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CenterPoint Energy: Investors Have Nothing To Fear

Summary The stock continued to decline after Q3. Equity investment write-down doesn’t reflect the investment’s true value. Results from core operations improved from last year. The market continues to be bearish about CenterPoint Energy (NYSE: CNP ). Given the company’s performance in 2015, it would seem that investors are doubting the stability of the utility company. After falling 20% from $23.43 at the beginning of the year to $18.68 before Q3 earnings, shares have since dropped another 8% to $17.10. Do the fundamentals support this rapid decline? Revenue continued to fall. Following Q2’s 19% drop, Q3 revenue decreased by 10% ($1.8 billion to $1.6 billion) as well, primarily as the result of lowering natural gas prices. However, this was offset by the drop in natural gas expense, which decreased from $702 million to $527 million. Due to various cost reductions, the company was able to decrease its operating expense from $493 million to $479 million. This impact may seem small, but this allowed the company to increase its operating income by 14% when compared to Q3 2014. This rise in operating profit is the first time the company achieved growth in 2015. Q1 and Q2 operating profit decreased by 13% quarter on quarter, and Q3 operating profit was flat. Isn’t this evidence that the company is improving? What are investors worried about? Possible Concern One thing that could trouble investors is the loss from equity investment ($794 million), which is the biggest reason that the company delivered a $900 million loss before taxes. The equity investment consisted solely of Enable Midstream (NYSE: ENBL ), a stock that I’ve talked about before. You can read my previous articles ( here and here ) to learn more about the company. Enable Midstream Partners is a midstream company that is suffering from industry headwinds. However, the company continues to deliver good cash flows due to its fee-based contracts. Furthermore, it is well capitalized with a good interest rate coverage ratio. Enable’s transported volume continued to grow in Q3, offsetting declining prices that negatively impacted product sales. Going forward, I believe Enable will come out on top even if natural gas prices don’t improve. What does all of this mean? I believe that the write-off of equity investment is not representative of Enable Midstream Partners’ true value. Core Operation Remains Stable Enough about Enable, what about CenterPoint’s existing operation? In my last article , I talked about the company’s stability. The Electric segment is not directly affected by commodity movements since it is not involved in power generation activities. The Natural Gas Distribution segment does have some exposure to commodity movements due to a time lag between purchases and deliveries, but the company actively uses derivatives to hedge any uncertainty. So overall, I would expect profit to be stable over the long term. CenterPoint’s stability is once again evident in Q3. Every single segment improved quarter on quarter. Operating income for the Electric segment rose 5%, Natural Gas Distribution’s operating income recovered from last year’s volatility, improving from a loss of -$8 million to a gain of $11 million, and Energy Services’ operating income increased by 17%. Takeaway I believe there’s nothing in the third quarter that was particularly alarming. The company continued to deliver stable profits amid a volatile commodity environment. Unfortunately, investors have been focusing on the wrong things. In particular, the Enable Midstream fear is overblown. Results from core operations should continue to improve, and that is what will really support the company as a whole.

CenterPoint Energy: Utility Assets In A Petri Dish

CenterPoint combines electric utility, natural gas utility, and midstream assets. Weakness in natural gas prices and a potential slowdown in Houston’s economy is creating anxiety among investors, and anxiety is the Petri dish of investor opportunity. The current yield of 5.3% makes patience waiting for a turn in CenterPoint’s markets an acceptable investment strategy. CenterPoint Energy (NYSE: CNP ) is an interesting electric and gas utility servicing Houston and Minneapolis as its two biggest markets. Within the overall consolidation trend in the utility sector, combined with the current appetite electric utilities have for gas utility and infrastructure exposure, CNP could become an interesting acquisition. According to its most recent investor presentation , CenterPoint is three regulated companies in one. In 2013, CNP spun-off and currently owns 55% of MLP Enable Midstream (NYSE: ENBL ). CNP is majority owner of the general partner and income from the Midstream Investments segment comprised 25% of 2014 operating income. Electric transmission and distribution segment services the electric needs of the greater Houston area, and accounted for 48% of 2014 operating income. Houston Electric owns no generating facilities and is regulated by the Texas Railroad Commission, the state regulatory body. Natural gas distribution in Texas and surrounding states combined with greater Minneapolis territory accounted for 23% of 2014 operating income. Other Energy Services chipped in 2%. CNP reports quarterly results as Midstream Investments and Utilities. CenterPoint’s service territory is outlined below: (click to enlarge) CenterPoint’s Midstream Investments performance has increased the share price and income volatility. In step with the current downdraft in the energy sector, income attributed to Midstream Investments has fallen significantly. In 2014, Midstream Investments generated $308 of reported equity income. For the second quarter 2015, Midstream Investments generated $43 million of reported equity income, substantially below last year’s $74 million. However, with the most recent quarterly distribution of $73 million, this segment’s cash flow has remained about the same. As with many MLPs, Midstream Investments fortune is tied to natural gas markets, and the midstream segment should improve with higher demand and prices. According to the latest presentation and factoring in its ownership interest, Midstream Investments equity income will move $13 million, or $0.04 a share for every 10% move in natural gas, ethane, and NGL prices. Management has offered guidance of Midstream Investments distribution income growth in the 3% – 7% range over the next two years, based on $3.15-$3.65 Henry Hub and $60-$70 WTI pricing by 2017. The Utility segment offers a balance to the volatility of Midstream Investments, but is not without its own concerns. Houston Electric generated 48% of 2014 income, or $595 million. Some fear a slowdown in the Houston metro area caused by a deepening despair in the oil segment will reduce electricity demand. While management points out that its economic base is more diverse than during the last downturn in the oil sector, a flattening of demand during these stressful times should not be unexpected. Underlying residential customer count growth has been around 2% compounded over the past 25 years, which is high for an electric utility. Houston Electric services 2.3 million customers and has a $4.1 billion rate base. CNP spends around $820 million a year on its electric capital expenditure budget, of which 37% is in transmission and 59% in distribution. Houston Electric’s current allowed return on equity is 10.0%, in line with the industry. The company has been granted a $13 million rate increase as of September with an additional $20 million pending decision. Regulated natural gas utility assets generated 26% of reported operating 2014 income, or $288 million. CNP services 3.3 million natural gas customers in five states, has a rate base of $2.2 billion and a capital expenditure budget of around $525 million. The average allowed return for the natural gas business is 10.3%. Last August, CNP requested $53 million in rate relief from its Minneapolis customers. Morningstar’s analysis recaps the positive and negative investment thesis for CNP: “Bulls Say: Strong utility earnings growth and solid cash distributions from Enable should allow approximately 4% annual dividend growth during the next five years. The formation of Enable will allow CenterPoint to focus capital expenditures on its utilities, resulting in an estimated 9% rate base growth during the next five years. Houston Electric’s service territory is located in one of the most economically vibrant metro areas in the country with annual customer growth averaging 2%, driving strong energy usage growth.” “Bears Say: The Transmission and Distribution segment’s operating earnings have recently benefited from abnormally high transmission right-of-way revenues. These revenues likely peaked in 2013 and likely will drop sharply over the next several years. Profitability in the competitive natural gas sales and service business remains challenging, with low basis differentials and severe competition. Low commodity prices and reduced gathering activity continue to pressure earnings from the pipelines and field services infrastructure serving dry gas regions. This will be a headwind for Enable.” Earnings per share have been under pressure from weakness in the Midstream Investments segment. Last year, CNP earned $1.20 a share, but current guidance is for $1.00 to $1.10 in 2015. The Utility segment is expected to contribute $0.71 to $0.75 a share with the balance $0.25 to $0.35 from Midstream Investments. These compare to 2014 adjusted earnings of $0.77 and $0.44, respectively. Based on a turn in its midstream business, management forecasts annual EPS and dividend growth at 4% to 6%, in line with other regulated utilities. Investors should take the time to review CNP’s free cash flow numbers. Over the past three years, CNP has generated higher operating cash flow than its capital expenditure budgets, accumulating $1.585 billion in free cash flow from 2011 to 2014, and $328 million for the trailing 12 months as of June 2015. CNP has produced positive free cash flow in five out of the previous 10 years. There are few utilities consistently generating positive free cash flow. Return on invested capital (ROIC) has historically been higher than utility industry averages at between 6.3% and 8.5% over the previous 10 years. The current weakness of its Midstream Investment business and the cautiousness investors are taking to the company is evident in the current valuation matrix. Based on previous 5-year averages, CNP offers value investors a reason to take notice. Below is a table of current valuation ratios, 5-year averages of the same, and an equivalent share price based on these averages: Ratio Current 5-year Avg Equivalent Price Price/Earnings 15.2 20.2 $ 24.58 Price/Book 1.8 2.2 $ 22.61 Price/Cash Flow 4.4 5.7 $ 23.96 Dividend Yield 5.3% 4.1% $ 24.39 Source: Morningstar.com, Guiding Mast Investments According to Morningstar, the current sum-of-the-parts valuation is in the $23 range. Estimates by segment would be $7 a share for Midstream Investments, $10 for Houston Electric and $6 for the natural gas distribution business. With a current price of $18.50, the spread is around $5, or 27%. Analysts are all over the board with their recommendation. According to finviz.com, the most recent analysis from Morningstar is 4 Stars, S&P Capital IQ is 2 Stars, Goldman reduced CNP to Sell, Credit Suisse recently upgraded CNP to Neutral from Underperform, Deutsche Bank is at Hold, Argus is at Buy, RBC Capital Markets lists CNP at Outperform, and Barclays’s is at Equal weight. Investors can take their pick: Buy, Hold, or Sell. CenterPoint’s diversified asset base could be of interest to larger utilities. The recent trend of electric utilities expanding by adding natural gas regulated utilities and by purchasing natural gas infrastructure to support expanding natural gas power generating facilities may favor CNP’s business profile. Midstream Investments focus has a strong Anadarko basin footprint covering a number of key active plays, including the SCOOP, STACK, Cana Woodford, Cleveland Sands, Tonkawa, Marmaton and Mississippi Lime plays. Other important midstream fields include Haynesville, Ark-La-Tex and Arkoma, and the Bakken. Electric utilities looking for long-term natural gas supply from these mid-continent areas could be interested in securing the infrastructure, hence CNP’s ownership of midstream assets could be of interest, along with CNP’s regulated natural gas customers. While there are no rumors of pending interest, the current consolidation trend is very powerful in the utility segment and at an enterprise value of $9.6 billion in equity ($23 times 425 million shares) and assumption of $8.6 billion in debt, a deal could be very financeable. With a current dividend yield of 5.3%, long-term utility and income investors are being paid to wait for a turn in the midstream business or for CNP to be active in the utility consolidation trend. CNP is a good example of stock valuations where investor anxiety is offering a Petri dish of opportunities. If CenterPoint is not on your radar screen to buy on further dips, it should be. Author’s Note: Please review disclosure in Author’s profile.

Exploring The Highest-Yielding, Dividend-Raising Utility

In a screen for the highest-yielding, dividend-raising utility I came across a Houston-based company with a 5%+ dividend yield. This company has provided solid investment results over the past decade. This article looks at what you might expect moving forward based on the company’s commentary. For dividend-oriented investors, David Fish’s list of Dividend Champions, Contenders and Challenges is the place to get your bearings. It’s nice because it provides you with a great subset of the types of securities you might be looking for: companies that have not only paid but also increased their dividend payments for at least 5, 10 and 25 years. Still, there are hundreds of names from which you can explore. As such, it can be helpful to whittle down the list to discover pockets of the investing world one by one. As an example, you might organize the list by utilities and then by “current” dividend yield. Naturally screens come with a bevy of limitations, but for exploration sake they work quite well. If you completed this exercise, you would notice that CenterPoint Energy (NYSE: CNP ) happened to be the highest-yielding, dividend-raising utility. Let’s explore. Tracing its roots back to 1866 , CenterPoint Energy began as the Houston Gas Light Company. Today the company has more than 7,400 employees serving more than 5 million customers. The business operates in four basic areas: natural gas distribution, electric transmission, natural gas sales and heating and cooling services. The largest segment is the Texas utility serving the Houston area, hence the utility category. However, the company also has a 55.4% limited partner interest in Enable Midstream Partners (NYSE: ENBL ), a natural gas and crude oil infrastructure pipeline. Incidentally, this also explains why CenterPoint has an above average yield – even when compared to other utilities. The payout ratio is well above average, and the share price has declined materially during the last year. Let’s take a look at the company’s history moving from 2005 through 2014:   CNP Revenue Growth -0.6% Start Profit Margin 2.3% End Profit Margin 6.6% Earnings Growth 11.7% Yearly Share Count 3.7% EPS Growth 8.7% Start P/E 19 End P/E 17 Share Price Growth 6.9% % Of Divs Collected 54% Start Payout % 60% End Payout % 67% Dividend Growth 10.1% Total Return 10.0% The above table demonstrates an interesting story. On the top line the company actually had lower revenues in 2014 as compared to 2005. Yet this alone did not prevent the company from generating solid returns. The quality of those sales improved dramatically, resulting in total earnings growth of nearly 12% per year. Ordinarily this number is boosted by a reduction in share count. In the case of utilities, the opposite usually occurs. CenterPoint Energy has been no exception: increasing its common shares outstanding from about 310 million in 2005 to almost 430 million last year. As such, the earnings-per-share growth trailed total company profitability – leading to almost 9% average annual increases. Investors were willing to pay a lower valuation at the end of the period, resulting in 6.9% yearly capital appreciation. Moreover, investors saw a 3% starting dividend yield grow by 10% annually, resulting in total returns of about 10% per annum. In other words, despite the lack of revenue growth and P/E compression, shareholders still would have enjoyed a solid return. This was a direct result of strong underlying earnings growth and a solid and increasing dividend payment. Moving forward, looking at the investment with a similar lens can be helpful. Since the end of 2014, both the share price and expected earnings have declined materially as a result of the broader energy environment. For this fiscal year the company has provided full-year earnings guidance of $1.00 to $1.10 per diluted share – well below the $1.40 earned last year. Still, the company has indicated that it expects to keep the dividend at its current rate, resulting in a 90%+ payout ratio for the time being (this simultaneously equates to 60% to 70% utility operations payout ratio). Moreover, CenterPoint has indicated that it expects to grow its dividend in-line with EPS growth (forecasted at 4% to 6% annually) through 2018. This isn’t speculation on my part or a collection of analyst’s estimates. Instead, its what the company is telling you to expect. Granted they could certainly turn out to be incorrect, but it should be somewhat reassuring given their greater stakes, more to lose, higher company knowledge, etc. Here’s what the next three years of dividend payments could look like with 5% annual growth: 2016 = $1.04 2017 = $1.09 2018 = $1.15 In total an investor might expect to collect $3.28 in aggregate dividend payments, or roughly 18% of the recent share price. Without any capital appreciation whatsoever, this would equate to 5.6% annualized returns. With a future earnings multiple of say 17, this would equate to a total yearly gain of about 8.9% over the three-year period. This is how I’d begin to think about an investment in CenterPoint Energy. You might perform a similar screen and come across the company. Yet this alone does not mean that it’s a worthwhile opportunity. Just because a company has an above average yield doesn’t mean that it’s a great investment. There are other factors at play. However, it does mean that the “investing bar” is relatively lower. A higher starting dividend yield, especially when coupled with reasonable growth, means that a good portion of your return will be generated via cash received. In this case you could see 5% or 6% annual returns without any capital appreciation. From there, if capital appreciation does come along, your investment returns start to approach the double digits. Finally, it’s important to be prudent in these assumptions as the slower growing nature of the business creates an out-sized emphasis on the valuation paid. You could see years of slow or moderate growth outweighed by compression in the earnings multiple. As such, a cautious approach is likely most sensible: expecting to receive a solid and above average dividend yield without the simultaneous anticipation of wide price swings to the upside.