More Than 20% Undervalued, This Cheap Stock With a 4% Dividend Yield Is a Buy

Like most utilities stocks, NiSource NI has been hit hard by rising interest rates in 2023, and as a result, it’s trading at a sizable discount to Morningstar’s fair value estimate. Thanks in part to constructive regulation, we expect NiSource to increase earnings faster and for longer than most other utilities. 

U.S. utility NiSource’s focus on electric and gas infrastructure, including renewable energy, creates a long runway of growth opportunities. We expect about half of NiSource’s operating income will come from its Indiana gas and electric utility and the rest from its six natural gas distribution utilities, excluding minority interests. We expect the gas utilities to grow along with the electric business in the near term, keeping that earnings mix about the same for at least the next four years. Driving that growth is $16 billion of investment that NiSource plans during the next five years for infrastructure projects. Constructive state rate regulations allow NiSource’s utilities to collect a return of and a return on the bulk of its investments within 18 months, enhancing cash flow. We expect modest customer growth combined with NiSource’s infrastructure growth investments to support 7% long-term annual earnings growth and 6% annual dividend growth.

Key Morningstar Metrics for NiSource

• Fair Value Estimate: US$33
• Star Rating: 5 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Low
  
  

Economic Moat Rating

Service territory monopolies and efficient scale advantages are the primary moat sources for NiSource’s regulated gas and electric utilities. State and federal regulators grant regulated utilities like NiSource 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 networks. In exchange for regulated utilities’ service territory monopolies, state and federal regulators set rates at levels that aim to minimize customer costs while offering fair returns for capital providers. This implicit contract between regulators and capital providers should, on balance, allow NiSource’s regulated utilities to achieve at least 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.

Read more about NiSource’s moat rating.

Fair Value Estimate for NiSource Stock

Our fair value estimate is US$33 per share. We assume NiSource invests nearly $14 billion of capital in 2024-27, including $2 billion for renewable energy projects in Indiana to replace its coal-fired power generation fleet by 2028. We expect NiSource’s safety-related gas distribution investments will remain well above maintenance-level spending for several more years, resulting in earnings growth at all of its gas utilities. In total, we expect 11% average annual rate base growth and 7% average annual earnings growth through 2027 on a consolidated basis. We use a 5.8% cost of capital in our discounted cash flow valuation, which incorporates a 7.5% cost of equity. Our cost of equity is lower than the 9% rate of return we expect investors will demand of a diversified equity portfolio. We believe our cost of equity reflects the risk associated with regulated electric and natural gas distribution utilities like NiSource operating in states that have constructive regulatory frameworks.

Read more about NiSource’s fair value estimate.

Risk and Uncertainty

Regulatory risk remains the key uncertainty. However, NiSource’s regulatory exposure is diversified with state-regulated gas and electric operations in six states and a federally regulated electric transmission system. NiSource has reduced some of the regulatory uncertainty related to its planned investments by securing preapprovals and favorable rate mechanisms that provide for customer rate increases as the utility makes its infrastructure investments. In 2020, NiSource announced it would eliminate all coal-fired generation from its power plant fleet by 2028, significantly reducing environmental, social, and governance risk.

Read more about NiSource’s risk and uncertainty.

NiSource Bulls Say

• We expect the dividend to grow near 6% annually during the next few years before accelerating to keep pace with earnings in 2025 and beyond.
• NiSource’s growth plan will support Indiana policymakers’ desire to cut the state’s carbon emissions by replacing coal generation with renewable energy and energy storage.
• New legislation has improved the regulatory framework in Indiana for NiSource’s electric and natural gas distribution utilities.
  
  

NiSource Bears Say

• Industrial customers account for over half of NiSource’s electric sales, higher than most utilities. Industrial sales are more sensitive to the economy than residential and commercial sales.
• Policies to reduce carbon emissions could be a long-term threat for NiSource’s natural gas distribution business if policymakers in states it serves aim to reduce retail gas use.
• NiSource’s large capital investment plan raises execution risk and the possibility of project delays.