Regulatory Hurdles And Rising Costs Will Erode Utility Profits

Key Takeaways

• Regulatory and legislative changes, along with stricter environmental rules, threaten Otter Tail's renewable and coal asset economics by increasing costs and pressuring long-term earnings.
  
• Rising interest rates, slow demographic growth, and uncertainty in electricity demand create risks of underutilized investments, delayed rate recovery, and volatile revenue streams.
  
• Strong utility investments, solid demand growth, operational diversification, and leading cost position combine to support stable cash flow, resilient margins, and long-term earnings growth.

Catalysts

Engages in electric utility, manufacturing, and plastic pipe businesses in the United States.

• The anticipated phaseout of renewable energy credits and new restrictions under recent federal legislation threaten the economics of Otter Tail's future renewable projects beyond its currently secured solar and wind investments, potentially raising capital requirements and pressuring future earnings growth by reducing the after-tax returns on major rate base expansions.
  
• Ongoing and possibly intensifying environmental regulations-despite recent EPA reconsiderations-pose continued risk to Otter Tail's coal assets, which could lead to elevated compliance costs, unplanned capital expenditures, and stranded asset charges, compressing net margins and long-term return on equity.
  
• Elevated interest rates and market expectations for a tighter monetary environment could materially increase Otter Tail's cost of capital, amplify debt service costs linked to its aggressive $1.4 billion capital plan, and erode future earnings and free cash flow, particularly as more projects are financed and the utility segment's earnings mix expands.
  
• Overreliance on projected earnings and rate base growth (highlighted as 9% CAGR for the electric segment) assumes robust ongoing electricity demand, but the company's exposure to rural, slow-growth demographics and uncertainty in securing large new load contracts exposes revenue forecasts to downside risk if expected load additions do not materialize as anticipated.
  
• Rising penetration of distributed energy resources (e.g., rooftop solar, batteries) and load uncertainty from electrification create risk that Otter Tail's substantial planned grid and generation investments may be underutilized or delayed in rate recovery, resulting in regulatory lag, diminished revenue growth, and less predictable long-term earnings streams.

Otter Tail Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Otter Tail's revenue will grow by 2.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 21.8% today to 13.3% in 3 years time.
• Analysts expect earnings to reach $185.6 million (and earnings per share of $4.72) by about August 2028, down from $286.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 22.9x on those 2028 earnings, up from 11.5x today. This future PE is greater than the current PE for the US Electric Utilities industry at 20.9x.
• Analysts expect the number of shares outstanding to grow by 0.18% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.78%, as per the Simply Wall St company report.

Otter Tail Future Earnings Per Share Growth

Risks

• Otter Tail is projecting utility segment compounded annual earnings growth of 9% driven by $1.4 billion in capital investments focused on grid reliability, renewables, and transmission, supported by favorable rate recovery mechanisms and regulatory approvals, which could underpin strong, steady earnings and revenue expansion.
  
• Large new electricity loads (potential 430 MW and 155 MW customers) under negotiation reflect utility demand growth driven by electrification and economic activity across their service territory, which may counteract rural stagnation concerns and support top-line revenue growth.
  
• The company's diversified model-including Utilities, Manufacturing, and Plastics-has delivered stable cash flows and enables the funding of growth investments without the need for external equity, mitigating financial risk and supporting long-term margin sustainability.
  
• Otter Tail consistently maintains electric rates below regional and national averages and has received S&P recognition as the lowest-cost investor-owned utility in the U.S., enabling ongoing customer base stability, regulatory goodwill, and a defensible market position that could cushion margins and earnings in periods of economic uncertainty.
  
• Despite normalization in Plastics pricing, Otter Tail continues to see strong demand and increased production capacity, while maintaining a five-year consolidated earnings CAGR near 22%; this resilience in both regulated and unregulated segments may support higher-than-expected long-term earnings and shareholder value.

Valuation

• The analysts have a consensus price target of $83.0 for Otter Tail based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.4 billion, earnings will come to $185.6 million, and it would be trading on a PE ratio of 22.9x, assuming you use a discount rate of 6.8%.
  
• Given the current share price of $78.57, the analyst price target of $83.0 is 5.3% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.