Renewable Energy Shift And Innovations Signal Strong Future Despite Analyst Concerns

Key Takeaways

• Avista's shift towards renewable energy and away from coal, along with advancements in wildfire mitigation and grid hardening, aims to improve sustainability, reduce costs, and enhance net margins.
  
• Investments in infrastructure and the focus on clean energy project construction highlight a commitment to innovation and environmental stewardship, poised to increase revenue and market opportunities.
  
• Transitioning to renewable energy and implementing wildfire mitigation strategies will significantly impact financials through increased expenditures and regulatory challenges.

Catalysts

Operates as an electric and natural gas utility company.

• The transition to renewable energy sources and exit from coal-fired generation with the anticipated transfer of interest in Colstrip to Northwestern, and the focus on clean energy goals, are expected to improve long-term sustainability and potentially lead to reduced operational costs and environmental compliance costs, positively impacting net margins.
  
• Investment in infrastructure, particularly the development and integration of the Kettle Falls biomass generating station and potential involvement with the Grid United North Plains Connector, showcases a commitment to innovation and environmental stewardship, potentially increasing revenue through new energy production and transmission projects.
  
• The advancement of wildfire mitigation efforts and grid hardening reflects a proactive approach to risk management, which can lead to reduced insurance and repair costs over time, potentially enhancing net margins by lowering unexpected expenses.
  
• The finalization of Avista's Integrated Resource Plan in 2025, focusing on clean energy project construction and transmission needs, signals forward-looking growth in renewable energy capacities, which could lead to increased revenue through new market opportunities and partnerships.
  
• Securing a new large electric customer and the expected issuance of $70 million of common stock in 2024 for capital spending underline the strategic approach to balancing capital investment with customer growth, aiming at enhancing earnings stability and growth potential through strategic capital allocation and customer base expansion.

Assumptions

• Analysts are assuming Avista's revenue will decrease by 0.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 10.1% today to 11.7% in 3 years time.
• Analysts expect earnings to reach $227.3 million (and earnings per share of $2.78) by about September 2027, up from $193.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.5x on those 2027 earnings, up from 15.6x today. This future PE is greater than the current PE for the US Integrated Utilities industry at 19.2x.
• Analysts expect the number of shares outstanding to grow by 2.85% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.8%, as per the Simply Wall St company report.

Risks

• The need for additional generation due to higher peak demand might lead to substantial capital expenditure, impacting net margins through increased costs and potential regulatory approval delays.
  
• Challenges in the ongoing general rate cases in Washington, with no settlement reached, may affect revenue recognition timing and could impact earnings negatively if the outcomes are less favorable than expected.
  
• The implementation of wildfire mitigation strategies, while necessary, involves significant investment in grid hardening and vegetation management, potentially reducing net income in the short to medium term due to upfront costs.
  
• The transition away from coal power (e.g., the Colstrip plant) and toward renewable energy sources requires significant capital investment in new projects and transmission infrastructure, possibly straining cash flows and increasing debt or equity issuance.
  
• Exposure to regulatory decisions on rate cases and energy recovery mechanisms, as mentioned, impacts the predictability of earnings and the ability to recover costs, which could lead to earnings volatility and affect investors’ confidence.

Valuation

• The analysts have a consensus price target of $46.33 for Avista based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $53.0, and the most bearish reporting a price target of just $36.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.9 billion, earnings will come to $227.3 million, and it would be trading on a PE ratio of 20.5x, assuming you use a discount rate of 5.8%.
• Given the current share price of $38.41, the analyst's price target of $46.33 is 17.1% higher.
• 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.