Tag Archives: energy

NiSource – Red Flags All Around

Summary NiSource’s coal operations have gotten it in trouble before; it won’t be the last. Floundering gross margins have handicapped profitability. Net debt/EBITDA over 4x indicates significant leverage. Nearly $500M in annual interest expense. NiSource (NYSE: NI ) is a provider of natural gas and electricity to customers across seven states. The company touts its long-term return potential, citing strong local market growth, geographic diversity, and sizeable upgrade potential on its existing infrastructure, on which it would be entitled to a fair return on its investment. NiSource recently completed a spin-off of its Columbia Pipeline (NYSE: CPGX ) business, which means the new NiSource generates nearly 100% of its revenues from regulated utility operations. This fact, plus management’s guidance of 4-6% annual dividend growth from here on out, has drawn in income investors that have been searching for low-risk, stable income options in a highly volatile market. Is NiSource deserving of this praise, or are there potential bumps in the road for the company in the years ahead? Columbia Pipeline Spin-Off NiSource completed the spin-off of Columbia Pipeline Group in early July. Pitched to shareholders as unlocking value by separating two distinct businesses into independently run, pure-play public companies. Shareholders bought the idea hook, line, and sinker. Columbia Pipeline owns an extensive route of pipelines connecting the Northeast Marcellus/Utica shale plays to important local locations along with hundreds of billions of cubic feet of natural gas storage. Customers are primarily contracted, fee-based giants in the energy/utility business such as Exxon Mobil (NYSE: XOM ) and Dominion Resources (NYSE: D ). The prospect of management-guided 20%+ annual EBITDA growth on a seemingly ever expanding domestic energy market drew in investors chasing big capital gains and solid dividends. Unfortunately for shareholders of this new entity, the market has sold off highly leveraged midstream energy MLPs like Columbia Pipeline (along with peers like Kinder Morgan (NYSE: KMI )) on fears related to the sustainability and growth potential of American energy production. Smaller companies like Columbia Pipeline have been more adversely affected by the sell-off; shares are down 40% in a few short months compared to a flat performance from the S&P 500. This lesson in volatility has likely been a tough pill to swallow for dividend investors who have likely grown used to relatively mild movements in price. While I think midstream MLPs have been oversold and selling here would be a mistake, investors should likely consider paring down exposure to Columbia Pipeline as the share price recovers. Pro-Forma Operating Results Unfortunately for shareholders, NiSource has done a mediocre job regarding transparency of breaking out Columbia Pipeline’s contribution to NiSource’s earnings results on its presentations. This is necessary for investors to properly evaluate how the utility business has been performing over the past few years. After digging around in the SEC filings, I’ve broken out NiSource’s utility operations above given its pro-forma Columbia Pipeline filings given here . Total revenue has grown marvelously, but gross margins have contracted. NiSource has never been known for efficient operations and that trend has continued into recent years. This has always been a concern for investors. Another concern with the company is its electric operations, which generated approximately 30% of total utility revenues in 2014. The vast majority of available power generation (2,540MW of 3,281MW, or roughly 77% of power generation) is fired by coal. Energy mix has been unchanged for years, and given my pessimistic outlook on coal, my opinion here should be obvious. With such a high percentage of ageing coal power plants, it is likely only a matter of time before these plants reach the same fate as the company’s Dean Mitchell Generating Station, which was shut down in a settlement with the Obama Administration. This agreement also led to the company being forced into $600M in infrastructure upgrades on these old coal plants. The company had avoided provisions that required these upgrades for years. Even pro forma to exclude the buildup in the Columbian Pipeline infrastructure over the past few years, NiSource has been a serial burner of cash and a big issuer of debt – the combined company has issued billions in debt over the past few years to cover cash flow shortfalls. After the spin-off, NiSource is being left with a $5.5B long-term debt load. With EBITDA falling in the $1.3B range for 2015, net debt/EBITDA will be a hair over 4x. This is manageable for a utility, but investors should be cautious, especially given likely capital expenditure requirements for NiSource to maintain and update its prior-mentioned aging coal power plants. Conclusion Management here has the opportunity for a fresh start towards operating a functional utility. Improving gross margins, investing in its business smartly, and paying down its debt. Unfortunately, the company is more like a three-legged chair at the moment – the very foundation of the company is wobbly. Coal-fired generation puts a target on the company’s back. Nearly $500M in annual interest expense cuts operating profit off at the knees. With the company trading at nearly 18x 2016 earnings estimates, shares aren’t cheap compared to peers. Fair value is closer to 15x 2016 earnings of $1.03/share, or $15.45/share. In my opinion, investors would be wise to avoid NI’s shares currently.

Oil ETFs Head To Head: USO Vs. DBO

No doubt, oil has been the hottest and most volatile commodity so far this year. It is again showing large swings in its prices. This is especially true as oil broke its near-term trading range and regained momentum, indicating that the worst might be over for the commodity. Notably, WTI crude surged near $50 per barrel mark on Tuesday’s trading, while Brent jumped to more than $53 per barrel. However, the prices retreated over 1% in Wednesday’s trading session. With this, both WTI and Brent are up more than 6% since the start of October. Oil Rebound in the Cards? The latest boost came amid signs of dwindling supply, improving demand and an increased willingness by major oil producers to support the prolonged slump in the market. The weakness seen in the dollar, a declining rig count and better demand/supply balance added to the strength. In particular, U.S. production dropped by 120,000 barrels per day to a one-year low of 9 million barrels in September from the earlier month. The Energy Information Administration (EIA) expects a dramatic drop in U.S. production through the middle of next year, before the momentum is resumed in late 2016. Oil output is expected to decline from 9.25 million barrels per day (bpd) 2015 to 8.86 million bpd in 2016. On the other hand, the agency expects global oil demand for 2016 to increase at the fastest pace in six years, suggesting that oversupply is easing faster than expected. It also raised the Chinese demand outlook from 11.41 million bpd to 11.48 million bpd for the next year. However, the latest inventory storage report from the EIA showed that U.S. crude stockpiles rose 3.1 million barrels in the week (ending October 2), much higher than the market expectation of a 2.2 million barrel build. Total inventory was 461 million barrels, still near the highest level in at least 80 years. Despite the bearish inventory data, the oil price rally seems to have legs – it is likely to continue for the coming weeks as the oil market begins to tighten. Given the renewed optimism and improving demand/supply fundamentals, many oil ETFs and ETNs have seen smooth trading over the past week. While the ETNs are leading, investors should look at the ETF options, which are more liquid, transparent and tax-efficient. That being said, the two popular oil ETFs – the United States Oil ETF (NYSEARCA: USO ) and the PowerShares DB Oil ETF (NYSEARCA: DBO ) – that provide exposure to WTI oil gained more than 6% in the past five trading days. Though the duo might appear similar at a glance, there are a number of key differences between the two that are detailed below: USO This is the largest and most actively traded ETF in the oil space, with AUM of $2.6 billion and average daily volume of around 24.9 million shares. The fund provides investors with exposure to front-month oil futures contract traded on the NYMEX. The expense ratio came in at 0.45%. As traders need to roll from one futures contract to another in order to avoid delivery, the fund is susceptible to roll yield. Notably, roll yield is positive when the futures market is in backwardation and negative when the futures market is in contango. Basically, if the price of the near-month contract is higher than the next-month futures contract, this is backwardation, and the opposite holds true for contango. DBO Unlike USO, this ETF follows the DBIQ Optimum Yield Crude Oil Index Excess Return plus the interest income from the fund’s holdings of primarily US Treasury securities. The Index employs the rules-based approach when rolling from one futures contract to another, in order to minimize the effect of contango. Instead of automatically rolling into the near-month oil futures contract, the benchmark selects the futures contract with a delivery month within the next 13 months, when the best possible “implied roll yield” is generated. As a result, DBO potentially maximizes the roll benefits in backwardated markets and minimizes the losses from rolling in contangoed markets (see: all the energy ETFs here ). The fund has amassed nearly $508 million in its asset base, while it charges 78 bps in annual fees. It trades in a good volume of 367,000 shares a day, on average. In Conclusion While DBO has better roll strategies with higher potential returns, it lagged USO in terms of investor preference. First, DBO charges a 33 bps higher initial fee. Second, it has some hidden costs in the form of bid/ask spread, as the ETF trades in lower volume than USO. Further, the construction of the ETF is a bit complex and requires the systematic study of many futures contracts. Original Post

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.