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El Paso Electric: Fairly Valued, No Significant Upside

Summary We initiate coverage on El Paso Electric with a Neutral rating and TP of $40. The TP is based upon company’s future financial performance and historical valuation against industry peers. Current political situation in El Paso may cause challenges in reaching a settlement with the PUCT. Thus, the company would have to face uncertainty related to litigation. PVR anticipates the regulators of Texas and New Mexico to finally allow the significant increase in rate base. However, the current stock price is not including uncertainty related to regulatory. EE would have to apply for relief in rates in challenging jurisdictions as a result of new generation investment. Plain Vanilla Research ((NYSE: PVR )) initiates coverage on El Paso Electric Co. (NYSE: EE ) with a Neutral rating and a target price ((TP)) of $40. Since September, the stock price of El Paso Electric has outperformed the Utilities Sector by 7.28 percentage points (ppts). This is shown in the chart below: (click to enlarge) However, we think that the performance is not sustainable in the future as the company is facing challenges on multiple fronts. This restricts the stock from offering significant upside potential. In addition to that, a dividend yield of only 3% is not very attractive to tempt dividend investors. We will be discussing the challenges below: 1. Political Circumstances In El Paso In the past, proceedings related to change in rate base in El Paso have been engulfed with politics a lot. The company can be anticipated to face an interesting stance from the City Council officials as they will try to create challenges for the company to reach a settlement agreement. Furthermore, the supporters of solar-powered energy have also entered the arena as the publicly-listed corporation is trying to create alterations in rate design, which would cause installers of rooftop solar panels to make a partial requirements fee payment. Instead of reaching a settlement with the City Council authorities, we think the company should play the long game and wait for a decision from the Public Utilities Commission of Texas (PUCT). Although, the road is long and would result in higher uncertainty but it will result in a more favorable decision for the organization. 2. Approval From Texas And New Mexico Regulatory Authorities We anticipate that the regulatory authorities of Texas and New Mexico will allow the significant increase in rate base at the end. However, the current stock price reflects that investors expect the regulatory authorities to allow the increase in rate in any case. We think that slight hindrance in regulatory approval will result in the stock price on a downward trajectory. Texas is responsible for contributing roughly three-fourth to El Paso Electric’s bottom line. Meanwhile, the remaining contribution is from the state of New Mexico. 3. Demand For Rate Relief Requests In Challenging Jurisdictions El Paso has the finished the construction of two peaking units located at the Montana Power Station (MPS). In addition to that, the company will be finished with the construction of the third unit by spring of next year and by year-end, the company intends to complete the construction of the fourth unit. The four units are natural-gas powered and will have a capacity of 352 megawatts ((NYSE: MW )). These units are built to cater the increasing requirement of electricity in El Paso’s service territory. Montana plant and support infrastructure is anticipated to have a cost of $375 million. The company has been lucky to experience an annual growth rate of 1% to 1.5% for the past several years in the service territory. Normally, the industry has been seeing flat or decline in power consumption. Derivation Of Price Objective PVR has based its target price (TP) of $31 at earnings per share ((NYSEARCA: EPS )) of $2.67 along with a forward P/E multiple of 15.39x. The following forecasted income statement reflects as how we have arrived at our 2018 EPS. Currently, El Paso Electric’s stock is exchanging hand at PVR’s forward price-to-earnings (P/E) multiple of 15.44x. In the past three-years, the stock has traded at an average forward P/E multiple of 14.94x. This reflects that the stock is trading at a premium of 6.5% against its three-year average forward P/E multiple of 14.94x. (click to enlarge) Meanwhile, against its peers’ combined forward P/E multiple of 12.23x, El Paso Electric’s stock is presently trading at a premium of 26.2%. In the past three years, the stock has traded at an average premium of 22% against its peers’ combined forward P/E. (click to enlarge) We have arrived at our target forward P/E multiple for El Paso Electric by calculating the three-year average forward P/E multiple of 12.24x for the combined industry peers. After that, we have applied the three-year historical premium of 22% to the historical average peers’ combined forward P/E multiple to reach El Paso Electric’s target forward P/E multiple of 14.93x. We have formulated the peers forward P/E multiple by combining our forward P/E ratios of Consolidated Edison (NYSE: ED ), PG&E Corporation (NYSE: PCG ), PNM Resources Inc (NYSE: PNM ), American Electric Power Company Inc (NYSE: AEP ) and Xcel Energy Inc (NYSE: XEL ) along with El Paso Electric. We have given their respective P/E weight according to their market capitalization.

El Paso Electric: A Strong Long-Term Position Is Mitigated By Short-Term Uncertainty

Summary El Paso Electric reported disappointing Q2 earnings in response to a mild early summer and regulatory lag that has caused the costs of recent capex to outpace revenue. The utility is well positioned to weather higher interest, rates due to the fact that most of its planned capex for the current decade has already been completed. Furthermore, it is in a better position than its peers to handle new federal environmental regulations, due to the low average carbon intensity of its existing power portfolio. The company’s shares are overvalued on both trailing and forward FY 2015 bases, while its FY 2016 earnings will be exposed to another cold early summer due to El Nino. While El Paso Electric’s long-term position is attractive, I encourage potential investors to wait for a margin of safety to develop to offset weather-related uncertainty in the next 9 months. Southwest electric utility El Paso Electric (NYSE: EE ) recently saw its share price approach an almost six-month high as continued delays to the Federal Reserve’s expected rate hike caused utility shares to rally. The company, which reported disappointing Q2 earnings due to the combination of an unfavorable regulatory environment and an unseasonably mild quarter in its service area, has yet to see its shares break their TTM high, and an unfavorable weather forecast is currently developing in its service area. That said, El Paso Electric occupies a unique position as producer of low- and zero-carbon electricity in states that will be subject to increasingly stringent federal restrictions on power plant emissions of greenhouse gases (GHG) over the next several years, providing it with a competitive advantage. This article evaluates El Paso Electric as a potential long investment in light of these conflicting conditions. El Paso Electric at a glance Headquartered in the eponymous Texas city, El Paso Electric is a public utility company that generates, transmits, and distributes electricity to almost 403,000 customers in west Texas and south New Mexico. The company owns and operates 2,010 MW of generating capacity, including minority stakes in two outside facilities. It also transmits and distributes electricity generated by 107 MW of solar power capacity via power purchase agreements. With a power portfolio that consists of 47% nuclear, 35% natural gas, and only 5% coal, El Paso Electric’s overall carbon intensity (tons of CO2 emissions per MWh of electricity) is substantially lower than the averages of the two states in which it operates and approximately half that of the U.S. average (0.31 tons CO2/MWh versus 0.62 tons CO2/MWh). This comparison will become more favorable still as the company exits its coal-fired power plant minority stake next year. It owns 1,834 miles of transmission lines, including a connection with Mexico, although its operations in Texas are responsible for 78% of its electricity and other non-fuel revenues. El Paso Electric operates within state regulatory schemes that are relatively favorable compared to those in other regions; its most recent rate requests, for example, would result in returns on equity of 10% and 10.1% in New Mexico and Texas, respectively. This advantage is offset by the presence of regulatory lag, however, that increases earnings volatility after the construction of new capacity in particular. Whereas capex increases are ideally quickly offset by rate increases, regulatory lag occurs when the rate increases due not occur until after the utility’s earnings have already begun to be negatively impacted by the consequent increase to depreciation, property tax, and O&M costs. Such lag affected El Paso Electric’s earnings in Q2 following the completion of two 88 MW high-efficiency, rapid start-up natural gas turbines that were brought on-line last March. The company’s capacity expansion has largely been completed, with a net increase of 68 MW planned through 2019, so lag will not be as much of an issue moving forward as it has been in the past. While peak demand has grown at a CAGR of 2.7% and residential customer growth has achieved a CAGR of 1.9% over the last decade, its existing capacity is expected to be sufficient for the time being. Finally, El Paso Electric does not boast as impressive a dividend history as many of its utilities peers, having only reinstated its dividend in 2011. While it has increased by 34% in the subsequent four years, the company’s dividend payout ratio remains below the sector average. Management is targeting annual increases of 4-6% until the payout ratio reaches the average. Even following a recent increase to the quarterly dividend of 5.4%, however, El Paso Electric’s forward yield is not especially high at 3.2%. Q2 earnings report El Paso Electric reported underwhelming Q2 earnings in August that missed on diluted EPS due to the combination of regulatory lag and reduced cooling degree days resulting from mild weather in its service area. The company reported total revenue of $219.5 million, down 13% YoY from $251.8 million (see table). Retail sales of electricity fell by 1.6% YoY as the number of cooling degree days during the quarter came in 15.2% below the previous year’s number and 11.5% below the decade average. The negative impact of this decline was partially offset by customer growth of 1.4% YoY. Fuel revenue fell by 31% YoY, mainly due to the presence of much lower energy prices compared with the same quarter of 2014. El Paso Electric financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 219.5 163.7 196.6 283.6 251.8 Gross income ($MM) 158.0 114.8 126.6 195.1 164.0 Net income ($MM) 21.1 3.5 4.2 52.5 30.1 Diluted EPS ($) 0.52 0.09 0.11 1.30 0.75 EBITDA ($MM) 79.3 52.8 51.6 121.7 90.0 Source: Morningstar (2015) Gross profit came in at $158 million, down by 3.7% YoY, as the revenue decrease was partially offset by a 30% decline to the cost of revenue resulting from a fall in energy prices over the same period. Net income declined by 30% YoY, from $30.1 million to $21.1 million. Diluted EPS fell to $0.52 from $0.75 in the previous year, missing the analyst consensus estimate by $0.08. EBITDA fell to $65.6 million from $74.1 million over the same period. The net income and EBITDA declines were the result of the aforementioned mild weather and regulatory lag, the latter of which caused the company’s depreciation and O&M costs to increase even as revenue declined. Interest costs also increased YoY as a result of the company’s long-term debt increasing by 13.4% YoY. Outlook El Paso Electric’s management stated during the Q2 earnings call that the company only had sufficient cash on hand to continue operations for 12 months, and it will need to raise new debt by late 2015 to finance capex beyond that point. Management also reduced its FY 2015 diluted EPS outlook range to $1.75-2.05 from $1.75-2.15 due to its poor Q2 result. New rates offsetting Q2’s regulatory lag are not expected to go into effect in New Mexico and Texas until Q2 2016. The earnings call was rather vague as to how the summer weather would impact the full-year results, although in past years, Q3 has usually been the company’s most profitable year due to high electricity demand from air conditioners fighting the summer heat. Temperatures in the service area were indeed high during Q3, although it remains to be seen whether or not this was enough to increase the number of cooling degree days on a YoY basis and offset the impact of the mild Q2 weather on the FY 2015 earnings. El Paso Electric’s earnings outlook for FY 2016 has diminished over the last several weeks, although this has not yet been reflected by analyst estimates. Meteorologists are continuing to forecast this year’s El Nino event to be one of the strongest on record . Previous such events have been characterized by colder- and wetter-than-average conditions in Texas and eastern New Mexico, with the most abnormal impacts being felt in Q1 and Q2. While more heating degree days in Q1 could provide the company’s earnings with a small boost due to electric heaters being employed, this will most likely be outweighed by yet another mild Q2 as El Nino remains in place through late spring, causing cooling degree days in El Paso Electric’s service area to remain below the decade average. While the company’s FY 2016 outlook has been dampened somewhat by the strengthening El Nino forecasts, recent federal regulatory developments have caused its long-term outlook to improve relative to its peers. In August, the U.S. Environmental Protection Agency [EPA] released its Clean Power Plan, which requires every state to achieve predetermined reductions to the average carbon intensity of its power plants by 2030. The regulation resembles a similar rule in the European Union in that each state’s target is a function of its current carbon intensity. In other words, the states with the highest starting intensities will be allowed to have the highest intensities by 2030, although, in the process, they will also have to achieve the largest reductions . Texas and New Mexico both have average intensities that are higher than the U.S. average, but below those states (such as Wyoming) that have the highest intensities. While they will be required to achieve sizeable reductions as a result, El Paso Electric’s average carbon intensity is well below the averages of both Texas and New Mexico as well as the U.S. Unlike its peers in both states, then, the company will not be required to phase out its existing (primarily coal) facilities in favor of new ones utilizing natural gas and/or renewables. It is therefore possible that the company will benefit under the Clean Power Plan if state regulators increase rates in both jurisdictions to compensate those utilities that still rely heavily on coal and petroleum for the expenses incurred in switching to less-polluting fuel sources. Finally, while the prospect of an interest rate increase by the Federal Reserve has inflicted substantial volatility on the utilities sector in recent months, El Paso Electric is unlikely to be as negatively impacted as its peers when the increase ultimately does occur. This is because the company is forecasting (.pdf) its capex to have peaked in FY 2014, with FY 2017 spending expected to be 38% below that high, and even FY 2019 spending to remain 8% below it in nominal terms. While the company’s interest costs on new debt will increase when the rate hike inevitably occurs, it will not be as exposed as those of its peers that anticipate ramping up their own capex over the same period. While management would not have known it at the time, El Paso Electric’s decision to undertake $1.3 billion in capacity investment between FY 2010 and FY 2015 could not have been better timed from the perspective of taking advantage of low debt costs. Valuation The consensus analyst estimates for El Paso Electric’s diluted EPS results in FY 2015 and FY 2016 have declined slightly over the last 90 days, in response to the company’s Q2 earnings report and a diminished weather outlook for the first half of next year. The FY 2015 estimate has fallen from $2.00 to $1.98, while the FY 2016 estimate has been revised to $2.56 from $2.58. Based on a share price at the time of writing of $37.34, the company’s shares are trading at a trailing P/E ratio of 18.5x and forward ratios of 18.9x and 14.5x for FY 2015 and FY 2016, respectively. The trailing and forward FY 2015 ratios are near the top of their respective 3-year ranges, albeit lower than they were at the beginning of this year. That said, the FY 2016 ratio is near its own low over the same period, creating a situation in which the company’s shares can only be considered to be undervalued in the event that its earnings next year achieve a 29.3% YoY increase. Conclusion El Paso Electric reported disappointing Q2 earnings in August, resulting from mild weather and continued regulatory lag. Management has reduced the upper limit of its FY 2015 EPS outlook range in response, although a hot Q3 may offset the previous quarter’s negative impact to a certain extent. Ultimately, I am more concerned about the likelihood that the strong El Nino event that has developed this year will persist into Q2 2016, in which case historical records suggest that the company’s service area could experience yet another cool start to the summer and a reduced number of cooling degree days. Over the longer term, I believe that the company’s outlook is superior to that of many of its peers due to its low carbon intensity and lack of planned capex during a future period of higher interest rates. However, given that its shares are overvalued on trailing and forward FY 2015 bases, and that the shares are only undervalued on a forward FY 2016 basis in the event that normal weather conditions prevail during that year, I encourage potential investors to wait for a margin of safety to develop in the form of underdeveloped shares to compensate them for the risk that El Nino will negatively impact earnings.

Empire District Electric: A Small Utility In An Uncertain Region

Summary Regulated electric and natural gas utility Empire District Electric has seen its share price fall sharply YTD in response to uncertainty over interest rates and state and federal regulations. Further uncertainty has arisen in recent months in the form of El Nino’s temperature impacts, with a warm winter in its service area likely. The company’s shares appear to be undervalued on a P/E ratio basis but this doesn’t account for the possibility of reduced natural gas demand in Q4 and Q1 2016. I encourage income investors to wait for the company’s shares to fall below $20 in response to disappointing Q4 and Q1 earnings before investing. Regulated electric and natural gas utility Empire District Electric (NYSE: EDE ) reported Q2 earnings that missed on both lines as mild weather in its service area hurt both sales volumes and margins. The company’s share price declined in the weeks following the report’s release, continuing a sharply lower trend that has been in place YTD in the aftermath of an adverse state court ruling (see figure). While the company’s share price is nearing a 5-year low, its investors are about to be confronted by additional weather-related uncertainty as well as looming federal regulations that could impact its energy generation portfolio. This article evaluates Empire District Electric as a long investment opportunity in light of these developments. EDE data by YCharts Empire District Electric at a glance Headquartered in Joplin, Missouri, Empire District Electric is a combined electric and natural gas utility, although it also operates small water and fiber optic services as well. Its service area encompasses 218,000 customers residing in 10,000 square miles of the tri-state border region of Missouri, Kansas, and Oklahoma, as well as part of Arkansas. Its electric generation, transmission, and distribution segment covers the full service area, although 86% of its revenues are derived from its Missouri operations. The natural gas service is limited to western and northwestern Missouri. Empire District Electric is a relatively small utility with a $948 million market cap at the time of writing, reflecting the sparsely populated and mostly rural nature of its service area. The company generates 94% of the electricity that it sells via 1326 MW of owned generating capacity. While its fuel source portfolio has shifted in recent years, it is mostly comprised of coal and natural gas complemented by a small amount of hydro. The balance of its electric sales are derived from 86 MW of coal and wind via power purchase agreements, bringing its total capacity to 1412 MW. Another 108 MW of natural gas combined cycle capacity is currently under construction and expected to begin operations in the first half of 2016. The electric segment is responsible for the bulk of the company’s revenues, bringing in 91% of the total on a TTM basis as well as 92% of gross income (or gross margin in the company’s parlance) over the same period. Its customers are broadly split between residential, commercial, and industrial, with residential being the largest group. The natural gas segment, which is comprised of transmission and distribution components, generated 7.5% of TTM revenue and 6% of TTM gross income, although both numbers were lower than in previous years. Finally, the water and fiber optic segments generated only 1.3% of TTM revenue and an unknown percentage of gross margin. The last several years have been rough for Empire District Electric and it underperformed the broader sector for many of them. Its annual earnings remained relatively flat between FY 2008 and FY 2012, only beginning to grow strongly in FY 2013. Unusually, for a utility, its annual dividend has actually declined and is now 12% lower than in FY 2008-2010. Reflecting the unique weather conditions in which it operates, the company had to suspend its dividend in the second half of 2011 after a category EF-5 tornado hit Joplin, destroying 7,000 houses and causing the company’s number of customers to decline by 1.5% for the year. Its ROE on a non-weather adjusted basis has largely lagged behind the sector average, excepting a period from late 2013 to early 2014 that saw it report above average returns thanks in part to large temperature swings in its service area. Empire District Electric’s earnings and share price volatility is largely due to the fact that the Missouri regulatory scheme that it operates within does not contain a weather decoupling mechanism. Such mechanisms, which are found in some regulatory schemes, establish a base rate case and then allow the regulated utility to either charge or refund customers on the basis of the difference between the case and its weather-related earnings. Such a mechanism would have a large impact on Empire District Electric given the large temperature swings that occur in its service area over the course of a year: Joplin records average highs of 91 degrees F in July and August and an average low of 25 degrees F in February, while heat index and wind chill factors make this range appear to be even larger. The company’s earnings are therefore very sensitive to abnormal temperatures since its natural gas segment is in demand in the winter while its electric segment is in demand in the summer. Missouri’s scheme does include a fuel recovery mechanism, however, to minimize the impacts of the kind of energy price volatility that the U.S. has experienced over the last year. Q2 earnings report Empire District Electric reported Q2 revenue of $134.5 million, down by 10.2% YoY and missing the consensus estimate by $17.1 million. The presence of mild weather during the quarter compared to both the previous year and the long-term average as well as the presence of a fuel cost refund of $1.4 million resulted in the decline. This was partially offset by a $3.5 million increase resulting from customer growth and the implementation of a previously approved rate increase. Mild weather also reduced natural gas demand for heating purposes in the early part of the quarter, although the fact that the quarter is generally slow for the segment meant that this had only a small negative impact on the revenue result. Gross income (or margin) came in at $93.3 million, up slightly YoY from $92.7 million. The electric segment’s margin increased by 1% YoY as lower fuel costs and higher consumption by its commercial and industrial customers offset lower revenue overall and reduced consumption by its residential customers. The natural gas segment’s margin remained flat YoY and, as with revenue, only made a small contribution to the company’s total result. Net income came in at $6.8 million (see table), down from $11.2 million YoY. This resulted in a diluted EPS of $0.15 for the most recent quarter, down from $0.26 in the previous year and missing the consensus analyst estimate by $0.09. Both the decline and miss were almost entirely the result of higher O&M costs and depreciation expenses, both on a YoY basis. The negative impact of the former, which was the result of a planned major maintenance outage, on the company’s FY 2015 earnings should be offset by lower O&M costs in the rest of the fiscal year. Empire District Electric financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 134.6 164.5 151.4 171.5 149.8 Gross income ($MM) 65.7 75.6 67.3 86.0 65.1 Net income ($MM) 6.8 14.6 11.1 23.9 11.2 Diluted EPS ($) 0.15 0.34 0.26 0.55 0.26 EBITDA ($MM) 39.8 48.2 39.7 56.1 41.6 Source: Morningstar (2015). The depreciation increase, on the other hand, was the result of an air quality control system that the company had installed at one of its power plants in order to bring it into compliance with U.S. Environmental Protection Agency [EPA] restrictions on power plant emissions. Existing investors are already familiar with such costs, which are the result of a structural lag in Missouri’s regulatory scheme that prevents utilities from rapidly recouping capex in the form of a rate base increase. Instead, capex such as the control system purchase and installation negatively impact the company’s earnings in the form of higher depreciation costs and property tax payments before (hopefully) being offset by a rate base increase several months later. The company’s management has indicated in previous earnings calls that it does not expect for this lag to be eliminated anytime soon, further increasing its share price volatility. Outlook Investors should be aware of three major developments set to occur over the next twelve months that could have a substantial impact on Empire District Electric’s earnings results. The first of these is the prospect of higher interest rates for the utility sector resulting from a rate increase by the Federal Reserve. Utility capex has been bolstered over the last several years by the presence of historically low interest rates, allowing them to increase maintenance, replacement, and new capacity spending without negatively impacting earnings via substantially higher interest costs. While the market has been expecting such an increase to occur in 2015, a decision by the Fed not to implement an increase at its most recent meeting and a weak October jobs report has caused expectations of a 2015 rate hike to fall sharply. The utility sector has been one of the market’s stronger performers over the last several weeks as a result of this delay. When the inevitable hike does occur, however, Empire District Electric is unlikely to be as severely impacted as many of its peers due to the fact that most of its debt does not come due until after 2030, while recent borrowings have achieved a roughly 4% interest rate. Investors can expect Empire District Electric’s earnings to smooth out somewhat over the next year since the company expects its capex spending to decline sharply through FY 2017 following a large increase in FY 2014. As a result of this decrease, it is only forecasting a 4% rate base CAGR in 2014-2019. Furthermore, customer growth in its electric segment is expected to remain quite low, averaging less than 1% annually over the same period. This latter expectation is surprising given the robust economic strength of its service area’s economy. For example, the unemployment rate in Joplin and the surrounding area recently fell to 4.3% as compared to 5.6% in Missouri more broadly (see figure). The Joplin housing market has also been growing at a faster rate than Missouri’s (see second figure) following a brief downturn in the wake of the 2011 tornado strike. While the service area’s economy is strong, however, the region does not have any of the population growth drivers found in either metro areas or rural areas (a latter example being the Dakotas up until a year ago). While the economy will prevent customer growth from turning negative, then, the fact that southwest Missouri and the tri-state area have few major draws will prevent it from increasing by much either. Missouri Unemployment Rate data by YCharts Joplin, MO House Price All-Transactions Index data by YCharts I do expect the company’s earnings to falter a bit in Q4 and Q1 2016 as the effects of this year’s especially strong El Niño are felt. Historically, the company’s service area has experienced warmer than average temperatures between October and March during previous El Niño events, raising the prospect of similar mild conditions and consequent reduced natural gas demand over the next six months. While long-range weather forecasting is by nature an inexact science, the probability that this year’s event will remain strong have only increased over the last several weeks, boosting the likelihood that Empire District Electric’s earnings will be weaker than expected when it reports in January and April 2016. Finally, potential investors should be aware of a recent federal regulatory development that has the potential to impact Empire District Electric’s longer-term operations, although the timing of the impacts will be difficult to predict. In August, the White House and EPA, making good on its previous threats to respond to Congressional inaction on greenhouse gas [GHG] emissions by wielding federal regulations, announced a Clean Power Plan that will require each U.S. state to reduce the carbon intensity (e.g., unit of CO2-equivalent emissions per unit of electricity) by a predetermined amount over the next 15 years. Missouri is required to achieve an especially large reduction . While each state will be allowed to draft its own plans for achieving its individual reduction and, in the case of Missouri, this likely will be accomplished in consultation with the state’s utilities, in practice the plans will almost certainly take one of two forms: either coal-fired power plants will be replaced by natural gas-fired plants or large investments in new renewables capacity will be made. It is worth noting that Missouri can achieve its required reduction by phasing out coal in favor of natural gas, a process that is especially attractive in light of other recent EPA regulations restricting other types of coal-related emissions from power plants. Such a scenario would likely result in higher capex for Empire District Electric as it improved the efficiency of and converted its existing coal-fired plants, thereby supporting long-term rate base increases despite a lack of customer growth. The Central Plains region is host to a large amount of potential wind energy , however, and it is also possible that Missouri would focus on minimizing electricity prices and simply require the utility to purchase wind-derived electricity from independent producers of renewable power. Alternatively, the state could also opt for distributed generation, such as the residential PV installations that were the subject of the aforementioned state court decision. These latter scenarios would not support the company’s capex to nearly the same extent. Valuation The consensus analyst estimates for Empire District Electric’s diluted EPS results in FY 2015 and FY 2016 have held steady over the last 90 days despite its share price volatility. The FY 2015 estimate remains at $1.39 while the FY 2016 estimate remains at $1.51. Based on a share price at the time of writing of $21.69, the company’s shares are trading at a trailing P/E ratio of 16.7x and forward ratios of 15.6x and 14.3x for FY 2015 and FY 2016, respectively (see figure). The forward ratios in particular have declined sharply since the beginning of the year and are approaching their respective 5-year lows. I do believe that a warm winter will cause the company’s FY 2015 EPS to come in under the analyst consensus, ending up near the bottom end of management’s range of $1.30-$1.45. In this case, the company’s shares appear to be fairly valued at present on a historical basis. EDE PE Ratio (TTM) data by YCharts Conclusion Empire District Electric’s share price has fallen sharply YTD as abnormal weather conditions and an unfavorable regulatory structure have helped to produce more volatility than normal. While the company’s forward P/E ratios have fallen to levels that would normally suggest undervalued shares, the analyst consensus for FY 2015 and FY 2016 have remained flat over the last 90 days even as the likelihood of higher than average temperatures occurring in the company’s service area in Q4 and Q1 has grown. That said, I do believe that recent federal regulations on power plant emissions could present the company with an opportunity for long-term capex growth, although this will depend on how the state of Missouri decides to adapt to the recent Clean Power Plan. As attractive as Empire District Electric’s 4.8% forward dividend yield is, I would prefer to see a larger margin of safety in the form of undervalued shares to compensate potential investors for a lack of near-term capex growth and customer growth. While that margin is not available at present, I would consider purchasing the company’s shares in the event that the share price falls below 15x its FY 2015 earnings, or $20/share at the time of writing, in response to warm winter weather.