WEC

Publicly traded companies mentioned herein: CenterPoint Energy Inc (CNP), Duke Energy Corp (DUK), FirstEnergy Corp (FE), Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), Invesco S&P 500 Low Volatility ETF (SPLV), iShares Edge MSCI Min Vol USA ETF (USMV), Utilities Select Sector SPDR Fund (XLU), WEC Energy Group Inc (WEC)

Highlights

The presenter is short shares of WEC Energy Group Inc (WEC), the regulated utility company that operates primarily in the Wisconsin and Illinois markets. Regulated utility equities have soared to record highs in part due to both declining bond yields and vast inflows from ETFs targeting low volatility. Equally important to the price appreciation of utility stocks has been their optimistic rate base growth guidance outlooks and market perception that they are immune to macro uncertainties. The presenter’s analysis leads him to consider continued enthusiasm for utility stocks misguided at current levels and he identifies WEC as most negatively exposed to near- and medium-term fundamental catalysts. In the near-term, he expects the company’s recent history of poor FCF generation and worsening credit metrics to reach a tipping point in 2020 and force WEC to reduce dividend growth guidance in order to avoid credit rating downgrades. This catalyst could occur in February 2020 when WEC announces its Q4’19 earnings and 2020 guidance. Based on a linear step-down of dividend growth from the current 6% guidance to a terminal rate of 1.5% by 2035, the presenter values WEC shares at $65. He also notes that there are other negative catalysts that may play out later in 2020 but is confident that the occurrence of this catalyst would cause the stock to realize this 26% downside from its current $88 per share. To hedge rate risk, the presenter is long three XLU March 2020 $65 strike calls at $0.95 each for every hundred shares short WEC. In his opinion, this creates an asymmetric short trade that would represent 23% upside if his base case plays out and provide solid upside even WEC trades up since WEC and XLU are closely correlated.