MGE Energy

MGE Energy reported second-quarter earnings per share of $0.89, up from $0.72 in the same year-ago period.

Why it matters: MGE Energy's electric business earnings increased $3 million in the quarter, as it completed key renewable energy projects. New customer rates approved in December and effective in January also aided results. Other income increased $2.9 million due to investment gains from energy industry venture capital investments. Excluding these gains, earnings are on track to meet our full-year expectations.

The bottom line: We are maintaining our $77 fair value estimate. Our narrow moat rating remains unchanged. MGE Energy's stock is up 3% year to date, in line with the Morningstar US Utilities Index return. Shares trade at a 4% premium to our fair value estimate as of Aug. 6 compared with our view that the US utilities sector is fairly valued. We forecast 6% earnings growth through our forecast period. Management does not provide earnings guidance.

Big picture: MGE Energy plans to invest $1.9 billion through 2030, which supports our growth outlook. A large component of the step-up of capital investment in 2027 is the planned purchase of 33% of the Rock Gen natural gas-fired generation facility from Dairyland Power Cooperative for $203 million. Regulatory approval is proceeding as planned. we expect the transaction to close in late 2027. Earlier this year, MGE Energy issued the equity to fund the transaction and its broader capital plan. MGE Energy enjoys regulatory clarity with approved rates for 2026-27 based on a 9.8% allowed return on equity and support for the company's capital investment plan.

Coming up: An upcoming gubernatorial election in Wisconsin could create uncertainty around stakeholder relations in the state. However, MGE Energy has consistently worked successfully with both political parties in the past.

Our fair value estimate is $77 per share after incorporating year-to-date financial and regulatory updates.

Increasing the equity weighting in our cost of capital, as well as updating our risk-free rate and equity risk premium assumptions, led to much of our recent 7% fair value cut. Issuing shares at a price below our fair value estimate also negatively affected the valuation.

We forecast 6% annual earnings growth during the next five years, due in large part to clean energy investments as the company expedites its transition away from coal generation.

We forecast stable allowed returns on equity and assume consistent regulatory treatment in Wisconsin. MGE Energy has near-term regulatory clarity after state regulators approved customer rates for 2026-27.

We forecast more than $1.9 billion in capital expenditures over the next five years for the company's regulated operations. We forecast $200 million of additional investment opportunities through its ownership in ATC.

In our discounted cash flow valuation, we use a 6.0% cost of capital.

We assign MGE Energy a Morningstar Economic Moat Rating of narrow.

Service-territory monopolies and efficient scale advantages are the primary sources of economic moats for regulated utilities such as MGE Energy. State and federal regulators typically grant regulated utilities exclusive rights to charge customers rates that allow the utilities to earn a fair return on and return of the capital they invest to build, operate, and maintain their distribution networks.

In exchange for regulated utilities’ service-territory monopolies, state and federal regulators set returns to minimize customer costs while offering fair returns to capital providers. We believe MGE Energy has healthy relationships with Wisconsin regulators, as exemplified by ratemaking mechanisms that allow the firm to more closely earn its allowed return on equity.

This implicit contract between regulators and capital providers should, on balance, allow regulated utilities to outearn their costs of capital, though observable returns might vary in the short run based on demand trends, investment cycles, operating costs, and access to financing. Intuitively, utilities should have an economic moat based on efficient scale, but in some cases regulation offsets this advantage, preventing excess returns on capital. The risk of adverse regulatory decisions precludes regulated utilities from earning wide economic moat ratings.

However, the threat of material value destruction is low, and normalized returns exceed costs of capital in most cases, leaving us comfortable assigning narrow moat ratings to many regulated utilities.

We believe the investment in American Transmission Co. supports MGE's efficient scale competitive advantage. Competitors have little incentive to build new transmission lines if one that ATC owns already is serving a market's full capacity. Capital costs for new transmission lines are too high and incremental benefits too low to offer sufficient returns on invested capital for two competing transmission owners. In addition, ATC benefits from regulatory protection. The Federal Energy Regulatory Commission approves new transmission lines only if there is a demonstrated need for new capacity.

Wisconsin is a favorable regulatory environment with a forward-looking test year and allowed returns above the national average.

The company's capital investment plans support our 6% annual earnings growth forecast.

MGE has numerous attractive growth opportunities across its business, particularly as it transitions away from coal through renewable energy investments.

MGE's large investment plan increases regulatory risk.

Regional economic growth opportunities might not materialize, lowering long-term growth investment opportunities, particularly with the company's lack of data center opportunities in its urban service territory.

As with all regulated utilities, rising interest rates will raise financing costs and could make MGE's dividend less attractive for income investors.