PNM Resources: Renewables Path Uncertain (NYSE:PNM)

Stock Market


Electricity poles and electric power transmission lines against vibrant orange sky at sunset on a hot day with flickering air. High Voltage towers provide power supply over a long distance.

Sebastian Frank/iStock via Getty Images

PNM Resources (PNM) is a regulated electric utility providing energy to customers in New Mexico and Texas. The electric utility sector has attracted a great deal of interest from investors lately, although PNM does not appear to be one that has attracted the market’s eye as the firm has very sparse coverage. Nevertheless, the company shares many of the same characteristics that have made the utility sector, in general, a favorite holding of risk-averse investors, such as retirees. The most notable of these is that utility companies typically enjoy remarkably stable cash flows, fairly high dividend yields, and tend to raise their dividends annually. PNM Resources is certainly no exception to this as the stock yields 3.06% at the current price, which is higher than many other things in the market. In addition to this, the company does have a reasonable valuation and some very real growth prospects that may entice some investors.

About PNM Resources

As stated in the introduction, PNM Resources is a regulated electric utility based in Albuquerque, New Mexico. Despite this headquarters location though, the company actually provides service to customers located in various areas throughout Texas and New Mexico:

PNM Resources Service Territory

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One thing that we note here is that several of the company’s service areas are based in proximity to major cities in both states. As such, the company’s 800,000-strong customer base is somewhat larger than we might expect. As I have noted in past articles on utilities though, the raw size of a company’s customer base has a very limited impact on its ability to prove to be a good investment. In the case of a utility instead, one thing that very much does matter is the growth rate of the population. This is because utilities are a fairly unique business. In particular, these businesses tend to be monopolies that are confined to only a single service area. As such, their ability to grow by adding new customers tends to be quite limited. Fortunately for PNM Resources, Texas is currently the second-fastest growing state in the nation, with the population increasing by 11.9% over the 2010-2019 period:

Fastest Growing States by Percent 2010-2019

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The Dallas-Fort Worth metropolitan area is the fastest-growing urban region in the United States, parts of which are included within PNM Resources’ service area, as we can see above. Thus, it does seem quite reasonable to assume that this is one of the things that’s driving the company’s growth. This is expected to continue, with the company growing its customer base at about a 1% rate over the next two years:

PNM Customer/Demand Growth

PNM Preliminary Q4 2021 Earnings Presentation

One of the things that we note above is that the total consumption of electricity in the company’s service area is expected to increase somewhat faster than the population. There are a few reasons for this. One of these is that the COVID-19 pandemic and some of the restrictions associated with it caused commercial and industrial users to consume less power than usual because of the sheer number of people that are choosing to stay at home. The COVID-19 restrictions have begun to be lifted so these places of business are reopening once again and are increasing their electric consumption. Another reason is that various commercial and industrial entities are opening new operations in Texas, which is one of the reasons for the population growth. Industrial and commercial users tend to consume more energy than residential ones so they will increase the grid usage more rapidly.

Naturally, as investors, we like to see much more than 2-3% growth. Fortunately, there are some other things that an electric utility can do to generate growth. Perhaps the most significant of these is to increase the size of its rate base. the rate base is the size of the company’s assets upon, which regulators allow it to earn a specified rate of return. Thus, when the company increases this amount, it can increase the amount that it charges its customers in order to receive that rate of return. The usual way by which this is accomplished is for the company to spend money in order to upgrade, modernize, or expand its infrastructure. PNM Resources plans to do exactly this and spend approximately $3.5 billion over the 2022-2025 period:

PNM CapEx Plan 2022-2025

PNM Preliminary Q4 2021 Earnings Presentation

This will unfortunately not increase the company’s rate base by $3.5 billion due to both depreciation and retirements, the latter of which will be discussed later. Rather, this should only increase the company’s rate base by $1.5 billion, going from $4.6 billion today to $6.1 billion at the end of 2025. That’s still a 32.61% increase over the entire four-year period though, which works out to a 7.31% compound annual growth rate over the period. When we combine this with the company’s current 3.06% dividend year, we can see the potential for a 10% to 11% annual return, which is reasonable for a utility.

One thing that we have been seeing from numerous utilities lately is a growing focus on “going green” and reducing carbon emissions. PNM Resources is no exception to this as the company has the stated objective of having 100% emissions-free energy generation by 2040. This may seem somewhat surprising when we consider that the area in which PNM Resources operates is not often considered one of the more progressive areas of the country but it’s a relatively common goal shared by most utility companies today. The area in which PNM Resources operates is also notably one of the best in the nation for the deployment of solar and wind power, so this ambition certainly makes even more sense. The company has curiously not discussed its plans to expand the use of these alternative energy sources, however. Instead, its near-term plans are largely limited to the retirement of old coal-fired power plants. The company currently has two of these plants, both of which are located in New Mexico:

PNM Resources Generation Capacity

PNM Resources

The retirement of these plants is one of the reasons why the company’s rate base will not grow as much as its capital expenditures over the 2022-2025 period. That’s because these power plants represent $1.3 billion worth of value that will be removed from the company’s rate base over the period. This is not at all an unusual thing for electric utilities to do right now. After all, as I have pointed out in the past, coal power plants produce substantially more carbon emissions than any other energy source so most companies have been retiring them in response to pressure from activists and government officials, despite the expense. Thus, even those investors that may want to avoid this destruction of value have no way to do that, short of avoiding the utility sector altogether.

Fortunately for PNM Resources, the area in which the company operates is among the best in the country for the deployment of wind and solar power, particularly in West Texas and New Mexico. This is due both to the climate and geography. In the case of wind power, the land is very flat, which allows the wind to blow unencumbered by trees, hills, or other obstructions. This provides for relatively steady winds that are somewhat stronger than what would be found in other areas (this is also one reason why offshore wind farms tend to be more effective than onshore ones). In the case of solar energy, much of the region is a desert and so it witnesses comparative few rainy or cloudy periods, both of which hamper the effectiveness of solar panels. Thus, a relatively flat desert is going to be among the better places to deploy both wind and solar generation facilities and PNM Resources seems likely to exploit this at some point.

Back in 2020, fellow electric utility Avangrid (AGR) announced that it will acquire all the outstanding shares of PNM Resources. The deal has not yet been consummated due to problems, however. The New Mexico Public Regulation Commission has unanimously rejected the merger due to problems that Avangrid has been having in New England, as the company has had more than $60 million in fines levied against it in that area by regulators. The rejection of this deal is almost certainly the reason why PNM’s stock price plummeted at the end of 2021:

PNM Stock Price 1-Yr.

Seeking Alpha

The two companies intend to continue pursuing this acquisition, however, and to this end they have changed the date for the final consummation of the deal to April 2023. Avangrid is a leader in renewable energy generation and PNM Resources hopes that the merger will better allow it to create a plan to execute its environmental goals, which as already mentioned are somewhat lacking in direction right now. The state’s regulators are not so convinced and believe that PNM Resources’ customers would be better served by the utility remaining independent. It’s admittedly uncertain how exactly this transaction will play out but potential investors should probably not buy the stock with the intent of profiting on the merger.

Fundamentals Of Electricity

As mentioned in the introduction, electric utilities have been attracting a surprising amount of attention from investors lately, particularly investors that are not often interested in such things. The biggest reason for this is the widely-promoted concept of electrification, which has been frequently discussed in the media and by politicians lately. Electrification refers to the conversion of things that have traditionally been powered by fossil fuels to the use of electricity instead. The most commonly cited things are transportation (electric cars) and space heating. This could be expected to greatly increase the demand for and consumption of electricity (I detailed the impact from electric cars alone here). This would naturally also increase the revenues and earnings of electric utilities like PNM Resources.

The U.S. Energy Information Administration apparently believes that this concept has been oversold. According to the agency, the American demand for electricity will grow at a 1-2% rate over the next thirty years:

American Electric Consumption Growth

EIA – Annual Energy Outlook 2021

This is nowhere close to what would happen if the promoters of electrification are correct. Thus, the government’s own analysts do not appear to believe that we will see widespread conversion from fossil fuels to electricity anytime soon. Rather, what we will likely see is utilities delivering slow and steady growth over time, just as they have always done. Thus, there is no reason to invest in an electric utility if one were hoping to profit off this trend.

Financial Considerations

It’s always important to have a look at the way that a company is financing itself before making an investment in it. This is because debt is a riskier way to finance a company than equity. This is because debt must be repaid at maturity. In addition, a company must make regular payments on its debt in order to remain solvent. Thus, these mandatory payments could push the company into financial distress if it has too much debt and some event causes its cash flow to decline. Although utilities tend to have reasonably stable cash flow, bankruptcies are certainly not unheard of in the sector.

One metric that we can use to analyze a company’s financial structure is the net debt-to-equity ratio. This ratio tells us to what degree the company is financing its operations with debt as opposed to wholly-owned funds. In addition, this ratio tells us how well the company’s equity can cover its debts in a bankruptcy or liquidation scenario, which is arguably more important.

As of September 30, 2021, PNM Resources had $$3.570 billion in net debt compared to $2.2129 billion in total shareholders’ equity. This gives the company a net debt-to-equity ratio of 1.61. Here is how that compares to some of the company’s peers:

Company Net Debt-to-Equity
PNM Resources 1.61
DTE Energy (DTE) 2.06
Eversource Energy (ES) 1.33
NextEra Energy (NEE) 1.22
Exelon (EXC) 1.13
CMS Energy (CMS) 1.89

(all figures as of September 30, 2021 in order to ensure accurate comparison)

As we can see here, although PNM Resources is far from the most levered company here, it also is pretty far from among the best in the industry. While this could be a sign that the company is utilizing too much debt, the fact that management appears more conservative than some of its peers is a positive sign. Overall, this is probably a reasonable level of risk with regard to the company’s debt.

Dividend Analysis

As already mentioned, one of the defining characteristics of utilities is that they often have a higher dividend yield than many other things in the market. This is partly a factor of their generally low growth rate which results in the sector returning a larger proportion of their cash flow to their investors than the high-growth sectors. PNM Resources is certainly no exception to this as the company’s 3.06% yield surpasses the 1.28% on the S&P 500 index (SPY). PNM Resources also has a history of steadily increasing its dividend, which is also common for utilities:

PNM 5-Yr. Dividend History

Seeking Alpha

Dividend growth is something that’s particularly appealing given today’s inflationary environment. This is because the company will be paying investors a greater amount of money every year, which allows the dividend to more effectively maintain its purchasing power. Naturally, though, we want to ensure that the company can afford the dividend that it pays out since we do not want it to be forced to reverse course and cut it.

The usual way that we evaluate a company’s ability to maintain its dividend is to look at its free cash flow. The free cash flow is the money left over from the company’s ordinary operations after it pays all its bills and makes all necessary capital expenditures. This is therefore the money that’s available to do things like buy back stock, reduce debt, or pay a dividend. Although the company has released its preliminary fourth quarter 2021 results, these are not final and information about the company’s cash flows was not included in these preliminaries. Thus, we will have to use the company’s third-quarter 2021 numbers. During the third quarter of 2021, PNM Resources had a levered free cash flow of $34.1 million and paid out $27.8 million in dividends. Therefore, the company did manage to cover its dividend but admittedly the coverage is fairly meager.

However, it’s common for utilities to actually fund their dividends out of operating cash flow and finance their capital expenditures through the issuance of debt and equity. This is largely due to the incredibly high cost of building and maintaining utility-grade infrastructure. In the third quarter of 2021, PNM Resources had an operating cash flow of $233.9 million. That’s obviously more than enough to cover the dividend with a significant amount of money left over. Overall, this dividend looks pretty safe and there is little that we really need to worry about here.

Valuation

It’s always critical that we do not overpay for any asset in our portfolios. This is because overpaying for any asset is a surefire way to generate suboptimal returns off that asset. In the case of a utility like PNM Resources, one metric that we can use to value it is the price-to-earnings growth ratio. This is a modified form of the familiar price-to-earnings ratio that takes the company’s earnings growth into account. A price-to-earnings growth ratio of less than 100 can be a sign that the stock is undervalued relative to the company’s earnings per share growth and vice versa. However, there are very few stocks that actually have a ratio that low in today’s overheated market so the best way to approach the valuation is to compare the price-to-earnings growth ratio to that of the company’s peers in order to determine which stock offers the best relative valuation.

According to Zacks Investment Research, PNM Resources will grow its earnings per share at a 5.18% rate over the next three to five years. As the company should be able to grow its rate base at a faster rate (as discussed earlier), this earnings per share growth rate seems a little low. If we use Zacks’ number though, it gives the company a price-to-earnings growth ratio of 3.40 at the current stock price. Here is how that compares to the company’s peers:

Company PEG Ratio
PNM Resources 3.40
DTE Energy 3.37
Eversource Energy 3.50
NextEra Energy 3.09
Exelon 2.44
CMS Energy 2.79

(all data courtesy of Zacks Investment Research)

Here we can see that PNM Resources looks rather expensive compared to its peers, which may be due to Zacks’ growth figure being potentially somewhat low. If we assume that the company’s earnings per share actually grows at the same 7.31% rate that we projected for the rate base then the price-to-earnings growth ratio drops to 2.74, which is roughly in line with the company’s peers. Overall, there may be some investment potential in the stock today, although the company’s lack of any renewable generation growth plans apart from its planned merger is rather concerning.

Conclusion

In conclusion, PNM Resources is a somewhat interesting electric company that for some reason has very sparse coverage. The company does have a few things going for it, including a very high rate base growth. The company’s failing merger though has certainly spooked the market and it’s fairly unfortunate that PNM Resources has no particular plan to grow its renewable generation capacity apart from the merger. The company is ideally situated for the deployment of both solar and wind too, which makes this even more concerning. I personally would prefer to watch this one from the sidelines until the company figures out its strategy.



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