constructive regulatory environment for utilities. We think the limited reopener of the utilities' rate case will once again highlight Wisconsin's constructiveness.

The company is moving aggressively on its renewable energy investment plan. It targets investing $5.4 billion for 3.3 gigawatts of new solar, battery storage, and wind generation development through 2027. The company plans to retire 1,400 MW of coal generation and to retire older, less-efficient natural gas generation. The company plans to use coal generation as a backup fuel only by 2030 and exit coal generation by 2035.

WEC has also allocated nearly $2.0 billion for unregulated renewable energy infrastructure investments. We think these are good investments for shareholders with higher returns than WEC's rate-regulated business with regulated utility-type risks. This is a contrast with many of its peers that are divesting commercial renewable energy portfolios to offset equity needs. WEC does not need any equity to support its current investment plan.

WEC Energy holds a 60% majority stake in ATC, through which it earns above-average equity returns despite recent FERC decisions.

Business Strategy & Outlook

Service territory monopolies and efficient scale advantages are the primary sources of economic moat for regulated utilities such as WEC Energy Group. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks. In exchange for regulated utilities’ service territory monopolies, state and federal regulators set returns at levels that aim to minimize customer costs while offering fair returns for capital providers.

This implicit contract between regulators and capital providers should, on balance, allow regulated utilities to outearn their costs of capital, though observable returns might vary in the short run based on demand trends, investment cycles, operating costs, and access to financing. Intuitively, utilities should have an economic moat based on efficient scale, but in some cases regulation offsets this advantage, preventing excess returns on capital. The risk of adverse regulatory decisions precludes regulated utilities from earning wide economic moat ratings. However, the threat of material value destruction is low, and normalized returns exceed costs of capital in most cases, leaving us comfortable assigning narrow moat ratings to many regulated utilities.

Narrow

Economic Moat

WEC Energy Group

WEC Energy Group, Inc. is a holding company, which engages in the generation and distribution of electricity and natural gas. It operates through the following segments: Wisconsin, Illinois, Other States, Electric Transmission, Non-Utility Energy Infrastructure and Corporate & Other. The Wisconsin segment refers to the electric and gas utility operations. The Illinois segment deals with natural gas utility and non-utility activities. The Other States segment pertains to natural gas operations of the firm's subsidiaries. The Electric Transmission segment holds interests in state regulatory commissions. The Non-Utility Energy Infrastructure segment includes Wisconsin Electric Power, which owns and leases generating facilities. The Corporate and Other segment refers to the firm's administrative and holding activities. The company was founded in 1981 and is headquartered in Milwaukee, WI.

Earnings data Q1 2024

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