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ITC Holdings is the largest independent FERC-regulated transmission utility with interesting growth opportunities. Even with the potential for lower allowed return on equity, ITC Holdings should generate 20% higher income per investment dollar compared to average state-regulated investments. The current share weakness has caused historical premium valuations to evaporate, creating a great long-term entry point. Morningstar has an interesting take on ITC Holdings (NYSE: ITC ). One key element of utility investing is the relationship between a specific utility’s geographic location and the regulatory environment in which it operates. Nowhere is this relationship more obvious than the current stand-off playing out in state regulatory offices across the country between distributed generation with rooftop solar and its impact on the base-load power generation profile of a specific utility. According to its fact sheet , ITC is an electric transmission company with a federally regulated rate base of $5.2 billion. The Federal Energy Regulatory Agency, FERC, is the rate-setting body for interstate transmission assets, and oversees 100% of ITC’s regulated revenues. ITC is the largest publicly traded transmission company, and operates one of the leading networks with 15,600 miles of high-voltage lines. This differentiator makes the company a unique player in the regulated utility sector. At the core of its lower risk are the higher allowed returns offered by the FERC versus the average state-regulated return on equity ROE. In an effort to draw needed investment capital to expand and upgrade the grid, the FERC has allowed a higher return on equity than the states, on average, have allowed. For instance, since going public in 2005, ITC’s FERC-allowed ROE has fluctuated between 12.1% and 13.8%, while the average state-regulated allowed ROE has been falling. The chart below from Edison Electric Institute plots the average awarded allowed ROE as of June 30, 2015, by quarter. As shown, the average state public utility commission PUC-approved ROE is substantially below those allowed for ITC’s equity investment. The most recent quarterly average from the EEI chart is a 9.73% ROE. The current rate mechanism approved by the FERC allows various ITC subsidiaries to earn the following ROE: ITC Transmission, 13.88%; METC, 13.38%; ITC Midwest, 12.38%; and ITC Great Plains, 12.16%. A comparison of federal versus state regulation is addressed in the most recent investor presentation PDF. The slide below outlines a few of the basic differences: (click to enlarge) Last year, Northeast consumer groups petitioned the FERC to lower its allowed ROE, and after a divisive skirmish, the FERC relented and is reducing allowed returns. The new rate approved for ISO New England transmission assets for ITC should be 11.7%, including a premium allowed for being an independent company. The FERC is under pressure to institute this rate across the country. Even with the potential lower rate, ITC could earn 20% more income from the same investment dollars compared to the most recent average state-approved ROE. This differential is the backbone of the company’s lower risk. From Morningstar’s analysis : “In our opinion, FERC’s formula rate-setting methodology is the most stable and least subject to political influence of any utility regulation in the United States. Therefore, we believe there is little risk of adverse regulatory decisions that would result in allowed returns below the average 10% state-level utilities returns or modify FERC’s favorable regulatory framework. This favorable regulatory framework covers 100% of ITC’s revenue and provides predictable earnings and cash flow. We believe the reduced risk associated with FERC regulation results in a lower average cost of capital than the typical utility.” Recently, its share price has been falling with the rest of the sector. The utility average peaked in January, and has fallen 15% since. ITC peaked in January as well, and has fallen 26% from $44 to its current $32.50. ITC stock has lost a bit of its love from analysts, with the current recommendations being two “Sell,” five “Neutral” and two “Buy.” The concern is based on the reduced ROE potential. However, ITC’s aggressive capital expenditure budget should partially offset lower ROE, driving earnings ahead by 8-12%. Currently, the company is forecast to invest $757 million this year, $852 million next and $818 million in 2017. Over the next three years, ITC’s regulated asset base could grow by over $2.2 billion. This capital expansion will be financed by $1.14 billion in new debt and the balance from internally generated funds. The company generates over $500 million in operating cash flow and pays out $100 million in dividends. Speaking of dividends, ITC recently raised its dividend by 14%, and the payout ratio remains well below the industry average at 38%. Utilities are generally considered to have a low payout ratio if it is below a 60% threshold. Earnings growth is expected to decline a bit to the 8-11% range. However, with a low payout ratio, the company’s dividends could continue to increase substantially above its EPS trend and still be below that of its peers. In an interview with the trade publication TransmissionHub , ITC management discusses two interesting expansion plans. It is proposing the first ever bi-directional connector from Ontario, Canada directly into the PJM grid at Erie, PA. The project is called the Lake Erie Connector, and the high-voltage cable connection would include 73 miles of underwater installation. The project is currently out for bids to potential customers and, if approved, the Lake Erie Connector could cost $1 billion. The second expansion opportunity is a joint venture with NRG Energy (NYSE: NRG ) and a private equity firm to rescue the Puerto Rican electric utility, Puerto Rico Electric Power Authority PREPA. After years of mismanagement, PREPA is on the verge of bankruptcy, driven partially by the need for capital expenditures to upgrade aging power plants to meet new environmental standards. Some generating plants are over 50 years in age and fail miserably in their pollution profile. An article published in Puerto Rico’s main business magazine, Caribbean Business , outlines the $3.3 billion proposed project: “The $3 billion investment would be used to expand PREPA’s existing liquefied natural gas-delivery infrastructure (in the range of $200 million); to bring online new combined-cycle, natural gas-turbine (CCGT) power generation and repower existing PREPA generation (1,200 to 1,500 megawatts [MW]) with investment ranging from $1.5 billion to $1.8 billion, and new renewable generation through solar power (300 to 400 MW) costing nearly $1 billion. The truth is that the coalition brings together three entities that could give PREPA a fighting chance to revitalize its obsolete infrastructure. York Capital, backed by more than $26 billion in assets, has vast experience in restructuring distressed assets; NRG Energy, a $33 billion energy company operates the largest conventional- and renewable-power generation portfolio in the mainland U.S.; and ITC Holdings is the nation’s largest independent electric-transmission company.” Morningstar, as usual, outlines the bull and bear case very succinctly for ITC: “Bulls say: ITC increased its annual dividend by 14% in 2014 and we expect annual increases to average close to 13% during the next five years. MISO expects capacity shortfalls, where the majority of ITC’s assets are located. The generation replacing the coal, mostly natural gas and wind, will require changes to the transmission grid providing substantial new investment opportunity for ITC. Management’s focus on high-voltage electricity transmission should result in better operating efficiency compared with integrated utilities that also have generation and distribution assets. Bears Say: An industrial group has asked FERC to cut ITC’s base allowed return on equity in MISO to 9.15% from 12.38%. An unfavorable outcome would result in lower allowed returns and dividend growth for ITC. ITC Great Plains and ITC Midwest have several competitors proposing transmission system development to move wind power from the Dakotas and Kansas east to load centers. Competition could limit growth opportunities. Several traditional regulated utilities have initiated plans to expand existing transmission or build new lines creating increased competition for ITC.” Below is a F.A.S.T. Graph for ITC going back to its IPO in 2005. Notice both the year-end dividend yield (red line) and the historical P/E (blue line). (click to enlarge) S&P Capital IQ offers a Quality rating for stocks trading longer than 10 years. ITC recently qualified for this evaluation, based on its 10-year history of generating earnings and dividend growth, two important criteria for dividend and utility investors. Company management has generated sufficient consistent growth to qualify for an A+ rating, which is reserved for only about 45 of the 4500 companies followed by S&P. Utility investors looking for a growth stock with high dividend growth potential and a lower regulatory risk profile should review ITC. With the current share price weakness, the company’s historical valuation premium has been reduced to virtually zero, as ITC trades in line with its slower-growth, state-regulated peers at a P/E of 15, when its historical P/E is in the 23 range. In addition, the company has not offered a 2.7% yield since year-end 2008. Now would be a great time to either institute a position or to add to an existing one. 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