Great Plains Energy: Reliance On Coal Remains A Problem
Summary 80% of energy generation comes from coal. Upgrades to coal plants to maintain compliance has cost the company billions. Cash outflows in 2014/2015 related to higher capital expenditures have increased a utility with already high leverage. Management has guided down capital expenditures for the next five years, in spite of at the same time hinting at replacing 700MW of coal generation with an alternative source. Great Plains Energy (NYSE: GXP ) owns and operates power generation facilities that provide energy to nearly one million customers in Kansas and Missouri. The company has been a stalwart of the Midwest region and has long been a favorite of institutional and retail investors. Unfortunately, Great Plains has been dead money for investors for years – the ten-year return on shares is actually negative ignoring the dividends collected. Is it time for investors to give up on the company or is there meaningful returns for shareholders on the horizon? Ugh – Coal-Fired Generation Coal. I’m not a big fan of coal-fired power generation in my utility investments and unfortunately, that makes up more than 80% of Great Plains’ power production, forming the foundation of their base load generation. I will give the company credit as its facilities are newer and more up to date than most of the facilities that are still operational in the United States. The company has been taking big steps to cut emissions, at no small cost to the utility and its customers. * Great Plains Corporate Presentation Great Plains has lowered sulfur dioxide and nitrogen oxide emissions levels measurably over the past ten years through the addition of various emissions reducing technologies at its plants such as scrubbers. However, the company has yet to make progress on actually changing its energy production makeup. Most other utilities are years ahead in the addition of natural gas energy production (widely viewed as the “transition” fuel between coal and renewables) and renewables like wind, solar, and hydroelectric. While the company is currently in compliance with current mandated power generation laws in the states it operates in, there is no guarantee state regulators or the EPA do not enact stricter rules in the coming years. Coal-fired generation just makes for an easy target for activists and the government due to its dirtier nature compared to alternatives; even the cleanest coal-fired plants emit substantially more harmful gases than natural gas-fired plants. Further compounding risk, Duke Energy’s (NYSE: DUK ) coal basin issues and PNM Resources’ (NYSE: PNM ) saga with the Obama administration regarding its San Juan facility show how easily utilities (and shareholders) can get stuck on the hook for hundreds of millions of dollars with no means of recapturing the outlay through rate increases on customers. Does Great Plains have a way out, or at least an idea of how to change its reliance on coal? We do have some vague guidance from management. Investors have been told that the company will cease coal-fired operations (700MW worth) at some of its plants “in the coming years.” Beyond that, we have no detail. How many years? How will the output be replaced? All questions we haven’t gotten an answer on (and one analysts haven’t bothered to ask). I think it is likely that we see a plan similar to that with Portland General’s (NYSE: POR ) Boardman coal plant in Oregon: building a natural gas plant adjacent to the existing coal plant and once complete, flipping the switch off at one facility and on at the other. This is likely to be at least a five-year project at minimum from the date of announcement. (click to enlarge) *Great Plains Corporate Presentation Unfortunately, per capital expenditure guidance given above, we haven’t been given any signs of when this will come into place. Management is guiding capital expenditures to come down across the board over the next five years, doing so to likely assure support for their dividend growth guidance while alleviating concerns about cash flow issues, which will be touched on later. Operating Results There is something to be said for top line consistency and Great Plains has it. While Missouri and Kansas aren’t the best areas of operation, they have been steadily improving over the past several years. Regulators in both states aren’t too harsh and there are several accelerated rate case mechanisms in place to allow yearly adjustments to the rate base. Nonetheless, operations and maintenance costs have exceeded revenue gains due to the additional maintenance needed on core facilities and the transmission/distribution infrastructure. When I mentioned investor concern regarding cash flow earlier, you can see how 2014/2015 have definitely resulted in sizeable cash outflows that are not covered by operations. Investors have watched the debt rise $500M from the end of 2013 to present. Net debt/EBITDA now comes in at 4.6x, indicating a substantial amount of leverage present in the business. Further compounding pressures, Great Plains has had a large debt balance outstanding for some time. This fact, along with its relatively smaller size, has resulted in a premium on the interest rates of company debt. More than 35% of operating income in 2014 ended up going to creditors, with similar percentages likely in 2015. This can’t continue, which means that capital expenditure guidance has to come down. Conclusion Management is in a tough place. Upgrades to bring coal plants into compliance have been expensive, running into the billions. Debt remains elevated, yet further costs related to a shift away from coal are around the corner. Management has no guidance on replacing 700MW of power with an alternative source and where those funds will come from is up in the air. Great Plains also seems stubbornly intent on sticking by their 4-6% annual dividend growth targets, despite the impact of the tens of millions of dollars in additional outflows these yearly increases cause. Shares of Great Plains have underperformed and trade at a discount to peers, but this is likely for a good reason. I don’t see a compelling investment opportunity here and I would advise owners to evaluate their holdings to see if this remains a good fit within their portfolios.