An Undervalued Defensive Stock to Buy With a 4% Yield

Evergy EVRG is one of the cheapest utilities stocks we cover. This regulated electric utility serving eastern Kansas and western Missouri has enjoyed surprisingly strong demand growth—and that could persist if new commercial and industrial proposals from Google, Meta, and Panasonic move ahead. Evergy is also one of the higher-yielding utilities stocks we cover, and we expect dividend increases to be in line with earnings for the foreseeable future. Evergy is a recent stock pick of Morningstar chief US market strategist Dave Sekera’s in 3 Overvalued Stocks to Sell and 3 Undervalued Stocks to Buy Instead. This undervalued stock also makes our new list of the best utilities stocks to buy.

With the integration of Great Plains Energy and Westar Energy complete and new management in place, Evergy is working to improve historically challenging regulation and invest in clean energy. The utility must secure constructive regulatory outcomes in Missouri and Kansas to support capital investment aimed at replacing aging coal plants with renewable energy and meeting higher electricity demand growth. Missouri’s legislation and regulatory changes in the past few years have helped reduce uncertainty for investors as Evergy transitions its generation fleet away from fossil fuels, but we still consider its rate regulation less constructive than most other states’. Kansas also presents challenges, although legislation in 2024 should help reduce regulatory lag. Regulators there have supported renewable energy investment for many years. Evergy’s extensive transmission network, which could top 15% of its asset base in the coming years, benefits from favorable federal regulation. Dividend increases have averaged 6% annually since the merger.

Key Morningstar Metrics for Evergy

• Fair Value Estimate: $65
• Star Rating: 4 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Low

Economic Moat Rating

A mix of federally regulated transmission assets and state-regulated generation and distribution assets gives Evergy an efficient scale competitive advantage. Missouri and Kansas regulation has improved enough that we now have confidence Evergy can earn and maintain returns on capital greater than its cost of capital for at least the next 10 years. Missouri legislation passed in May 2018 allows utilities to defer 85% of depreciation expense on qualified capital improvements and receive a return on this investment equal to the weighted cost of capital in the preceding rate case. This and other regulatory changes are an improvement over past Missouri regulation and reduce regulatory lag, boosting earned returns. New legislation in Kansas also should boost returns on capital.

Read more about Evergy’s moat rating.

Fair Value Estimate for Evergy Stock

Our fair value estimate is $65 per share. We assume Evergy invests more than $13 billion during the next five years, including more than $1 billion in renewable energy and other grid infrastructure projects. We expect electricity demand growth in Evergy’s service territories to remain higher than the national average for at least the next four years. We assume annual earnings growth at the high end of management’s five-year 4%-6% target based on our view that Evergy will receive constructive regulatory treatment as it executes its growth plan. We also expect Evergy will keep operating costs mostly flat. We use a 6.2% cost of capital in our discounted cash flow valuation, which incorporates a 7.5% cost of equity. A 2.25% long-term inflation outlook underpins our capital cost assumptions.

Read more about Evergy’s fair value estimate.

Risk and Uncertainty

Customer resistance to higher rates is the key uncertainty surrounding Evergy’s growth. Less favorable regulatory outcomes are more likely when electricity rates are climbing. Evergy is working to offset the upward pressure on rates from its renewable energy investment by reducing operating costs. Retiring coal plants with high operating costs could offset some of the new renewable energy investment costs on customers’ bills. Like all regulated utilities, Evergy must obtain regulator approval to charge higher rates; an adverse decision would negatively affect earnings, cash flow, and dividend growth. Evergy is well positioned to manage its environmental, social, and governance risk, primarily from greenhouse gas emissions, as it retires coal plants and replaces the capacity with wind and solar energy.

Read more about Evergy’s risk and uncertainty.

Evergy Bulls Say

• We expect annual dividend increases in line with earnings growth during the next three years.
• Operating cost savings are helping offset customer bill increases related to capital investments.
• Recent legislation has improved the regulatory framework in Missouri and Kansas. This should reduce regulatory lag and boost earnings growth.

Evergy Bears Say

• Evergy must convince regulators that retiring coal plants and investing in renewable energy is a good trade-off for customers.
• Its rate settlement in Kansas in late 2023 is based on a 9.4% return on equity, below the 9.5%-10% awarded by regulators in other states.
• Environmental rules could become stricter, requiring additional capital investment or higher operating costs that Evergy might not be allowed to recover in regulated rates.

This article was compiled by Susan Dziubinski and Sylvia Hauser.